Like So Much Mulberry Bark

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by Jeff Thomas, International Man:

In 1260, Kublai Khan created the first unified fiat currency. The jiaochao was made from the inner layer of bark of the mulberry tree. It’s of interest that the mulberry tree was quite common in Mongolia. What allowed Kublai Khan to get away with treating tree bark as currency was that each bill was cut to size and signed by a variety of officials. They affixed their seals to each bill. To further ensure authenticity, forgery of the chao was made punishable by death.

But even then, why would people accept bark as being of the same value as gold and silver, which had successfully served as “money” for thousands of years? Well, to begin with, the chao was redeemable in silver or gold. But just to make sure it was accepted, Kublai decreed that refusing to accept it as payment was also punishable by death.

Today, we’re more sophisticated. Governments no longer threaten to kill people for refusing to use a fiat currency; they just make it extremely difficult to deal in anything but fiat currency.

At the time, Kublai was involved in an ongoing war with the Song. The war had drained the treasury and Kublai was finding it difficult to continue to finance the war. And so, in 1273, he issued a new series of the currency without having increased the gold and silver in the treasury.

In 1287, Kublai’s minister, Sangha, created a second fiat currency, the Zhiyuan chao, to bail out the previous one, to deal with the budget shortfall. It was non-convertible and was denominated in copper cash.

There’s an old saying that, if you find yourself in a hole, the first thing to do is stop digging. Yet, throughout history, leaders, having created a Ponzi scheme of fiat currency and finding out that it has its pitfalls, invariably keep digging ever faster.

In Kublai’s case, as in so many other cases in subsequent history, inflation of the chao led to economic disaster. The chao became an utter failure.

Today, most dictionaries define inflation as being “an increase in the price of goods”; however, the traditional definition is “an increase in the amount of currency in circulation.” An increase in the cost of goods due to an increase in the amount of currency in circulation is a near-certain eventuality, but it should not be the definition. This distinction is an important one, as it allows us to focus on the root problem rather than the outcome.

Marco Polo visited Asia just in time to see the initial success of the chao. Upon his return to Venice, he informed Europe of the concept of fiat currency. Although he had been in Asia long enough to see the collapse of the currency, Europe took to the idea of fiat currency like ducks to water, and fiat currency has been used in the Western world ever since.

Not surprisingly, European fiat currencies experienced the same outcome as the chao. Over time, every fiat currency ever created has failed and always for the same reason: Governments become overextended (generally due to warfare), excessive printing is implemented to bail the government out, and the resultant inflation collapses the currency.

Fast-forward to the US in 1971. President Richard Nixon had a problem. The treasury was being drained of gold by trading partners such as France. The US was waging war in Vietnam, which was also draining the treasury. Mr. Nixon’s Treasury secretary, John Connolly, with support from other presidential advisors, recommended that the president dig the hole deeper, by going off the gold standard and printing dollars.

Sound familiar?

It’s unlikely that Mister Nixon was aware that he was making exactly the same mistake Kublai had made, seven hundred years previously, and that he was doing so for the exact same reasons, and based upon the same recommendations from his advisors.

However, the US, at that time the greatest creditor nation in history, stepped off the economic cliff.

And yet, that occurred almost fifty years ago. In the past, fiat currency collapse has generally been far swifter. Why has the dollar been in suspended animation for so long?

Well, for that, we look once again at real money: gold and silver.

The US had joined both world wars late. In the early years, the US became the suppliers of munitions, equipment and vehicles for the two wars. And more to the point, they insisted on being paid in gold.

(It should be noted here that, as often as the US government and the Federal Reserve have tried to argue to Americans that gold is not really money, during wartime, the US would accept nothing else in payment for goods shipped to other countries.)

By the end of the two world wars, the US held the lion’s share of the world’s gold in its vaults and therefore could dictate to the post-war world what the economic standards would be.

They came up, first, with the concept that the world would use the dollar as the default currency and, later, that it would be the petro-dollar – the currency to be used for the settlement of all oil-related transactions.

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