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First off apologies to those Italian car aficionados that may have gotten offended by the title.

I have nothing against the Fabbrica Italiana Automobili Torino that has had the FIAT moniker since 1899.

No, my ire is directed to the relatively new upstart that goes by the same FIAT name and is the current monetary system utilized worldwide by essentially every country.

The day the financial world changed for the worse.

August 15, 1971 should go down as a day of financial infamy.

It is only fitting that it was Nixon, the president whose parting words were “I am not a crook,” who was the one who ushered in the new monetary policies that essentially gave governments carte blanche to manipulate the value of the dollar.

It was on this day that Nixon took the United States off the gold standard and essentially forced FIAT down our throats.

Gold standard versus FIAT.

You might be thinking to yourself, “What’s the big deal Xrayvsn?!?!!   Money is money!   As long as I get paid in dollars I couldn’t care less if it is backed by gold or if it is under the FIAT system.”

It is true that there is very little difference in the appearance of the dollars you are given under either system, but the implications from the change are far more insidious and go well beyond how a bill looks.

One of the great advantages that the gold standard had for individuals was the security that it was backed by something tangible, namely the vast stores of gold that the US government had.

The universal appeal of gold.

Gold has always been cherished, dating back to ancient civilization where craftsmen would create ornate jewelry out of gold several millennia ago.

Gold has thus always been coveted, with many lives lost in trying to procure it.

Despite the long history of gold spanning millennia, its use as a means of currency is relatively new, only dating back to 550 B.C.

Gold was a convenient way to store value due to its density and was light years in improvement to older methods of exchanging value.

Eventually even gold became an inconvenient way of transferring wealth for goods and services.

The birth of the gold standard occurred in 1861 (officially legalized in 1900 by the Gold Standard Act).

This marked the point in time when paper currency became a proxy for gold and ushered in a new era of money that touted convenience while still maintaining financial security as it was backed by physical gold.

Other countries quickly followed suit as it was easier to participate in global trade with paper currency backed by physical gold.

The tie between US paper currency and gold was so strong that the Treasury Department’s Bureau of Engraving and Printing (BEP) formalized it by actually printing “Gold Certificate” on the various denominations which, until 1933, could actually be redeemed for physical gold.

The beginning of the gold/paper currency disconnect.

In 1934 the Gold Reserve Act was passed that severed the direct relationship between paper currency and gold bullion.

Not only were individuals unable to redeem their gold certificates for gold, it actually made holding on to these certificates illegal.

So what was the inciting factor for this drastic act?

Americans were were still reeling from the 1929 market crash and in the midst of The Great Depression.

Desperate to jump start the economy, President Roosevelt had his hands bound by the Gold Standard Act which had fixed the value of gold to $20.67/troy oz.

The best way to jump start the economy was to devalue the dollar, which is precisely what Roosevelt did after the Gold Reserve Act, increasing the value of gold to $35/troy oz.

Essentially more dollars could be printed without needing an equivalent increase in gold reserves.

The Gross National Product increased an average of 8% over the first 4 years after the Gold Reserve Act was implemented.

Severing the last thread between Gold and Paper Currency.

The monetary system in place prior to FIAT was the Bretton Woods system that essentially made the US dollar the world currency and backed by physical US gold.

As mentioned earlier, Nixon gave the deathblow to the Gold Standard by economic policies collectively referred to as the Nixon Shock in 1971.

Like the great depression, another crisis in the preceding years necessitated this move by the standing president.

The United States was entrenched in the Vietnam war.

Because of concerns foreign governments had of the United States during the Vietnam war, there was a “run on the bank” on an international scale, with many of these nations starting to redeem their US dollars for physical gold.

The conversion from the gold standard to FIAT based monetary policy was only supposed to be a temporary measure in order to halt the exodus of gold outside of its borders during this trying time.

The financial implications of FIAT.

No longer was the dollar backed by something tangible such as gold.

Now the value of the dollar was backed by “the full faith and credit of the government.”

What does that exactly mean?

It means every dollar you own has its value tied to the reputation of the government.

You are essentially trusting the government will do things to preserve the value of your hard-earned dollar.

Problems With FIAT.

Conflict of interest.

Say you were borrowing money from an acquaintance.

Would you rather pay them back with money that is worth less, the same, or more than the day you borrowed it?

I don’t know about you, but I would love to borrow money and pay the same amount back with less valuable dollars.

The US debt is absolutely staggering and increasing by the second as this US Debt Clock clearly demonstrates.

So what is a government like ours to do?

Well, courtesy of this “temporary” change to FIAT that has now lasted almost 50 years, you can just print more money.

No longer bound by having to back up circulating notes with actual gold, you have literally been handed the keys to the printing press.

There is really nothing at risk except your reputation, you know the same reputation that is the entire foundation for the value of the dollar you are now printing carte blanche.

Continually printing more and more money and putting it into circulation without having anything tangible to back it up creates the insidious enemy that all consumers, most notably fixed-income retirees, face, namely inflation.

FIAT and Inflation.

Unless the “faith and credit” of the government markedly rises (who judges this by the way?) and is deemed more valuable, every extra dollar printed and in circulation makes each member of the collective worth less.

This is unlike a stock split where, although each share is less valuable, the overall amount of wealth is preserved by the individual due to a corresponding increase in number of shares held.

In a FIAT system, you are still holding to the same number of dollar bills you started out with, but now they are just less valuable and your wealth is reduced.

Monetary policy by the feds is therefore a careful balancing act between trying to keep its constituents/lenders happy and trying to pay off its debt as cheaply as possible.

Tilt too much on the side of the latter and you run into problems such as hyperinflation, which the citizens of Venezuela have acutely felt the repercussions of as their government went on a printing spree.

How bad did a Venezuelan citizen have it because of a FIAT system unchecked?

In one year, from 2018 to 2019, the inflation rate was estimated at 10 Million percent.

That was no typo.  The inflation measured in the MILLIONS for a single year!.

At its peak in 2018, Venezuelan goods cost 65.37 thousand times more than the year before.

The money was essentially not worth the paper it was printed on.

So should FIAT stand for Financial Independence Also Threatened?

I don’t care how FAT FIRE you think you are, if goods cost 65 thousand times more than you anticipated, you are going to run out of money in a hurry.

There is no safe withdrawal rate (SWR) in that situation.

Surely our government won’t let that happen, right?

I am sure Venezuelans thought the same thing too.

We are living in unprecedented times and who knows what the future holds.

I am particularly curious about what the long-term effects of the CARES act will have on our economy.

Pumping 5 trillion dollars of money that is not tied to productivity back into the economy certainly will devalue the dollar and therefore likely lead to even higher inflation.

And we all know the erosive powers of inflation.

It reduces your purchasing power as the prices of consumer goods skyrocket.

It is the savers of this world that will feel the brunt of this scenario as they are receiving money worth less than the value that was set aside originally.

There will be some people that may benefit in a hyperinflation scenario such as those who locked in long term low fixed rate loans prior to hyperinflation rate increases.

These individuals will be paying back debt with money vastly discounted in value compared to the original dollars received.

Is there a way to protect ourselves from this doomsday FIAT scenario?

I see a few potential safe havens that may be able to counter the hyperinflation FIAT risk.

• Tangible income producing assets.
  • Stocks.
    • The increase in share prices and dividends should mirror trends in inflation and likely make it a wash.
    • Side note: Bonds would not do so well in a hyperinflation scenario as rising interest rates would make current bond positions less valuable.
  • Real Estate.
    • Like stocks, rental income can be expected to increase in order to match inflation.
    • Landlords will have the capability to raise rents similar in magnitude to that of other consumption items.
• Precious Metals.
  • Because precious metals, most notably gold, have a theoretical finite amount, they are considered great hedges against inflation.
  • Gold prices increase as the dollar declines because it takes more dollars per ounce to buy it.
  • Increases in mining expenses from inflation also factor into the higher price of gold.
• Treasuries/TIPS.
  • US Treasury Inflation Protected Securities (TIPS) automatically adjust returns to the investor to keep up with inflation, giving that investor a real return.
• Decentralized Cryptocurrency.
  • Bitcoin is the most famous example.
  • Bitcoin is quite polarizing amongst investors because, currently, it is more of a speculative play that causes mainstream investors to shy away from it.
  • There are a lot traits of Bitcoin that have merit, however, and make it quite appealing for me.
    • Finite amount of Bitcoin.
      • Unlike FIAT systems, where there is theoretically an infinite amount of currency that could be in circulation, Bitcoin’s creator, Satoshi Nakamoto, set the limit of Bitcoins at 21 million.
      • The same principles behind precious metals as an inflation hedge would apply to Bitcoin due to this finite construct.
    • Controlled release of Bitcoin into the digital world.
      • Bitcoins are digitally mined and the amount of bitcoins rewarded to miners performing these complex computations decreases with time, called the Bitcoin Halvening.
      • This is analogous to gold mining in that as resources get used up you have to work harder and incur more costs to find the remaining stores.
      • This creates scarcity which should then propel its value higher.
  • This is definitely the riskiest option of the bunch as not only is it quite volatile, but its longevity is uncertain.
    • Governments could decide to make Bitcoin illegal and force consumers to only use approved forms of currency.
    • Explosion in the different types cryptocurrencies creates competition and it is hard to predict which one, if any, will be truly adopted long term.
    • As mentioned above, investing in cryptocurrencies in its infancy makes it truly speculative.
      • The amount invested should only be something you are comfortable with completely losing.  (For me I think the upper limit would be 3% of your total net worth).

 

 

Note:

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-Xrayvsn