Gold or Fiat (Paper) Money


Today, the world is experimenting with a total fiat money system. That is, paper and electronic money that are not redeemable for gold or anything of value, unlike in the past. Accordingly, the world has observed countless economic and monetary crises worldwide, with the current global crisis being the latest and most severe since World War II.

The reason why the world adopted a total fiat monetary system was not grounded in economics but rather, in politics. Money, when not redeemable for gold, gives immense benefit to those who issue it and use it for the first time – that is the rationale for why counterfeiting is illegal. Today, most money is issued by commercial banks in the form of mere accounting entries when they give out loans, thereby enormously benefiting bankers from the first use of money that is created out of thin air.

Banks create such money through the fractional reserve banking system. In Malaysia, the current statutory reserve requirement is 2%. Thus, a deposit of, say, RM1 million allows the banking system to create additional new money to a maximum amount of RM49 million!

It is such creation of money out of thin air, which comes with compounded interest charges attached to it, that causes money and debt in an economy to grow exponentially, outstripping the real economy. This is the fundamental cause of inflation.

The famous monetarist and Nobel Laureate Milton Friedman remarked that inflation is predominantly a monetary phenomenon, that is, it is basically caused by the banking system. For example, 20 sen could buy breakfast in the early 1970s – 10 sen for roti canai and 10 sen for teh tarik. Now, perhaps you can only get a glass of water for that amount. In this context, the dollar, since 1957, has lost 87% of its value or purchasingpower.

In stark contrast on the other hand, gold has retained its relative value remarkable well over the centuries. Prof Roy Jastram of the University of Berkeley, California, studied the value of gold relative to other commodities using data over a 400-year period from 1560 to 1976, and found the metal’s value has remaimed remarkably stable. He named his book The Golden Constant. Similar observations are obseryed in the historic of Islam. For example, during the Prophet’s time in the early 7th century, a sheep cost one dinar (4.25g of gold). Today, a dinar – costing about RM500 each – can still buy one sheep. Therefore, gold has held its value for over 1,400 years! The above examples are evidence that gold is indeed a good store of value and has intrinsic value.

But what about data which shows that the gold price was around US$400 per ounce in 1980 and 1990, when the US Consumer Price Index had risen by more than 60%? Isn’t that evidence that gold is not a good store of value? The myth is, after the collapse of Brenon Woods and the emergence of the pure fiat monetary system, there is evidence of major global financial institutions colluding against gold to suppress its price and prevent it from rising as a monetary unit.

The gold anti-trust action committee (GATA) was formed in the US in 1999 to advocate and initiate litigation against illegal collusions against the price and supply of gold. Since the present fiat monetary system allows banks to create money out of thin air, gold is, therefore, a banker’s natural enemy. As such, it is not uncommon for bankers to “attack” gold in the markets, in their writings and at conferences.

But now, in the face of a collapsing dollar, colluding against gold to suppress its price may not work because people, as well as nations like China, will simply gobble it up at low prices. On top of that, in the wake of the global recession and times of turbulence, if I may borrow Alan Greenspan’s term, it is highly unlikely that gold will fall back to the US$750 to US$800 level. Indeed, the opposite is highly likely.

Source : Dr Ahamed Kameel Mydin, Islamic University Malaysia (Extract from The Edge)

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