In 2000 gold stood at just below $300, and when the euro arrived it stood at just over €250. Confidence was nearly absolute in the U.S. dollar at the time and the currency the world’s energy was priced in. The euro was about to be launched to replace currencies like the Deutschemark, the French Franc and the rest of Europe’s currencies. Today and eleven years later, gold is standing six times higher than the level at the turn of the century, despite all attempts to keep it contained. Why?

History of Money

Since the dawn of man people have needed money with which to exchange goods. Then it extended naturally to saving money for the day when times were difficult –times like winter and old age when no money was coming in. Money had to reflect a value that would hold until the day when there was a need to use savings. It therefore had to be sought after through the generations and not just at one particular point in time.

Because of man’s inherent greed and distrust, the item that represented money had to be something desired throughout the ages. Before the motor car, oil had little value except to give light at night. Precious metals and their rarity served the purpose of money far better. By using gold and silver, one did not have to trust man nor put faith in his IOU’s, which may or may not have value at the time it was necessary to change them back into money. With the fleeting nature of man, his businesses, his governments and even the changing wealth and power of his countries, there was little of permanent value that could last throughout the ages that could compete on so wide a global scale as precious metals. Gold is recognized in even the farthest foreign reaches of the world. Look back and count the number of governments there have been in history and count the times gold and silver represented money.

As man moved into the industrial ages the value of precious metal globally allowed the growth of the British Empire an empire on which the sun never set. As the power crossed the channel somewhere in the 20th century gold still held rein in the entire world as money alongside silver (to a less significant extent). The principle that reinforced the enduring nature of money was that precious metals lay beyond the control of governments. But it did stifle the growth of the banking system. It highlighted any expansion of the money system and it highlighted the abuse of the ‘money printing presses’ because it was a ‘value reference’ for such money. It acted as a judge and control over national money.

Abandonment of Money Backing

After the Second World War the power of the U.S., globally, had replaced that of Britain, which steadily shrank for the next 40 years. When it became clear that the dollar should be devalued, to reflect its declining value, the embarrassment that that would cause against the price of gold, was too much for global money systems see happen. So in 1971, when the link between the dollar and gold was cut there began a series of stated and unstated devaluations of the dollar against gold. To eliminate the embarrassment and loss of value together with the benefits of being the world’s sole reserve currency, trust in gold was attacked. This attack lasted for the next forty years and saw the value of gold against currencies pulled back from $850 at its peak to $275 at its low. How could one then trust such a barbarous relic?

In those forty years the dollar ruled supreme, just as the power and influence of the U.S. did. The path blazed by the U.S. in removing the backing of gold from their money systems showed the way for all the world’s governments. More than that, the breaking of the link to gold allowed the entire world to do the same and issue money against nothing at all, just a vague notion that somehow governments would honor all their obligations if a crisis occurred. Where one did see this trust broken and confidence in currencies disappear, the isolated and distant nature of the countries involved allowed the major nations to continue with the unbacked money experiment. It was only until 2007 that serious flaws in these experiments became apparent.

An integral part of the system based on unbacked money was the rise of a global banking system. This gave scope and depth to the economic growth that a world under the dollar could enjoy. The control and power that the U.S. could enjoy through USD dominance was greater than any empire before it could impose through military dominance alone. Better than that, the trade deficits they had seen undermine the dollar before that were now turned into a constant ‘tribute’ on the rest of the world by printing money instead of earning it.

Government’s Capacity to Control Money

And here we are in 2011, looking at the second most important currency in this unbacked money system losing its name by the day. While governments will attempt to limit the collateral damage a default of Greece (and who else?) the contagion effect of the loss of confidence will run like an epidemic. In the end the very structure of the money systems will be questioned. As government management of their debt and other finances are seen to be lacking, as well as out of their control, confidence in the very system is in decay.

Whether unintended or intentional the three roles of money as seen by governments today conflict with each other and undermine their international value. These roles are…

1. To encourage growth – Quantitative easing is designed to stem the effects of deflation and to allow a damaged banking system to continue to lend to the economy in the hope that business will expand because of the ease of plentiful liquidity. (Is that happening?) The use of the supply of money to either expand or contract the economy undermines its ability to be a measure of value of business, assets or an economy.

2. Dollar hegemony is designed to permit the expansion of the global economy with the U.S. as its hub. This it does irrespective of the state of the U.S. economy. Unfortunately, the state of the U.S. economy continues to dominate the value of the dollar, which conflicts with its role in the global economy. The fact that like the trunk of a tree, how all other unbacked currencies react to the state of the dollar, affects the competitiveness of those (subsidiary?) currencies in the global economy. As we have seen with the Swiss Franc, its value will be undermined if the U.S. and its dollar underperform other economies and currencies. Right now the Swiss National Bank is weakening the Swiss Franc.

3. Price stability. Investors must ask themselves, when a currency must maintain price stability through its management by its central bank, does this mean that the overall asset values must be kept stable, or must the currency itself be kept stable so that it accurately reflects any changing value of assets? This answer to this question depends on the will of either government or central banks not on any reliable inherent value the currency may have.

It is impossible for these three functions of money to act in harmony with each other. Even worse the very nature of government, power and control, dictates that money act as the tool of government and its country, before it can act as a measure of value and secondly as a means of exchange.

We are now moving to a point where there is a fundamental separation of money’s role as a means of exchange and a measure of value. The cost in terms of economic functioning, let alone well being, will be huge. In the past such turmoil has led to social unrest at the very least and the toppling of governments and occasionally civil war or economic catastrophe at the worst. The difference, this time, is that it is not simply a single country that will suffer but in this global world, whole economic zones will be badly affected. It is even possible that the entire global economy will be badly affected.

The commercial banking system has acted as the veins and arteries of the global economy. Sad to say their perception of their role has been to make more and more profit. This has conflicted with government objectives frequently, as it does today. That profit motive has been the equivalent of a hardening of the arteries. The decline of the world’s leading bank shares worldwide this last week, gives us an indication that the process of financial breakdown may have started already.