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I didn't come up with the phrase "when money dies," however I think it is a very appropriate phrase to use and understand as part of today’s (circa January 2011) economic conditions. The phrase captures an important idea that paper money issued by governments has a finite life; at some point, it becomes worthless, or dies. Paper money is called a fiat currency when it is not linked to something that is a store of value like gold or silver. Throughout all of history, fiat currencies have had a 100% failure rate. The death of a currency is often a protracted affair. It takes years and when it unfolds, the people who experience it, hardly believe it. This is the tale told by Adam Fergusson in his book When Money Dies. First published in 1975, the book has been out-of-print for years however the demand for the book remained high. A used copy on Amazon recently cost $800 however Public Affairs reissued it in October of last year (2010). The book is a history of the death of the German mark in the 1920s. It is also a scary reminder of the devastating effects of inflation and a cautionary tale for U.S. central bankers and politicians who play so fast and loose with the U.S. Dollar which became a true fiat currency in 1971. At that time, President Nixon removed the link between the US Dollar and gold (which had a value of $35 an ounce); and all of the gold owned by the US is stored at Fort Knox in Kentucky. If you don't know what happened to the German mark, here's what you need to know from the book When Money Dies. In 1913, the German mark, the British shilling, the French franc and the Italian lira were all worth about the same; four or five of any of these would buy you a U.S. Dollar. By 1923, a decade later, you could exchange one shilling, franc or lira for up to 1 trillion marks. "Although," Fergusson writes, "in practice, by then, no one was willing to take marks in return for anything. The mark was dead, one million-millionth of its former self. It had taken 10 years to die." How did that happen? The short answer is that post-Imperial Germany found itself with a crushing load of debt. Raising taxes or cutting spending is politically difficult in any age. And so it was in Germany. To deal with these debts, Germany chose the path of least resistance; it printed lots and lots of money. Sounds like the fiscal position the U.S. government finds itself in today; bleeding deficits with no end in sight. And then we add to these deficits, more debt and entitlements with no end in sight. The solution so far is "quantitative easing" which is more money printing. In a new introduction, Fergusson writes: "Money may no longer be physically printed and distributed in the voluminous quantities of 1923. However, ‘quantitative easing,' that modern euphemism for surreptitious deficit financing in an electronic era, can no less become an assault on monetary discipline." Now let’s go back to understand the situation in early 20th century Germany. Eventually, prices started to rise as the mark lost purchasing power. One of the great strengths of the book is the on-the-ground view you get from the people who lived through it. It gives you an unsettling look at German society as it starts to dissolve and as inflation starts to wreak havoc. It started slowly, with commodity prices starting to rise everywhere. But as the years wore on, prices kept going up in big steps; soon the damage was remarkable. In just eight years since 1913, the price of rye bread rose 13-fold. Beef rose 17-fold. Sugar, milk, pork and potatoes went up 23-28-fold. Butter went up 33-fold! And these were official prices. As a practical matter, real prices were often a third higher. It is hard to fathom. All this brought out the worst in people. Germany became an ugly society, looking for blame. As Fergusson writes: "They picked upon other classes, other races, other political parties, other nations." There was a long list of villains: "the greed of tourists, or the peasants, or the wage demands of labor, or the selfishness of industrialists and profiteers, or the sharpness of Jews or the speculators making fortunes in the money markets." Erna von Pustau, who lived through it, described what it was like. She said "My allowance and all the money I earned were not worth one cup of coffee. You could go to the baker in the morning and buy two rolls for 20 marks; but go there in the afternoon and the same two rolls were 25 marks. The baker didn't know how it happened. His customers didn't know how it happened. It had somehow to do with the US Dollar, somehow to do with the stock exchange, and somehow, maybe, it had to do with the Jews." As we know what would happen later in Germany, her comments are particularly chilling. Each year, people thought it could not get worse. "And yet things always did get worse; it went from bad to worse," Fergusson writes. "It was unimaginable in 1921 that 1922 could hold any more terrors. They came, sure enough, and were in due course more than eclipsed, with the turn of the following year." Germany plunged into hyperinflation. The price changes get ridiculous to talk about, the numbers so large that they are practically meaningless. Who can imagine paying 500 billion marks for a dozen eggs? It's also interesting to see how society dealt with this breakdown in the currency. The idea of real wealth became very important. Not the kind of wealth denominated in abstract printed marks but real wealth that one could use. People bought things. Hugo Stinnes, an industrialist, bought factories, mines, newspapers. The man on the street bought what he could trade. Fergusson ends with a powerful observation: "In war, boots; in flight, a seat on a boat or train may be the most vital thing in the world; more desirable than untold millions of worthless paper currency. In hyperinflation, a kilo of potatoes was worth, to some, more than the family silver; a side of pork more than the grand piano." Despite the awful experience of the 1920s, Germany would repeat its errors again and again. In the 1930s, Hitler would crank up the presses to print more money. By 1948, the reichsmark (which replaced the old mark) died. So Germany created the deutsche mark. Yet it wasn't much better. It lost two-thirds of its purchasing power by 1975. Such is the fate of all paper money and fiat currencies. Repeating a fact from earlier in this blog post, throughout all of history, fiat currencies have had a 100% failure rate. I will leave it to you to decide how much relevance Germany's experience has to the U.S. today. I find many alarming parallels. I would point out, too, that the U.S. Dollar has lost 98% of its purchasing power since 1913. And the U.S. Dollar is among the best currencies of the last hundred years. That says something about paper currencies, doesn't it? It's also why staying ahead of inflation is one of the chief tasks of investing. In a previous (circa Dec 2010) blog post, it was highlighted that a recent Wall Street Journal article points out “Corn is up 44%, milk is up 6.5%, hot rolled coil steel is up 4%, copper is up 29% and oil is up 14% from a year ago.” Across Corporate America, more companies are wrestling with when and how much to raise prices as raw materials costs climb. Also, the prices of gold and silver are up too. All of these things point to the obvious: The US Dollar is buying less. We are seeing today the beginnings of real inflation. It can and will get much worse. As a way to justify Quantitative Easing, which is more money printing by the Federal Reserve Bank, the Fed tells us inflation is under control. In fact, it is complaining that the inflation rate may be too low. This is like the New York Police Department complaining about the lack of crimes. Ben Bernanke, the current chairman of the Federal Reserve Bank, would have us believe the Fed can calibrate inflation within tolerances of 100 basis points. But it way overestimates its powers. Once the inflation train gets going, it will be very hard to slow down (remember former Fed Chairman Paul Volcker chose to raise interest rates to 22% in the early 1980s to whip inflation). One day, the Fed will wish inflation were only 2%. In the meantime, what to do? Obtain more financial education and learn how to protect yourself during these trying times. I favor a quote from Steve Forbes … Forbes says that pursuing additional financial education and the resulting increase in our financial literacy will open our eyes to being savvy with our money and using alternative wealth creating strategies; this will be they key to resolving our financial crisis. To gain the necessary financial education, it is best to pursue association with, access to, and membership in, a wealth creation community. As a result, you will learn about alternative wealth creating strategies and consider investments in non-dollar denominated assets … perhaps emerging markets … perhaps energy assets that are inherently useful like oil rigs, hydropower, or methanol plants … perhaps precious metals, rare earths, water rights, oil, natural gas, potash mines, or gold mines … things hard to build, difficult to replace, and costly to substitute … definitely not financial stocks, definitely not retail stocks, definitely not commercial property. For those wanting protection of their purchasing power in gold, there are several ways that may be appropriate to obtain this protection. These include direct ownership in minted coins, use of gold exchange traded funds, gold mutual funds, and junior gold stocks. Many are investigating having part of their IRAs in gold, silver, precious metals, and non-dollar denominated currencies. In addition, for those that truly believe sovereign risk is the greatest risk we all face, it is wise to learn how to implement a multiple flag strategy to diversify this risk or provide protection against higher taxes, capital controls, hyperinflation, civil unrest, erosion of personal liberty, and the rise of a police state. With a multiple flag system, you consider taking preparations like, but not limited to, establishing a foreign bank account, purchasing some real estate overseas, seeking alternate sources of income, dual citizenship, and carrying multiple passports. I will continue to provide examples of things we need to learn, the secrets of the insiders, as part of being savvy with our money, and introduce alternative wealth creating strategies, in future articles and updates at my blog over the next few weeks. In addition, a good book to read would be “When Money Dies” by Adam Fergusson; it describes the nightmare of deficit spending, devaluation, and hyperinflation in Weimar Germany. Also, I want to thank Chris Mayer at Agora Financial as he was the source of some of the ideas and material about Capital & Crisis investing mentioned in this post. Finally, I would like to provide Best Wishes for a Prosperous New Year!
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