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Monday, Dec. 22, 2014

Not Worth A Continental

Posted Friday, June 3, 2011, at 8:24 AM

 

 

That's the punch line to a 200-year-old joke. The joke was that the item being discussed was not worth a continental.

What is a continental?

Before our current United States Constitution, our fledgling nation was under a constitution organizing it as a confederacy. The first national currency was the continental. The United States issued continentals to pay for Revolutionary War material and also to pay the various financial obligations of the government. Have you noticed that we don't use continentals any more?

Our present constitution says a few things about our currency. Among other items, it refers to dollars as the standard unit of account. Dollars were Spanish silver coins weighing one ounce; also known as pieces of eight as one dollar equaled eight Spanish reales.

Article I, Section 8 of the U.S. Constitution grants, among others, the following powers to congress: "The Congress shall have Power To . . . borrow money on the credit of the United States . . . To coin Money, regulate the Value thereof, and of foreign Coin, and . . . To provide for the Punishment of counterfeiting the Securities and current Coin of the United States . . ."

Article I, Section 10 of the U.S. Constitution prohibits the several states from doing several things, including: "No State shall . . . make any Thing but gold and silver Coin a Tender in Payment of Debts . . ."

Why is this in the constitution? Notice it says "coin" money, not print money. This is because of the experience with the continental.

Continentals were a "fiat" currency, meaning that they were not backed by gold or silver. Since the nation was run by politicians, and politicians do things for political gain rather than because it is the right thing to do, they continued to print continentals diluting their value. By 1780 (only 4 years after the Declaration of Independence) continentals traded at 1/40th their face value against silver and gold coin. By 1781, continentals had become so worthless, they ceased to be accepted as money. Even Adam Smith criticized the continental calling them a "violent injustice" and "a scheme of fraudulent debtors to cheat their creditors."

From 1792 until 1933 gold and silver coin, issued by the U.S. Mint, circulated with paper notes, issued by private banks, which were convertible to one ounce of silver per dollar note or one ounce of gold per twenty dollars in notes. In 1933, gold coin was withdrawn from circulation and dollars were exchanged thirty five to one ounce of gold. By 1964 silver was withdrawn from circulation and dollars could be exchanged forty five to one ounce of gold. In 1971, U.S. Government declared it would no longer exchange dollars for gold or silver and dollars became a fiat currency.

From 1971 until 1991, the value of the dollar dropped from forty five to an ounce of gold to four hundred for an ounce of gold. From 1991 until 2011, the value of the dollar dropped from four hundred to an ounce of gold to one thousand five hundred for an ounce of gold. These changes generally correspond to the increasing numbers of dollars being printed.

One of the most successful investors of all time, Warren Buffet, insists that gold is a waste of money. He would rather have productive farmland or a profitable business.

Why should a dollar be backed with more than the full faith and credit of the United States?

Today, the United States Federal Reserve has $52.5 billion of capital backing a $2.7 trillion balance sheet. Less than 2 percent of all federal obligations are backed by any real collateral. In 2008 when the major banks failed, it was discovered that our biggest investment banks were leveraged 30-to-1. When asset values fell, those banks were quickly wiped out. Now the Federal Reserve (which bought those toxic assetts) is leveraged 51-to-1! If the value of the Fed's portfolio were to fall by just 2 percent, the Fed itself would be wiped out."

Why has gold been considered money for more than 5,000 years?

Value is based on sacristy. The more common, the less valuable. The more scarce, the more value. Gold is geologically rare. The world supply of gold increases at approximately 1 percent per year with a total of 166,000 tons of gold presently in existence above ground. Gold is elemental. It cannot be manufactured and the supply cannot be artificially expanded. Moreover, it is a "noble" element, which means that all of the "slots" for electrons in its atoms are full which makes it virtually indestructible. Gold is also virtually useless in industry. Therefore, very little is consumed in industrial processes and it's value is not driven by industrial cycles.

While the number of dollars in existence has doubled in the past year, the amount of gold in existence has remained remarkably stable compared to the global population since the days of Rome.

As the Fed's second round of Quantitative Easing (printing money) is coming to its planned end this month, the financial pundits are announcing that a double dip recession is virtually inevitable. The experts are already stating that there will have to be a third round of Q.E. money printing.

What is the future of the United States dollar? It might not be worth a continental.



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