The money supply increases naturally by exactly the amount of increases in productivity in a healthy economy, notes Stansberry & Associates Investment Research Founder Porter Stansberry. He doesn’t have to point out that the economy isn’t healthy, nor that the money supply expands every time the printing presses run to bail out a failing business and bring on a new iteration of quantitative easing. The solution is a simple (albeit not necessarily easy) one, Porter tells us in this exclusive Gold Report interview: Return to the gold standard. That will happen, he says, when the people say, “Enough!”

The Gold Report: You’ve written a lot about the gold standard recently, and an article in your S&A Digest argues that we should greatly prefer gold-backed money because it would limit the ability to increase the money supply. It goes on to point out that increasing the money supply essentially causes inflation. If regulations prohibited governments from expanding the money supply, would fiat currency be as good as the gold standard?

Porter Stansberry: In theory, it could be, but in practice that’s never happened. I suspect that the market wouldn’t have much faith in such rules, and they’d be abused eventually. During the Volcker and Greenspan Federal Reserve periods, from roughly 1981– 2006, two central bankers created a de facto gold standard because they remained relatively consistent vis-à-vis money supply targets.

Volcker absolutely targeted money supply, as did Greenspan up until about 1999. He moved away from that stance due to Y2K fears and then the 2001–2002 recession. So we’ve seen long periods in fiat systems where money supply growth was targeted and fairly reliable.

The problem, of course, is that the gold-standard rules don’t apply across the banking systems. When the Fed was targeting money supply, bankers lobbied for all kinds of changes related to reserve ratios, which allowed them to massively increase the leverage on their balance sheets. Famously, the investment banks—Bear Stearns, Lehman Brothers and others—went from, say, 15:1 to 50:1. That had a tremendous impact on the amount of credit in the economy, which ultimately led to the collapse we well remember. Then the Fed started to radically increase the money supply to help reduce the impact of those bad loans.

That’s a long way of saying that efforts to mirror a gold standard by rule have never been effectual in history, and they haven’t worked in America over the past 40 years.

TGR: So changing the reserve requirements, in essence, increased the money supply.

PS: Let’s talk definitions. When I’m talking about the monetary base, I’m talking about the size of the Fed’s balance sheet, which is the foundation of the U.S. fractional reserve banking system. When you increase the size of the Fed’s balance sheet, you can have multiple increases of the actual money supply from that base. By targeting that base, Volcker restrained credit growth in the economy. Greenspan was less successful at that because he chose to expand the monetary base for political reasons.

In any case, just controlling the monetary base did not control the impact of increases to banks’ balance sheets and leverage ratios, simply because they lobbied successfully to change the rules. They got permission to increase their leverage. The monetary base didn’t change, but the money supply increased due to the actions of the banks. It would have been impossible under a gold standard for the simple reason that the banks would be subject to runs on their gold. That doesn’t happen in a paper system.

I’m not saying that there would never be another run on a bank, but bankers would have a palpable fear of losing control under a gold standard because the market discipline is so much fiercer now. They never would have leveraged 50:1 under a gold standard. It would have been completely implausible.

But as long as there’s this notion that they can get a bailout of any size by turning on the printing press, maybe the discipline isn’t quite so sound. That’s exactly what we’re seeing. So rather than allowing runs on the bank or rather than allowing banks to default and for depositors to lose, the government is printing as much money as is required and is giving it to the banks.

TGR: Is expanding the money supply actually a bad thing?

PS: In a healthy economy, the money supply would increase naturally by exactly the amount of increases in productivity. In fact, one of the main features of the gold standard is that it creates a balance between creditors and debtors. Creditors are more willing to lend money because they know the money they’re going to be repaid will be sound. Likewise, borrowers are more reluctant to take on debt because they know there’s not an easy way to repay it.

One of the main reasons you should prefer a gold standard is that it limits increases in the money supply to real increases in productivity. A second reason is that it simultaneously limits the availability of credit. Those limits mean that powerful interests in the economy and/or the government can’t simply create whatever credit they need to buy whatever assets they want. In a true free market, credit is relatively difficult to come by and can’t be manipulated by the various interest groups.

But in a free market that uses paper currency, it’s very difficult to actually maintain ownership of key assets because competitors in the marketplace may have access to political capital that allows them to buy whatever they want. You see this all the time in various industries, particularly those influenced by the government. In media, for instance, a very small number of vested interests end up owning and controlling all media properties because they have access to credit that their competitors don’t. That’s very difficult to pull off in a gold-standard system.

TGR: When you say they have access to credit that their competitors don’t, are you talking about on a worldwide basis?

PS: I’m talking particularly about the U.S. system, where the well-connected, money center banks—J.P. Morgan, Bank of America, etc.—essentially have access to unlimited amounts of credit, and they can finance almost any kind of takeover they choose, especially if it’s favored by the government that they do so. They can do that because, again, there’s so much flexibility in the monetary base, and credit is so easy to come by. It can be printed. You can’t print gold, so under a gold standard, the government wouldn’t allow the banks to have that much credit because it wouldn’t be able to bail them out.

TGR: So if the U.S. went to a gold standard, wouldn’t international companies have an advantage over those based in the U.S?

PS: No, not at all. If our currency were backed by gold, it would be very difficult for foreign investors to buy U.S. assets. One of the big calamities of our current situation is that by devaluing the dollar by 20% over the last three years—which is what’s happened—our government has made everything in the U.S. 20% cheaper for foreign investors. We’re burning the family furniture to keep the heat on in this country.

It doesn’t make any sense to devalue an economy the size of the U.S. by 20% merely in the hopes of making the stock market or employment go up a couple of percentage points. Giving away your country by devaluing your currency in order to produce economic activity is madness. That couldn’t happen under a gold standard.

TGR: One of your articles drew the link between devaluing the currency and calling it what it is: inflation. Your great chart, the CRB Futures Index Growth since 1955, shows a spike in 1971 when the U.S. went off the gold standard, and then bounces around rather wildly, never going back to the ‘71 levels. Presumably, that shows how the dollar’s purchasing power has declined, and you relate it to inflation. Interestingly, you also wrote that well-known economists—including some at Stansberry & Associates—continue insisting that there’s no inflation. What arguments do they use to support their viewpoints, and why are those arguments flawed?

PS: The most well-known person in the deflationist camp is Robert Prechter, but there are many others, including some who work for me who are persuaded by those arguments. We have a running debate because I think these people are foolish to be able to look at any long-term chart of the dollar’s purchasing power and claim any deflation’s going on.

TGR: When did this trend in decreasing purchasing power begin?

PS: Pick your date, and the dollar has lost 90% of its purchasing power from that day. A good way of thinking about this is to think about being a millionaire in 1900. To be a millionaire in 1900 was just unheard-of rich. At the time, gold was worth $20 an ounce, so to be a millionaire then, you’d have been worth 50,000 ounces of gold. And today? That amount of gold is worth about $100 million.

So gold’s supply-and-demand dynamics haven’t changed that much, and its intrinsic value, I would argue, hasn’t changed at all. What has changed, of course, is that the value of our dollar has collapsed by almost 100%. If you go through history and you realize that in 1971 gold was worth $35 per ounce, you can see that it’s declined 97% since then.

Just during the time Greenspan was at the Federal Reserve, the purchasing power of the dollar fell by about 50%. There’s no deflation in our money supply, and therefore no real lasting decline in prices. For people to say otherwise, I think, is incredibly stupid. No evidence whatsoever suggests that a fiat-backed currency system will ever cause a lasting deflation. And to believe that a short-term decline in prices in one market or another is tantamount to deflation is simply bad economics. It’s not true at all.

You have to look at broader measures of prices to see the impact of inflation, and you have to understand the impact of increasing the monetary base. If you increase the monetary base threefold, over time you’re going to see a very large increase in prices. Then, beyond all these nuts-and-bolts aspects, just look at history. Where is the fiat currency that collapsed because it became too valuable?

TGR: Part of the logic in going to a gold standard is to eliminate the inflation or eliminate the devaluation of the dollar. Isn’t some level of inflation a good thing?

PS: Why? Why should the monetary system favor one party over another? Why should debtors have an advantage over creditors? Doesn’t that retard lending? Doesn’t it retard economic growth when creditors constantly worry what the inflation rate’s going to be?

TGR: Speaking of economic growth . . .

PS: The fastest period of wealth creation in American history happened in the decade of the 1880s, during which the U.S. was on the gold standard. If you go back all through history, you find that economies do better with sound money. It’s no mystery why. You can’t make long-term investments without stability in the money. The instability does nothing but increase the prestige and power of the vested interests who control money supply, interest rates and the inflation rate. It makes it impossible for everyone else to do business.

Why isn’t a gold standard automatically the status quo in a democracy? Why would anyone ever want to get away from that, allowing the government to have both the swords of justice and the scales of money under its control? The outcome is always the same disaster. Credit grows uncontrollably and eventually the printing presses have to get turned on to pay back all the debt. Needless to say, we’re in the midst of one of those scenarios now.

TGR: Were any economists in 1971 warning that at some point down the road, abandoning the gold standard would trigger these credit problems and massive inflation?

PS: Absolutely, and some great economists were raising these issues as early as 1933, when FDR began to really move the U.S. away from the gold standard by making gold inconvertible, meaning that you couldn’t go exchange your dollars for gold at the bank. From that point forward, we were really on a pseudo-gold standard. All the economists who warned about what would happen were right.

TGR: And people apparently didn’t know the history of fiat currencies.

PS: True. Also, of course, it takes a lot longer for paper systems to break down than people expect because they’re completely reliant upon the confidence of the people using the system, and it’s in everybody’s best interest to play “hear no evil, see no evil”—nobody wants to see the whole house of cards crumble. But eventually it does crumble and people hedge their potential inflationary losses by buying gold and silver. That’s happening now.

TGR: A common argument is that there isn’t enough gold either in vaults or in the ground to return to the gold standard. The amount of gold above the ground was estimated at 158,000 tons in 2008, or 5 billion ounces. The nominal gross domestic product (GDP) in the U.S. is $14 trillion.

PS: The nominal GDP has nothing to do with the monetary base, which is where to look in terms of understanding a healthy ratio between gold and the dollar. The monetary base in the U.S. is a fraction of the GDP—about $2.865 trillion. Even so, if you tried to back every single dollar with an ounce of gold, you’d have an astronomical price of gold—that won’t work.

You want a gold standard that you can get to without taking 50 years or without greatly reducing the amount of money in circulation in your economy—a sensible transitional period that isn’t so deflationary that everyone goes bankrupt. Going from a situation in which we’d had inflation of 4–6% a year over the last 40 years to a period where you’re actually having deflation of the monetary base by 4–6% a year in order to get back on the gold standard would devastate debtors. You want a transition that treats creditors and debtors fairly and gets the economy back on a fixed standard, from which point we can move forward.

But you don’t need an ounce of gold backing every single dollar to maintain the standard in the vault. You need good lines of credit so that demand can be met. That was done over long periods of time, hundreds of years, very safely, very effectively, with relatively small amounts of gold in reserve.

Obviously, you need more reserves during times of crisis when people are nervous about the system. But what makes the system work is that the price at which people can demand gold remains unchanged. And people need faith that balance will return even if there’s a disruption in the demand system. After the Civil War, for instance, it was important that the greenback returned to its prewar value, that the gold standard was reinstated at the same price. And that price remained in effect all the way until 1933. So it’s not important to have an ounce of gold to back every single dollar; it is important, however, to have a reserve system that works, confidence that it works, and the political will to stick to the price to ensure that it keeps working.

TGR: That good credit you mentioned, especially when you hit economic bumps—where does that credit come from?

PS: The various large bullion banks would have swap lines with one another. If there’s an economic problem in Germany, for example, the Fed might lend gold to the German Central Bank to meet requests for the redemption. You can do it any way you want.

TGR: Would other countries also have to return to the gold standard to have that international credit option?

PS: The U.S. could do it alone, but it would certainly work a lot better if more of our trade partners agreed to the same standard. The economic area would be larger, too, so there would be more diversification of labor and more economic growth.

TGR: You’ve suggested that we could return to a gold standard by setting a target date 10 years in the future and then allowing the market to reach the appropriate price level. Taking only 10 years to get it back in balance sounds optimistic.

PS: It really depends on what you want the price to be. After the Civil War, it took 14 years because it was important to the bankers at the time that we return to the right price.

You probably could set the price easily between, let’s say, $5,000 and $8,000 per ounce of gold, and have the reserves necessary to make the system work today at the Treasury. People could go exchange dollars for gold as much as they wanted, and have confidence in the system at that price. You could do it right now.

TGR: What would be the catalysts to spark the move to return to the gold standard?

PS: I think the catalysts will be the destruction of the dollar and the ongoing inflation. Look at corn prices. When people around the world can’t afford food because the U.S. dollar has lost its purchasing power, it leads to revolutions, unrest, violence, people abandoning the dollar, failures of banks, collapsing markets and all these volatilities that we see. In my mind, returning to the gold standard is inevitable because nothing in human nature has changed in 4,000 years. As long as there is paper currency, it will be debased, and it will cause problems. Sooner or later, people will tire of it and return to gold. I think we’re in the middle of that transition as we speak.

TGR: If we’re in the middle of it, when do you suppose we’ll actually have a plan to go back to a gold standard? Steve Forbes says it’ll happen within the next five years.

PS: I think it’ll happen during the next Administration. At some point, to get people back to work, to get the country moving in the right direction, we’ll have to make a big economic readjustment. We’re going to have to get rid of the large overhead costs of government, return to lower taxes, and return to sound money.

TGR: Do you really think anything like that can happen, considering the recent debacle over the debt ceiling in Congress?

PS: I personally think we’re going to have an enormous dollar crisis, and that we’re only in the very beginning of it. The dollar has lost 20% of its value since 2008. I think it will lose another 20% over the next 12 months, and the population in America will get really tired of that very quickly. I expect a big political change in this country when people are fed up and say, “We’ve had enough—enough bank bailouts, enough of the money printing, enough of our wages being stolen by inflation. We want a system that doesn’t depend upon the good graces of politicians for its value. We want to use gold as money so that our savings are protected.”

TGR: So the people rather than the politicians will provide the political will needed to return to the gold standard?

PS: Absolutely. Politicians are never leaders in political thought. They follow the polls.

TGR: You’ve made it pretty clear that had we been on the gold standard we wouldn’t be struggling with this economic crisis. You mentioned people’s wages being stolen by inflation. Millions of Americans aren’t even making wages these days because they’ve lost their jobs. And we still have that tremendous debt load hanging over us.

PS: There’s no doubt at all that if we had been on a gold standard we would have never seen a credit bubble the size of the one we have now. It would have been very difficult for us to have the kind of economic problems we’re having.

As for the debt, there’s 400% of debt-to-GDP in the U.S. right now—not future liabilities, not Medicare out to 100 years from now. We can’t get people back to work and jumpstart our economy because we cannot afford to pay these debts. These debts are also the reason why we have to keep printing more money. We’re absolutely drowning in debt, and the only way out is to paper those debts over by printing enormous amounts of money that will devalue people’s wages through inflation and also, of course, diminish their net worth by lowering the value of everything they own.

The total debt in our country right now is $56 trillion, and the Fed has monetized roughly only $3 trillion of it through quantitative easing (QE) so far. We haven’t even begun to see this happen yet. We’re going to see QE3, then QE4, and on and on. And, in general, each level will be larger than the previous, so the numbers will get bigger and bigger as the Fed races against the market to devalue these debts.

TGR: Then how do we get back on the gold standard?

PS: Sooner or later people will say, “Enough!” I can’t tell you when that day will arrive, but I’d be surprised if the next Administration comes and goes without a return to gold.

TGR: This has been a pretty compelling conversation, Porter, and a lot of our readers will want to watch your video/read your essay that goes beyond what we’ve talked about today.

But before we let you go, you’ve said that unless investors are willing to speculate and start shorting equities, they probably should stay out of the equity market because you’re looking at a long, serious bear market. You advise these people to put 50% of their money into short-term Treasuries and 50% into gold. What’s the logic of the Treasuries if you expect the dollar to be devalued?

PS: One-year Treasury bills offer some protection from inflation because they have such a short-term duration. You won’t lose a lot to inflation with such instruments. They pay you something to hold them, too—although not very much.

The reason for holding these instruments is to reduce the volatility of the gold holdings. If you’re not going to hold other securities, all you want is to keep the value of your account stable. Taking half of the uptick in gold over the last year—a gain of maybe 20% and there’s no way that price inflation has been 20% in the last year—you’ve made a net gain in real terms.

If people are simply able to retain the purchasing power of their savings in the midst of this massive global monetary crisis, they’ll have done a great job. The thing to do now is not to lose, and the safest way not to lose is to go half gold, half cash.

On the other hand, investors who are in a position to be able to speculate can look at my newsletter’s portfolio and see that we’re long certain stocks that are positioned to profit from these problems and we’re short the stocks that are positioned to suffer from them.

After serving a stint as the first American editor of the Fleet Street Letter, the oldest English-language financial newsletter, Porter Stansberry began Stansberry & Associates Investment Research, a private publishing company, 11 years ago. S&A has subscribers in more than 130 countries and employs some 60 research analysts, investment experts and assistants at its headquarters in Baltimore, Maryland, as well as satellite offices in Florida, Oregon and California. They’ve come to S&A from positions as stockbrokers, professional traders, mutual fund executives, hedge fund managers and equity analysts at some of the most influential money-management and financial firms in the world. Porter and his team do exhaustive amounts of real world, independent research and cover the gamut from value investing to insider trading to short selling. Porter’s monthly newsletter Porter Stansberry’s Investment Advisory, deals with safe value investments poised to give subscribers years of exceptional returns. You can learn more about Porter and his ideas by clicking here.