Fiat Currencies and the Debt Death Spiral

Every Tuesday Chuck releases a new Trader Tip video on YouTube. This week we will discuss fiat currencies, and how to protect your portfolio in a hyperinflation money-printing environment. Watch the Trader Tip Episode for more information! 

You can read the episode transcript below or watch the video that follows.
If you have any questions, please reach out to us. We look forward to being a continued part of your trading education!


What is fiat money? Fiat money is government issued currency that is not backed by a physical commodity, but rather by the government that issued it. It's often called paper money. The value of that money is derived from the relationship between supply and demand and the stability of the government, rather than the worth of the commodity backing it. Most modern currencies such as the dollar, the euro, the Japanese Yen, the British Pound, these are fiat currencies. The world pretty much operates on a fiat currency system.

Now, with fiat currencies. It's not backed by gold or silver, and if you recall, some of the recent Facebook Lives I've done, I talked about three ways that the government controls the populace. One of them is through the money supply, and you can see fiat money gives Central Bank's control over the economy because they control how much money is printed, and one danger of fiat money, which we're going to talk about today is that governments can print too much of it, resulting in hyperinflation.

What actually makes good money? When we say good money, what does that mean? This is money that will last through time. See, money is really important. Because without money, the economy grinds to a halt. Because either you have to do everything yourself, you got to raise your own food, you got to hunt your own food, you got to come up with your own sources of heat, and you will spend all day long, just trying to to survive. It's not fun. Think about it, you'd be out chopping wood, you'd be out growing a garden, growing your garden, you'd be out hunting, and then you'd have to slaughter, and clean and freeze, all before you can even cook your food. There'll be no time for the fun in your life, if you had to do it all yourself. Or people will specialize but then they have to barter, they have to exchange one good for the other, and that is incredibly inefficient. You grow corn, and you want to have a new iPhone. Well, if you go to Apple, they don't want your corn. You got to find someone else to exchange your corn with, that actually would have something that Apple would want. Incredibly inefficient.

Money is the grease in the economy, it makes the economy go, it allows you to specialize in your gifts, which is such a massive thing. I think one of the greatest evolutions in human history is that humans have been able to evolve into their strengths, and this is really at the core of capitalism. People really don't understand what capitalism is, that's topic for another day, but in capitalism, you focus on what you're great at, and others focus on what they're great at, and you exchange, you do what you're best at, and someone else comes in and helps you in all the other areas of your life by doing what they're best at. Good money is the grease to the system. Money is really important. We're talking about fiat currencies today. If we're going to talk about this, what actually is good money?

I got this from my partner Mark, and I loved it, and it's basically for to have good money, good money has four characteristics. Good money is durable. Good money is portable. Good money is divisible and good money has intrinsic value, it has value on its own. It has something of value that gets exchanged back and forth between parties that have value in other ways.

We're going to look at five different potential forms of money, and some of these have been used through history, some of these are newer.

  • Gold, which is a time tested form of money.
  • The dollar, which is a fiat currency.
  • A REIT, which is basically real estate, but for our discussion, it's paper real estate, right, it's paper. A REIT is a paper, like a share that's backed by real estate.
  • The S&P 500 like spy. Again, it's a paper asset backed by 500 companies.
  • Oil ETF like the USO, which is again backed by crude oil.

All of these could be exchanged. Let's look at the first test of durability. Is gold durable? Yes. Is the dollar durable? Yes. Is the REIT durable? Yes. Is the S&P 500 durable? Well, no because these companies can go bankrupt. Is oil durable? Yes.

Okay, let's go to portable. Is gold portable? Yes. Is the dollar portable? Yes. Is real estate portable? No. is the S&P 500 portable? No. Is oil portable? No.

Next is divisibility. Is gold divisible? Yes. Is the dollar divisible? Yes. Is a REIT divisible? Yes. Is the S&P 500 divisible? Yes. Is oil divisible? Yes.

Okay, then let's go to intrinsic value. Does gold have intrinsic value? It does. Does the dollar have intrinsic value? No, it's just paper. Does real estate have intrinsic value? Yes, it holds its value through time. Does S&P 500 have intrinsic value? Yes, these companies actually produce goods and services and make money. Does oil have intrinsic value? The answer is yes.

When we go through here, we see the only one of the five that has a checkbox in all four areas is gold. Gold is durable, portable, divisible and has value. The difference between gold and the dollar is that gold has value, and the dollar does not.

With fiat money, it allows the government to print money, and it's really the central bank, the central bank actually creates money to drive the economy. They have the ability to create it or destroy it, to put it into the system or take it out of the system, and so one of the issues with a fiat currency is there's no limit to how much money they can make.

They can make as much as they want, and we get into a situation where there is a linkage, a dangerous linkage between a democracy and paper money, and the reason is, quite simply, the populace, the population over time, will vote themselves money, and there's no limit to how much money they can print. Politicians want to get reelected; they don't really want to do the right thing, they want to get reelected. In seeking reelection, they do things to make their constituents happy. They put social programs in place, and you're going to see this and what we call the debt death spiral.

Every government in theory should balance its budget, but the reality is the combination of democracies with a fiat currency, governments are not balancing their budget, and they're taking on more and more debt when they don't balance their budget, and when they finance the difference between their tax revenues or how they raise money, and what they spend, they finance a difference by launching more debt by issuing more debt. What's happening is the debt is really growing and in the last 14 years, it has exploded, and you'll kind of see this. The debt has really exploded, which is setting a framework for a lot of issues.

Look at this. The US dollar up until 1971, was actually a gold backed currency. The form of how it was backed changed at first change under Franklin D. Roosevelt during the Great Depression, and then it changed again, well it didn't even change, it was removed by Richard Nixon in 1971. What happens when your dollars are backed by gold, if you are getting paid in dollars, but you ever start to have a doubt that the dollar really has the worth that you think it does, you can exchange it for gold. There's an exchangeability link. Okay, and after Franklin Delano Roosevelt, FDR actually made it illegal to hold gold, and remove the ability of citizens to swap it. Gold was made legal again after World War Two, but the ability to swap it for the average citizen was gone. Now, countries could swap it, and that's effectively what was happening.

Everything changed when Lyndon Johnson launched the Great Society in the 1960s. Prior to that point, you can see on this chart, that basically inflation would pop up around wars. The reason why is is that the only time the government didn't balance its budget was during war, and in theory makes sense. We need to win the war. We're going to do whatever we have to do to win, including borrow money and spend more than what we have. They wouldn't balance their budgets during war, but soon as the war ended, they'd go back to balancing their budget. That changed under Lyndon Johnson and the great society because they launched social programs, they launched welfare, and subsidized housing and all these other things, and they had no idea how much it was actually going to cost. They thought they did, but they were just wrong. As this happen, this started creating massive debts. At the same time, we had launched a war in Vietnam. We had a war in Vietnam and a great society in our desperate exploding. Richard Nixon came in, and he didn't change any of that he kept doing everything stayed in place, the debts, the deficits every year, continue to stay in place even grow.

One of our big trade partners at the time was France. France is getting all these dollars from us and giving us goods and services, and it came a point that France said, this is ridiculous, you're running these deficits, we don't think the dollar is worth near what it should be, because you're cheating by running these deficits. We want the gold. They start giving dollars back to the United States government, United States government started giving gold and very quickly, the government realized, like holy crap, we're not gonna have any gold left. Basically, Richard Nixon talked with different government people about it, they made the decision to sever the link, so you could not get gold anymore, and be basically launched the dollar as a fiat currency, not a gold backed currency.

The one thing that saved it at that time was Henry Kissinger convinced the Saudis to buy to accept dollars as payment for all our crude, and that launched what's called the petrol dollar, and that is what allowed the dollar to become the world reserve currency, because all crude transactions had been paid in dollars really ever since.

Look at this chart, look what happened in 1971, you can see that inflation just exploded with paper money, and you can see that the value of the dollar collapsed. The dollar has declined by 96%, since 1913, and it's declined significantly, just since Nixon in 1971. One interesting thing, if you look at this chart, everybody thinks that stocks just go up and up, but the reality is that gold has gone up just as much as stocks. This is a chart of S&P versus gold, and you can see over the last 50 years, the rate ratios unchanged, this means that gold has gone up as much as S&Ps.

Now, we said that, that balancing budgets allow governments to borrow more money than they ever borrowed before, and this is true, and not only that, but because they could do that the government then actually started backing certain programs that encourage people to borrow, and so you can see government debt is at an all-time high, student debt, which is backed by the government is an all-time high, but because the money supply keeps growing and growing, and the central bank sets interest rates, so they can actually set interest rates artificially high or artificially low, and they have tended to set them artificially low, especially since 2008.

You can see since 2008, automotive debt has exploded, corporate debt has exploded. Basically, debt everywhere is exploding, and if you know how debt works, it has to be paid back. You can't just leave it out there forever. If everybody borrows money, it needs to be paid back, and if it doesn't get paid back, it causes major problems. Because what if your brother borrowed money from you, and you knew he was going to pay you back next month, and you were relying on his payment to make your mortgage payment, and then he didn't pay you? Well now all of a sudden you can't make your mortgage payment and you default, and it creates a chain reaction where default leads to default leads to default leads to default. It's this nasty cycle. That's what we're working into. This is a problem.

This chart shows how quantitative easing and just think of this as the central bank, creating money and putting money into the system. Okay, we can see since 2008, is there's been essentially like five quantitative easing programs, QE 123 and QE infinity, and then what was called Operation Twist. What you can see is anytime these went into play, stocks rallied, but whenever they stopped, stocks went sideways to down. Well, right now I'm trying to take this off and stocks are going down. So, gains are supported only as long as QE continues, and when you try and take it off markets they often riot, which is a big, big dangerous issue that we have.

Then we have the debt death spiral. The populace is struggling. What happens is the government says, well if we launch programs for the populace, this will help us get elected or help us stay elected. They're struggling so we'll launch government policies a social net, to help them get by. They launched the policy, and in order to fund the policy, you can't just create out of thin air to fund the policy, you have to create more money. The central bank creates more money. The government borrows this money, increasing the level of debt, they put it into the system and then putting it into the system prices rise. Because prices rise the populace now starts to feel poor again.

Just look at this year, look how much your gas has gone up, look how much rent has gone up, look how much mortgages have gone up, look how much food is gone up, everything is going up. All of a sudden, people's purchasing power is like 25% less than it was at the beginning of the year. They're 25% poorer and they're pissed. What does the government do? They say, well, we'll help you out, we'll launch some more programs to get you more money, and then we need to create money to fund the programs, which causes prices to rise all the more which then people feel even poorer. This is what happens in the death spiral, and this is what's happening in Japan right now, and this is what is starting to happen to us, and ultimately, this is how civilizations this is how the money collapses, and then you end up with mass panic, mass riots, mass distortions and displacements, and everything has to get fixed, and started new. This is where we're at.

The problem with inflation, and the problem with this cycle, is that it leads to corruption. In a fiat currency system, the government will inevitably print ever increasing amounts of currency. This makes the price and cost of living rise faster than wages. The average person feels the pain but they don't know where it's coming from, they're just pissed that everything's getting more expensive. The politicians promise more freebies. In order to pay for the freebies, the government prints more money, raising debt and taxes.

This creates more inflation and a cycle repeats, but here's the thing, every time the government does this, there's a two way thing going on, they are campaigning an idea they're helping the populace, but in these programs, there's cronyism, there is some party that is massively benefiting from what the government is doing, really what's happening is the rich who are connected to the government get favorable treatment from the government, and this allows them to become richer. When you get into really bad inflation, the rich actually become richer, and the poor become poorer. Then, in this environment, the government gets into edicts, money printing, price controls, wars, all these sorts of things to try and distract you from what's actually going on. None of these things will work, but the populace doesn't know it, they come behind it like yeah, it's someone else's fault. Let's go invade them. Let's go kill them. Let's go make sure that you go after the rich or let's make sure that our rent prices can't go up. None of these things will work.

What you need is good money going all the way back to what we talked about the beginning. Good money prevents unneeded debt. Good money creates stability in the economy that people feel confident to engage in. These are really important things because we face them all the time.

As we wrap up today, I want you to think about are you prepared for what we've talked about? To counteract this, you need to own real assets. Need to own things like real estate. Need to own things like gold, farmland, timber, things of this nature. Do you have that? Or do you just have all your net worth in your retirement accounts? Because in an environment like this, your IRAs, your 401k's are going to get killed. Are you ready for that? If not, you need to start asking yourself questions about what you need to do to start switching around your portfolio so that you will be safe in an environment like this.

Lots to think about. As you know, I come to you every Tuesday teaching you different topics like this that are designed to help you become elite in your trading and investing. Have a great week. See you next week. Bye.