Lost Purchasing Power for Our Paper Dollar

The US dollar became a pure fiat currency in 1971. Before that, the dollar was backed by gold under the Bretton Woods system established after World War II. In 1944 the Bretton Woods Agreement established the US dollar as the world’s reserve currency, backed by and pegged to gold at $35 per ounce. Other currencies were pegged to the dollar. Increasing government spending on social programs and the Vietnam War led to inflation and an overvalued dollar. This, combined with a negative US trade balance, resulted in an outflow of gold to other countries from the US hoard. On August 15, 1971, President Richard Nixon ended the international convertibility of the US dollar to gold, effectively ending the Bretton Woods system and rendering the dollar a fiat currency backed only by trust in the US Government. This event is known as the Nixon Shock.

In 1973 the US dollar was allowed to “float” in value as well as the price of gold

By 1973, the US dollar’s value was allowed to float against other currencies, with its value determined by supply and demand on international currency markets. I would also contend with the increase in computer programming, the manipulation of markets also increased dramatically during this time as our country became more of a Wall Street economy or financial services economy as the US slowly but surely stopped manufacturing and making stuff here. The US dollar also transitioned to a full fiat currency, backed solely by the “full faith and credit” of the US Government rather than by gold. We have pretty much seen our fiat dollar lose purchasing power since this time and we have seen gold reflect that lost purchasing power from our dollar at a much higher price.

America is experiencing lost purchasing power from our US dollar

Lost purchasing power from our US dollar refers to the decrease in the value of the US dollar over time due to inflation. Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. When the purchasing power of the dollar declines, each dollar buys fewer goods and services. This means that, over time, the same amount of money will not buy as much as it did in the past. For example, if you could buy a loaf of bread for $1 in 1980, but in 2020 the same loaf of bread costs $3, the purchasing power of the dollar has declined. In this case, the dollar has lost about two-thirds of its purchasing power over those 40 years. Bread in 2024 is even much higher than that as the trend of lost purchasing power continues.

Many factors can contribute to a loss of purchasing power of our currency

As the general price level increases, the value of a dollar decreases. If the money supply grows faster than the growth in real output, it can lead to inflation. If the dollar weakens against other currencies, imports become more expensive, potentially leading to inflation. The loss of purchasing power is a significant concern for many people because it affects their standard of living over time, especially if their income does not keep pace with inflation. The higher price of gold over time is a direct result of this including the increased money supply and the devaluation of our paper currency.

Lost purchasing power is a direct result of “printing money out of thin air”

The phrase the government prints money out of thin air is a metaphorical expression that refers to the government’s ability to create new money without having it backed by a physical commodity, such as gold or silver. In modern economies, central banks (like the Federal Reserve in the US) have the authority to create new money through various means. We have seen a huge expansion of the creation of money in the last 20 years due to Quantitative Easing, adjusting bank reserve requirements, and abnormally low interest rate policy. These money programs by the Fed are a direct result of what we are experiencing today. We can all see the bubble in asset prices, the fragility of the banking system, and the lost purchasing power of our currency. These are all reflected in a higher gold price over time.

Quantitative Easing Programs by the Fed leads to a loss of purchasing power

Quantitative Easing (QE) can lead to a loss of purchasing power of the currency through inflation. When the Federal Reserve engages in QE, it creates new money and uses it to purchase government bonds or other financial assets from banks and institutions. This increases the money supply in the economy. The increased demand for government bonds from the Fed drives up their prices and lowers their yields. This, in turn, lowers interest rates across the economy, as rates on many types of loans and securities are tied to government bond yields.

Lower interest rates make borrowing cheaper, encouraging businesses and individuals to take out loans to invest and spend. This increases the amount of money circulating in the economy. As more money chases the same amount of goods and services, the increased demand can lead to rising prices. This is especially true if the economy is already operating near full capacity. As prices rise, the purchasing power of each unit of currency decreases. In other words, each dollar can buy fewer goods and services than it could before.

Adjusted bank reserve requirements ultimately affect the purchasing power of our dollar

Adjusting bank reserve requirements can affect the currency’s purchasing power through its impact on the money supply and potential inflation. Reserve requirements are the amount of customer deposits that banks must hold as reserves, rather than lending out. When the Federal Reserve lowers the reserve requirement, it allows banks to lend more money, which can increase the money supply. During this process, it is safe to assume that our paper currency loses purchasing power. It is also safe to assume that this lost purchasing power is ultimately reflected by a higher gold price. History shows this to be true.

Low interest rates set by the Fed can contribute to a loss of purchasing power over time

Abnormally low interest rates set by the Federal Reserve can contribute to a loss of purchasing power over time, primarily through their potential to encourage inflation. When the Fed sets interest rates very low, it becomes cheaper for businesses and individuals to borrow money. This can lead to increased spending and investment. As more people and businesses borrow money, the money supply in the economy grows. Banks create new money when they make loans, so more lending leads to more money in circulation.

Low interest rates can also lead to increased investment in assets such as stocks, bonds, and real estate, as investors seek higher returns than they can get from low-yielding savings accounts and bonds. This can potentially lead to asset price inflation or bubbles. If the increased money supply and spending lead to demand growing faster than the economy’s ability to produce goods and services, it can put upward pressure on prices, leading to inflation. If inflation occurs, the purchasing power of the currency declines. Each dollar will buy fewer goods and services than it did before.

The US Government cannot stop spending and borrowing

Increased government spending and borrowing can contribute to a loss of purchasing power over time, particularly if the spending is financed through monetary expansion rather than taxation or if the economy is operating at or near full capacity. When the government spends more than it collects in taxes, it runs a budget deficit. To finance this deficit, the government typically borrows money by issuing bonds. If the central bank purchases these government bonds (a form of quantitative easing), it increases the money supply. In effect, the government is financing its spending by creating new money.

If the growth in the money supply outpaces the growth in the economy’s productive capacity, it can lead to inflation. With more money chasing the same amount of goods and services, prices can rise. High levels of government borrowing can also lead to higher interest rates, as the government competes with private-sector borrowers for funds. This can crowd out private investment, potentially reducing economic growth and productivity. If government debt becomes very high, it can undermine confidence in the government’s ability to repay its debts. This loss of confidence can lead to higher interest rates, reduced investment, and potentially, a decline in the value of the currency. If these factors lead to inflation, the purchasing power of the currency declines, as each unit of currency buys fewer goods and services. This is becoming more blatantly obvious in today’s financial environment.

A higher gold price can often reflect a loss of purchasing power in a currency

Gold is often seen as a hedge against inflation and a store of value, and its price can rise when investors believe that the purchasing power of a currency is declining. Unlike fiat currencies, gold has a relatively stable supply. New gold is mined each year, but the amount is small compared to the total supply. This limited supply growth is one reason why many investors see gold as a stable store of value over time.

When a currency is losing purchasing power due to inflation, investors may turn to gold as a way to protect their wealth. As the currency’s value declines, it takes more units of that currency to buy the same amount of gold, driving up the price of gold in terms of that currency. A rising gold price can also reflect a lack of confidence in a currency or the government’s economic policies. If investors believe that a government is mismanaging the economy or that a currency is at risk of significant devaluation, they may buy gold as a safe haven asset.

Over long periods, the price of gold tends to rise in terms of fiat currencies. This is because fiat currencies, which are not backed by a physical commodity, tend to lose value over time due to inflation, while gold’s value is more stable. Over the long term, a sustained rise in the gold price is often seen as an indicator that a currency is losing purchasing power due to inflation or other factors. Other central banks of the world see this as they continue to purchase record amounts of gold. The real question is: Are you?

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