Real money, such as gold and silver, is adopted by the market and traded for goods and services voluntarily. The government's fiat currency is something different. Most people forget we have legal tender laws forcing us to use the scrip that the Federal Reserve and Treasury create from thin air.
The business of creating bills for pennies and trading them for, in some cases, a hundred dollars is a good one. Creating electronic journal entries costs even less. Governments won't let go of this business without a fight.
Ultimately, the government will drive the value of its paper to the value of, well, the paper. At its essence, the printing of money is a silent and devious way to tax the public. Eventually the public catches on. Charles Mackay wrote in his classic book Extraordinary Popular Delusions and the Madness of Crowds, “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”
We are in the one-by-one process and the government knows it. The first signs of capital controls have surfaced. Toting $10,000 worth of financial instruments out of the country is verboten. The US government has signed agreements with countries and banks around the world to keep money inside the US.
But what happens when the citizenry want to leave the government's currency? If history is any indication, the government will get mean.
John Law: The World's First Keynesian
France went broke continuously fighting wars from 1689 to 1713 under the reign of Louis XIV. If that wasn't punishment enough for the French people, they suffered famines in 1693 and 1694, and one extraordinarily cold winter of 1708-1709. Currency devaluations became the norm, and the French people developed a distrust of paper money.
Philippe II, duc d'Orléans, ascended to regent with the death of Louis XIV, as Louis XV was still a minor. The French economy was in a shambles. Philippe allowed his Scottish friend John Law to implement a new monetary system to help the ailing economy. The Scotsman's idea, revolutionary at the time, was that a stalled economy required more money and lower interest rates to rebound.
What came to be known as Law's Mississippi system was the first attempt at Keynesian economics, nearly 200 years before Keynes was even born. Law refinanced government debt with Mississippi Company shares supported by an influx of banknotes of the bank he controlled, General Bank.
French people speculated in Mississippi Company shares, pushing its price up manyfold. Meanwhile, Law's bank, now known as Royal Bank and part of the government, printed hundreds of millions of new banknotes.
Law Gives Investors a Choice—Bad Paper or Worse Paper
With Mississippi shares trading at 10,000 livres, many investors wanted to sell their shares and put their money in silver or gold. The regent stepped in with a flurry of decrees to stop the sales.
He gave Law's company a monopoly for the refining and separation of precious metals. A couple weeks later, the duc d'Orléans fixed banknotes at a five percent premium to silver coin, and ruled that silver could only be used for payments under 10 livres and gold only for payments less than 300 livres.
In addition, all foreign letters of exchange could be paid only in notes. Andrew McFarland Davis wrote in the Quarterly Journal of Economics, “Law foresaw that, unless he could prevent the circulation of coins, it would all be quietly remitted across the border.”
When Mississippi Company share prices began to fall, the regent stepped up his use of force. He confiscated old gold and silver coins in late 1719. A month later, a decree was passed authorizing the search of all homes for concealed coins. A week after that, banknotes were decreed the official currency throughout the kingdom.
Those who informed on their neighbors were rewarded. “They excited, encouraged, paid informers,” writes Davis. “Valets betrayed their masters. Citizen spied upon citizen.”
It wasn't just coin holders who lived in fear. In February 1720, the restrictions began to accelerate. Philippe made the wearing of precious stones punishable by confiscation and a huge 10,000-livre fine. Futures transactions were banned. Goldsmiths were forbidden from manufacturing vessels of gold and silver. No person was allowed to have more than 500 livres worth of coin in his or her possession. Only goldsmiths and jewelers were allowed to have articles of gold and silver. All payments of 100 livres and greater were to be made in banknotes.
Law and Philippe went as far as to fix the price of the Mississippi shares. Precious metals were demonetized. Their intent was to have only two circulating mediums in France, banknotes and Mississippi Company shares. Both were under their control.
Mississippi Bubble expert professor Antoin Murphy explains why the shares of Mississippi Company did not collapse. “Most wealth holders in France faced the classic Keynesian two-asset choice, that is money (banknotes) or bonds (shares of the Mississippi Company). The price of the shares did not collapse because French investors were locked in to holding either shares or banknotes.”
The true measure of the crash can be seen when you convert Mississippi Company shares from livres to British sterling. In sterling terms, Mississippi shares fell 84% in nine months. The exchange rate for livres/sterling fell two-thirds in that same period.
Gono the Hyperinflator
As modern hyperinflations go, the Zimbabwe version engineered by central banker Gideon Gono was the most destructive. Zimbabwe went from “Africa's breadbasket” to economic basket case, ultimately destroying its currency. When all was said and done, $100 trillion Bank of Zimbabwe notes were worth more as eBay curiosities than they were in commerce.
Before the Zimbabwe dollar went kaput, the government imposed an exchange control system to manage money movements at all levels, even before Robert Mugabe took over in 1980. Once the committed Marxist took office, anyone with money did whatever they could to get it out of the country.
Mugabe confiscated all foreign shares held in nominee name and ordered them sold to the government, paying for the shares with government bonds. He confiscated farms owned by whites and attempted to take over white-owned businesses.
Zimbabwe's commercial sector collapsed. Eventually capital was limited to travel allowances for holiday and business. The Reserve Bank of Zimbabwe approved all other payments.
Foreign exchange rates set by the government were a fraction of the black market rate. The supply of foreign exchange was severely restricted and heavily regulated. For instance, section (ii) of “16.3.6 Supply of Foreign Exchange to the Currency Exchange” stated, “Receipts from tourists, sales by NGOs, Embassies, and individuals are to be immediately forwarded to the Reserve Bank at the ruling auction rate.”
Things weren't exactly great in Zimbabwe when Gideon Gono took office in 2003. At the time, the annual inflation rate was 619%. However, the delusionary central banker made things even worse. Four years after taking the job, Gono blamed his country's inflation rate of 4,500% on “the differences that Zimbabwe has had with its former colonial master, the UK,” and added, “we are busy laying the foundations for a serious deceleration programme.”
Gono's deceleration program wasn't all that serious: By the end of 2008, the inflation rate exceeded 231,000,000%. Zimbabwean police inspectors' Christmas bonuses that year were the equivalent of one American cent.
God Was on Gono's Side
“To ensure that my people survive, I had to print money,” Gono told Newsweek. “I found myself doing extraordinary things that aren't in the textbooks. Then the IMF asked the US to please print money. The whole world is now practicing what they have been saying I should not. I decided that God had been on my side and had come to vindicate me.”
Gono didn't think money printing had anything to do with inflation. He commissioned a study of the stock exchange, and, unsurprisingly, the study argued “that the Stock Market has been traditionally one of the drivers behind Zimbabwe's hyperinflation.”
Gono closed down his country's stock exchange in November of 2008, and said a couple months later “unless there is more discipline and honor, the exchange will stay closed. I can't be bothered. I don't know when it will open.” The stock market opened again in February of 2009, but trading was thin and conducted only in US dollars.
Zimbabwe abandoned its currency later in 2009 and the US dollar became legal tender. Capital controls remain in place with property sellers only able to keep the first $50,000 of the sales price. The Reserve Bank of Zimbabwe keeps the rest for a year, making sellers involuntary lenders to a bankrupt government.
Venezuela: Have Credit Card, Must Travel
Venezuela has had currency controls since 2003. The official Venezuelan exchange rate is 6.3 bolivars to the US dollar. However, government controls aimed at curbing inflation have made dollars worth up to 60 bolivars on the black market.
These controls have led not just to a scarcity of dollars but have made airline tickets very dear. All flights out of Caracas are sold out until September 2014. It makes perfect economic sense. If a Venezuelan can get out of the country and get a cash advance on their credit card, they can pocket the difference between the black market and official dollar exchange rates.
“You have an economy in Venezuela in which probably the most profitable activity involves arbitraging of dollars, or getting dollars at the official rate and then selling them at a higher rate in black market, as opposed to actually investing those dollars in productive activities,” said Erich Arispe, director of a sovereign debt group at Fitch Ratings in New York.
They call it “credit card scratching.” If a Venezuelan makes it to a neighboring country, he can withdraw $1,000 with a credit card at the official exchange rate of 6.3:1. Then he can go home to Venezuela and sell the dollars on the black market, where that $1,000 can fetch 60,000 bolivars. Not a bad return.
But even when the scheme is successful, what can Venezuelans buy with it? The country's official statistics define more than 21 percent of the supply of food and essential items as “scarce.”
South Africa: Enterprising Citizens vs. Capital Fascism
The capital controls put in place during apartheid in South Africa remain in place. A writer for BusinessDay in Johannesburg describes the exchange-control manual as “a document that would make Franz Kafka recoil in horror. The section governing the personal transactions of South Africans could only have been written by a schoolmarm with a fascist streak.”
For instance, the manual instructs South Africans that, “The amount of jewellery to be carried by travellers must be reasonable in relation to their financial means and standing.”
During the apartheid years, South Africans would have friends living out of the country open bank accounts for them. When the friend visited South Africa, trip expenses would be deposited in the South African's bank account out of the country in hard currency. Once in South Africa, the host would pay for everything in rands (R). This was a way to get money out of the country.
There's even a story about a wealthy businessman who was so desperate to get a large amount of money out of the country he put his money into constructing a yacht in Cape Town. Once it was finished, he sailed it to Britain and retrieved the cash by selling the boat.
At one time, South Africans would trade cash for travelers checks and krugerrands to send out of the country, but that became difficult. A friend tells me capital controls are much relaxed these days. Up to R4 million can be moved out the country for investment purposes. My friend brings all she can to America, and has gained nearly 20% over the past few years just by exchanging the rands for dollars. She points out that while the South African stock market has gone up in rand terms, it has gone nowhere in dollars.
Yes, It Can Happen Here
Don't think the US government is beyond using draconian measures to keep you from protecting yourself. From Franklin D. Roosevelt's Executive Order 6102—Requiring Gold Coin, Gold Bullion, and Gold Certificates to Be Delivered to the Government:
By virtue of the authority vested in me by Section 5(b) of the Act of October 6, 1917, as amended by Section 2 of the Act of March 9, 1933, entitled “An Act to provide relief in the existing national emergency in banking, and for other purposes,” in which amendatory Act Congress declared that a serious emergency exists, I, Franklin D. Roosevelt, President of the United States of America, do declare that said national emergency still continues to exist and pursuant to said section do hereby prohibit the hoarding of gold coin, gold bullion, and gold certificates within the continental United States by individuals, partnerships, associations, and corporations…
The great lady of liberty and Ayn Rand's economics tutor, Isabel Paterson, captured the chilling effect of FDR's despotism.
Never shall we forget the line of women we saw turning in their savings, under threat of ten years in jail and ten thousand dollars fine, while the multimillionaire Senator Couzens stood up bravely on the floor of the Senate and promised to “hunt them down” if they tried to hold out a few dollars.
The government's printing press as an instrument of theft requires force. You shouldn't expect Washington to stand by silently while you try to protect yourself by trading depreciating dollars for gold, stocks, foreign currency, or whatever else.
No government in history has had it this good. The US has financed more debt than the world has ever seen by way of central bank money creation, and still maintains the world's reserve currency. It's akin to an economic miracle: a 21st century digital alchemy. This magic is only possible because other governments are even worse currency debauchers.
Eventually the jig will be up, and many will be trampled in a rush to the exits. Some won't make it out. Be warned, be early, and move at least some liquid assets to friendlier climes.