I have a friend who, with a lot of experience and knowledge has told me to buy gold and silver for the last few years. I also have a lot of friends who don't understand why. I am going to try to explain this. What I am not going to try to do is convince anyone. That's your choice.

I recently pointed out that, to me, food is a reasonable currency. Where I live, you don't need energy to heat where you live, driving a vehicle is the exception rather than the rule, taxes are minimal, health care is free and such, the one obvious thing you need regularly is food.

With two or three growing seasons here each year, this country is capable of feeding itself. It doesn't because it exports a lot of food and imports other food but it is capable. In fact, about the only dietary item that a rural family tends to purchase that isn't produced in Nicaragua is cooking oil. The main reason that is necessary is that these people generally don't have refrigeration to store butter or lard which they could produce.

Thus, the best short-term way to save excess capital is with a lot of sacks of beans, rice and corn in your storage shed and, if you have pasture, buying an extra cow or pig. It's that simple, it is done and it works.

For some, this approach isn't practical. This may be because they don't have a good place to store their sacks of beans or graze an extra cow. The other possibility is that they have just accumulated so much excess capital that storing it in beans and such becomes impractical.

We have been taught that IOUs are a good way to save excess capital. That is, you trade your sack of beans or 100 lbs. of cow flesh to someone and, in return, you get a note that says they owe you the equivalent value of the sack of beans or cow flesh.

Unfortunately, the person who bought your beans may not have what you need—:some cooking oil or a toothbrush. While, ultimately, he may package the beans in small bags and sell them to a retail store getting an IOU in return and that retail store may sell cooking oil or toothbrushes. Resolution of these IOUs to get what is needed to everyone gets complicated. I will interject here that a computerized indirect barter system (a LETS being an example) would address this but that is not the system most commonly in place these days.

The solution has been to have some outside entity handle all the IOUs. That is, they produce their own IOUs and people agree to use them as a medium of exchange. We call that a fiat currency. They are not issued by anyone who produces anything and, in fact, they usually charge you to use them but they make barter a lot easier. Some of these fiat currencies are issued by banks, others by governments.

Now, let me emphasize that there is no value added here other than convenience. The issuer of the fiat currency doesn't contribute any product, they just offer a service. That service is clearly just overhead. Now, somehow, that overhead needs to be paid for.

With a bit of slight of hand, here is how a bank makes a living. They charge you to use these IOUs. They didn't just print them up and give them to you so you could conveniently get from owning beans to a tooth brush. They charged someone to use them. That is, someone borrowed some of these IOUs so they could give them to someone else to pay for a product. For example, your sack of beans.

Thus, someone now owes more IOUs to the bank than they have in real product value (the sack of beans). That means that they need to increase the price of the small sacks of beans they sell to the retail store to cover their debt interest as well as their labor. The result, of course, is that the retail store has to increase prices to cover increased wholesale costs. Now, when you go to buy your toothbrush which might have been worth two pounds of beans, you have to pay three pounds of beans equivalent in these IOUs.

If you somehow manage to accumulate too many of these IOUs to keep in your wallet, you are offered an opportunity. The place that issues the IOUs will store them for you. And better than not costing anything, they will actually give you more back than you brought in as long as you agree to let them use them. Now this is where it gets really strange. I mean, these IOUs really had no value other than this bank said they did. They just printed them up but said then had a value. So, they could just print more.

Well, not exactly. You see, if they print too many then people start to think this who process is a scam (which, of course, it is). By having your IOUs there they get to pretend they have some value. That is, it is not just something they printed up but something that you think has value. So, they claim they have deposits. Of course, they really don't own anything. These deposits just represent things they owe to you and, if fact they owe more because they promised to pay you back more than you brought in.

In order to get more of these IOUs so they can afford to give you back yours, they get someone to borrow some of the IOUs that actually belong to you. The bank, of course, charge a fee for their use. And the cycle continues.

If you want to investigate a bit more you will see it actually gets worse. Specifically, once they have loaned your IOUs to someone else, they now tell us that they have more assets and can then justify printing more IOUs. If you understand this, great. If not, it is only important to the extent that things are much worse than you may initially see as far as the value of these IOUs.

Time for the big punchline. All this playing around didn't create anything other than inflation. That is, beans and toothbrushes now cost more than if you had traded your beans with the guy who made toothbrushes. There was nothing new created other than overhead. Put another way, lots of people who didn't grow beans, make toothbrushes or contribute anything of value to the system benefited. But, as long as lots of people agree to play this game, those IOUs can maintain their value.

On to Gold and Silver

It's time to look at how gold and silver are better than IOUs. The main reason for this lengthy introduction is that most people can't see how a fiat currency is no more than a confidence game because it is just the way things are done. Well, historically, it wasn't. And, historically, all fiat currencies have eventually lost their value.

Now, precious metals were not the only currencies. Roman soldiers were paid in salt. Natives in Central America used cacao beans. In other words, things that were useful like your sack of beans. But, on a larger scale precious metals make more sense than salt.

The two basic reasons that precious metals are better than any fiat currency is:

1. They have real costs associated with making more of them.
2. They have much lower transaction overhead.

If you, as a banker, want more gold you need to mine it. Instead of just having someone run a printing press, you actually have to acquire it through a costly process. (I recently read the average cost of acquiring new gold is around $350/oz.) While current gold prices are much more than this, this is better than the cost of paper and ink. It is also likely that this cost will continue to rise.

Transaction overhead is reduced because there is no middleman printing IOUs and processing them.

What about Speculation?

Anything beyond saving enough of your own beans to eat between now and when you harvest your next bean crop is speculation. Investing in the future price of commodities, petroleum or anything else is speculation. How you view speculation and the need for speculation is more related to religion (yes, really) and the economic system you live in.

On the economics side, look at Communism and Capitalism. By that, I mean how they are defined. Implementation is, well, some strange mix which you can at least represent with parts of each.

An accepted definition of Communism is "From each according to his ability, to each according to his needs". My personal definition of Capitalism is "Grab as much as you can". In between you can find implementations where some items are allocated Socialistically. That means everyone chips in by giving a part of their beans to the government and the government gives those beans, minus the cut for government overhead, to those they feel need the beans.

What we are talking about is how politics modifies the economic model. There are, as expected, a lot of potential and real problems here. But, let's keep it simple. How does the government decide;

1. How many beans to collect for redistribution?
2. Who needs to give the government a share of their beans?
3. Who needs to receive beans from the government and in what quantity?

I am describing a typical government model, something that mixes Communism and Capitalism. To help support my analogy, let me explain how it is supposed to work within either pure system.

In a pure Communist system, everyone is expected to work hard to produce as many beans as they can and put those beans in a common storage facility. Everyone is then allowed to take out as many beans as they need from that common storage facility. In this pure system, there is no government overhead.

In a pure Capitalist system, everyone is on their own. That is, each person can produce as many beans as they want and do whatever they want with them. There is no government overhead.

For you, the person that needs to eat, in a Communist system, either you all eat or you all starve. In a Capitalist system, those that have beans eat and those that don't starve. While I haven't done a survey, I expect that in any group you will fine some that thing the Communist idea as "fair" and others that think the Capitalist idea is "fair".

Enter politics. In a modified Communist system, the government is there to watch and make sure everyone does their part producing beans and doesn't take out too many beans. As they are busy watching they, of course, don't have time to grow beans.

In a modified Capitalist system, the government is there to convince more (or less) people to grow beans and to decide how to re-allocate the number of beans everyone has in an attempt to make sure everyone has some amount of beans to eat. If, of course, the government re-allocated them to meet people's needs, you would have effectively created a Communist system with a lot of government overhead.

We could now spend the next 100,000 words discussing which system is better and why. And, in the end, few if any people would change their mind. The good news, however, is that isn't the problem we are trying to solve. Remember, we are talking about speculation. It should be obvious that a Capitalist system encourages speculation and a Communist system discourages it. On the other hand, a Communist system discourages initiative for personal gain.

Where politics and religion fit in is in establishing what modifications to the basic model is allowed. What is painfully obvious is that adding any rule, whether politically or religiously motivated, adds overhead in the form of bigger government. That is, whether we are adding environmental controls, access to health care or a bigger military, it is all in the form of a tax on individuals.

Specific issues aside, in any system there is going to be some control on the permitted level of speculation. Implementations between pure Communism (no speculation) and pure Capitalism (unlimited speculation) is really the purpose a government serves. That is, deciding at what point one player seems to monopolize an industry or when the action of one exceeds an acceptable damage level to the common good. Below that, what is supposed to control speculation is a tax on speculative gains. That tax is then used to subsidize the bean supply of those less fortunate.

Continuing with the US model for a moment, how less fortunate is defined varies. For example, those who worked are allocated more beans than those that did not. That is, someone who recently became unemployed is entitled to more beans than one who has no employment history.

OK, let's get back to precious metals vs. fiat currencies. There are taxes associated with earning money and, in many cases, spending money. Thus, whether you are being paid in a fiat currency or a precious metal makes no difference. If, however, you accumulate wealth, there is where you will see a big difference. The most obvious is that it is typical to invest fiat currency either in a bank account to gain interest or to invest in stocks or bonds.

At first, you would think that all you can do is store the metal somewhere and when you decide to use it, it has not changed in value. This is where things get interesting. We tend to think in terms of the value of a fiat currency. For example, someone living in the US, will express the value of precious metals in US dollars. But, does that make sense?

We then hear the price of gasoline, beans and such expressed in terms of a fiat currency. We hear that the value of our house has gone up 10% or your salary has increased by 10%. We are happy when our salary and value of our house goes up more than the price of gasoline and beans. But, what makes these changes happen?

The short answer is the government. By putting more money into circulation (i.e., printing more fiat currency), the value of each unit of currency will drop. By decreasing the amount of money in circulation, the value of each unit should go up. There is no change in the number of things, just the value we assign to each thing. By changing the amount of money in circulation and encouraging various types of investments by controlling interest rates, the government is able to control what we see as a good use for the money we have.

If, on the other hand, we have our wealth in precious metals, the government has no such control. People can save and spend precious metals as they wish.

Historically, the US government assigned an exchange value between the fiat currency and gold. It then maintained a quantity of gold equal to the value of the fiat currency in circulation. This meant that the government was not able to manipulate the value of the currency as it does today. Thus, while me might not have liked the amount of government overhead or their choices of what to do with their cut, at least there was something real that limited their manipulation of the IOUs.

Well, not so now. With the now regularly expected bill to raise the debt ceiling, we continue to allow the government to pretend that they can pay back all the IOUs. Well, bad news. They can't. Unfortunately, it is was too late for a responsible legislature to just say no to raising the number of IOUs. Saying no today would be an immediate disaster so they continue to pretend to say yes and hope the disaster will happen when they can blame it on someone from a different party.

As I said at the start of this article, it is not here to convince anyone of anything. Hopefully, however, it has managed to make you think a bit. Even if you don't make any drastic changes, maybe you will make a bit of room for a sack or two of beans in the garage.