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Saturday, March 26, 2011

What is a Dollar?

Gold-stater question of the day:

What is a dollar? Do you know? Take a minute and try to come up with a definition.

Ron Paul asked this question to Ben Bernanke. Bernanke answered with several long rambling Econo-speak paragraphs that mentioned a basket of goods and services, a basket of international currencies, stability, employment, the current banking crisis, regulation and oversight.

Used to be that a dollar was a note redeemable by a set amount of silver and gold. Period.

Thus it was a medium of exchange and a store of value: money.

Unfortunately even that direct convertibility led to a terrible inflation because the Fed issued 60 times as many convertible notes as there was gold in its vaults. In 1933, when the economy turned down a second time after a crisis of confidence, Roosevelt confiscated and outlawed bullion ownership, in order to prevent a redemption of those notes which would have resulted in a run on the Fed.

At that point a dollar was only a medium of exchange and no longer a store of value.

In 1980, when Alan Greenspan was asked what a dollar is, he replied that it is a promissory note, which though not tied to gold, should be administered as though it were tied to gold. (say what?)

You see, in his youth Greenspan wrote a treatise on the Necessity of Gold as a protection against Wealth Confiscation by the Government. Once he became Fed Chairman, he issued more paper notes tied to nothing than any human in the history of the world - until he was outdone by Ben Bernanke who continues to set records.

In accounting terms, any promissory note - like the dollar - is worth the Present Value of the Cash Flow of the Issuer. What does this mean? It means that whomever issues the note must be earning something after all costs and expenses are paid. If you take those earnings over time and divide them by the number of outstanding notes you should be able to come to some reasonable present value for the note.

If there are no earnings after expenses and obligations over time - you have a negative cash flow - like the United States of America - then the notes can only be fobbed off on a Greater Fool who will accept them, though they have no present value whatsover. This is what we call a Ponzi Scheme. (in econo-speak we say the notes have no transversality - which means they are a Ponzi Scheme.)

Such notes always lose value over time. There are no exceptions either in theory or in reality. Or in history. All incontrovertible paper money in the history of the world eventually became worthless.

The dollar has lost 95 percent of its purchasing power since it lost its convertibility into gold in 1933.

And gold? It is recorded that a Roman senator's suit at the time of Augustus (complete with the purple murex striping) cost about 4 aurii: 1 ounce of gold. Now an Armani suit costs $1400 dollars, or an ounce of gold. A pretty good store of value over the last 2000 years.

This is why gold, as long as it is priced in these incontrovertible promissory notes backed by a government with negative cash flow must continue to rise over time.

Do not try to time the gold bull. Accumulate gold.

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