Mar 28, 2011

PROTECT YOUR CASH

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Protect Your Cash
What does the history of money say about how you should handle yours today?

By: Kim Kiyosaki | 8/16/2010

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Link: http://www.womenentrepreneur.com/2010/06/protect-your-cash.html


Happiness was the focus of my last column, "The Happy Entrepreneur." Why? Because so many people say, "I'd rather be happy than rich." My response? Why choose only one when you can have both? So this month, I'm focusing on the basics of money. How did money evolve to what it is today, and how does that affect how we handle our own money in the future?

The History of Money
Winston Churchill once said, "The farther backward you can look, the farther forward you are likely to see." To see what lies in our financial future, let's take a look backward through history.

In the early ages, many things acted as money; people would trade or barter their personal possessions for things they wanted. Livestock and crops were commonly traded objects. Later, spices, cowry shells, beads and grains were offered as items for trade. When I was in grade school I learned the story of North American Indians exchanging "beads and trinkets" in my history classes. The beads were actually made of clamshells and were called wampum.

The Story of Greece
In about 650 B.C., silver coins first appeared in Lydia (now Turkey). Coins of bronze and gold were then made in Greece, Persia and the Roman Empire. Athens, Greece--the world's first democracy and the world's first free-market system--is where gold and silver first flourished. Classical Greece is considered one of the great civilizations of all time. What caused this powerful civilization to fall?

As Greece prospered under its new monetary system, it got involved in a war that turned out to be much longer (22 years) and much more costly than anticipated. The country was running out of money to fund the war, so Athenians came up with a brilliant idea. They discovered that if you took 1,000 gold and silver coins and mixed 50 percent copper into them you could then create--and spend--2,000 coins! Up until this point anything you bought was priced based upon the weight of gold and silver. Now the gold and silver coins were a mixture of gold, silver and copper. There were more coins in circulation, but the values of those coins was less. As more funds were needed to pay for the war, less and less gold and silver went into the coins and a higher percentage of copper was used. Within the next couple of years the war was lost, money had become practically worthless and Greece collapsed. Rome rose up as the new great power.

The Story of Rome
Rome's story is not so different. Romans also added other metals, such as copper, into their coins. They went a step further and made the coins smaller. They also minted the same coins but put a higher face value on them. The coins eventually became no more that tin-plated copper or bronze. Because the Romans were able to make so much money with no real value to the money itself, the market was flooded with these coins. So now more and more money was chasing the same number of products, which drove up the price of products and led to massive inflation.

Because the economy was so poor, the government jumped in and put the unemployed to work by hiring thousands of new soldiers and creating numerous public works projects. The cost of paying these soldiers, funding the new projects and doling out welfare to the existing unemployed was too much for Rome to bear. It simply could not print enough coins to sustain the system. The Roman Empire was now in hyperinflation. The empire fell. As history repeats itself, you will see that debasing--or devaluing--the currency to pay for war, public work projects and welfare is a pattern destined for ruin.

Currency vs. Money
I am using the word "money," which at times is not accurate. Money has a value in and of itself. A gold coin today can be exchanged for just over $1,200 US for goods and services anywhere in the world. Money is always currency in that it can be used to purchase other items that have value. Currency, however, is not always money because it does not have value by itself. For example, pull a $20 bill from your wallet. Do you think that piece of paper you are holding is worth 20 dollars? No, it's probably worth about five cents as paper you can write a shopping list on. As Greece and Rome started mixing other metal into their coins, the coins became a currency, an agreed medium of exchange, with little to no true value of their own.

Let's look at how our current currency came into being.

Paper Currency
Paper currency first appeared in China between the 9th and 15th centuries. It ended badly for China when the amount of currency the country printed skyrocketed, causing severe inflation, and China's paper currency vanished. (Is this sounding all too familiar?)

In 1775 the first dollars were printed in the U.S. They were called the Continentals. They were created to finance the Revolutionary War. With no tangible value of their own they, too, lost their value and became worthless.

The Gold Standard
In 1816 England made gold the standard of value. What that meant was that the country could only have (or print) as much paper currency as it had physical gold in the country's supplies. In other words, the paper currency was backed by gold and could be redeemed or cashed in for physical gold. In 1900 the U.S. went on the gold standard, and by 1914 most of the world was on the gold standard. The price of gold was fixed at USD 20.67 per ounce.

In the U.S. the gold standard was suspended several times--twice during World War I and in the 1930s to fight off deflation.

The Gold Reserve Act
In 1933 and 1934 President Franklin Delano Roosevelt played a couple of games with gold and currency. The government had many outstanding contracts and obligations to pay back after the war. In order to keep from going bankrupt, here's what Roosevelt put into action:

On August 28, 1933, Roosevelt signed an executive order making it illegal for American citizens to own gold. People were required to turn in their gold in exchange for Federal Reserve Notes (dollars). The result was more gold reserves into the vaults of the U.S. government.

Roosevelt then enacted The Gold Reserve Act. This act increased the set value of gold from $20.67 per ounce to $35 per ounce. The purpose of this move was to devalue the dollar. That accomplished two things:

1.It made U.S. goods less expensive to buy in foreign markets.
2.It made the conversion of gold into U.S. dollars more attractive to foreign buyers. Instead of getting $20.67 for one ounce of gold, foreign buyers could now trade their gold for USD 35.00 per ounce.
The U.S. government now had more gold in its supplies, which meant it could hold or print more money. Plus, with the new price of gold now at $35 per ounce, it could print 35 dollars for every ounce of gold vs. the previous 20 dollars. The money supply could now be expanded.

Bretton Woods
In 1944, toward the end of World War II, 730 delegates from 44 countries gathered at the Mount Washington Hotel in Bretton Woods, N.H., to determine how to renew the economies of countries and live in peace as trading partners. A monetary system was established whereby rules and regulations were put into place for how countries were to conduct themselves in monetary affairs.

The Bretton Woods Agreement was born. It was decided that all countries would peg, or fix, their currency to the U.S. dollar. This meant that each country's currency exchange rate was set against the dollar. It was also decided that the U.S. would make the dollar redeemable in gold at a rate of $35 per ounce.

Fateful Year: 1971
Everything changed in 1971 when President Richard Nixon took the U.S. off the gold standard, which meant that U.S. dollars could no longer be redeemed for gold. Nixon did this because U.S. gold reserves had diminished greatly, and the government feared there would be a run on the existing gold supply. To avoid this, Nixon simply declared that the U.S. dollar would no longer be converted to gold. At a snap of his fingers, the global monetary system was changed forever. The dollar was no longer backed by gold. It was backed by nothing. It became what is known as a fiat currency. Fiat currency is paper money that the government declares to be legal tender, or money. It has no intrinsic value of its own. When the U.S. dollar was backed by gold, you could demand gold for your dollars. No longer.

Since the Bretton Woods system had pegged all the world's currencies to gold through the U.S. dollar, all currencies on the planet suddenly became fiat currencies. These countries had no say in whether or not to keep the gold standard. The U.S. made a decision, and others adhered to it because of the Bretton Woods Agreement. All currencies also became free-floating, meaning their exchange rates were no longer at a fixed, or set, rate. Exchange rates fluctuated based upon the supply and demand of the marketplace.

Today
Today all currencies throughout the world are fiat currency. They are backed only by the confidence of their citizens. The risk of fiat currency is that since it is not linked to any tangible reserves, the government can print as much of it as it wants. If, for example, the U.S. government continues to print at the rate it currently is, we face the possibility of great inflation, or hyperinflation. The dollar is only as good as the confidence people put in it. When you see the price of a loaf of bread go from $3 to $10 to $30, you'll quickly lose faith in the good old U.S. dollar, and our money could eventually become worthless.

Why is it important to look back at the history of money? It is said that history repeats itself. If that proves true, given your money today, I would ask two questions:

1.Is saving money, be it in a bank or in your underwear drawer, the smart thing to do? That dollar you are saving will buy you less in the future than it will today. Since 1971 the U.S. dollar has lost about 90 percent of its value. The 1971 dollar will now buy you 10 cents worth of goods. So, is saving those diminishing dollars really a secure strategy for your financial future?

2.If I don't save money, then what do I do? Wouldn't it be wise to put your money into things that historically go up in value as the dollar goes down in value? This is where you need to do your homework. For example, in the past 12 months, the price of gold has increased 35 percent and the price of silver has increased almost 40 percent. Ask yourself, "Are there other places I can keep my money (or my devaluing dollars) that make more sense in the long run for my financial security and well-being?"

Historically, the entire world has never been in the monetary situation it is in today. Individual countries have faced this, but never the world as a whole. The old money advice we grew up with does not work today. Pay attention to history, watch how things unfold today, and make smart decisions for your own financial peace of mind.

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