In 1913, the US Congress authorized the creation of the Federal Reserve. Its mandate was limited, but it grew over time to become the central planner of all things monetary. In 1933, President Roosevelt outlawed the ownership of gold. In 1944, the soon-to-be-victorious allied powers signed a treaty at Bretton Woods, agreeing to use the US dollar as if it were gold. Their central banks would hold dollars and borrow dollars, and pyramid credit in their own currencies on top of the dollar.
The US dollar was redeemable by foreign central banks, and so this was effectively a scheme for various currencies to have a fixed exchange rate between each other and to gold. It, at least, had the virtue of limiting credit expansion, as there was still this one tie to gold and hence to reality.
The problem with fixing the price of one thing relative to another is that whichever one is undervalued is hoarded and whichever is overvalued is dumped. The US government set the price of gold too low, and so foreign central banks were increasingly demanding delivery of gold.
By the time President Nixon was in office, something had to be done. In 1971, he defaulted on the gold obligations of the US government. This had the effect of severing gold from the monetary system, plunging us into the worldwide regime of irredeemable paper money. One consequence was that the exchange rates of the various paper currencies were allowed to "float" against one another.
This was the prescription of Milton Friedman, monetary quack. He actually said:
"If internal prices were as flexible as exchange rates, it would make little economic difference whether adjustments were brought about by changes in exchange rates or equivalent changes in internal prices. But this condition is clearly not fulfilled. The exchange rate is potentially flexible in the absence of administrative action to freeze it. At least in the modern world, internal prices are highly inflexible."¹
And that's why we have volatile foreign exchange markets today, because Friedman and his followers wanted to compensate for labor law and other regulation that make certain prices ratchet only upwards, but never downwards.
This fraudulent, unworkable, and dishonest scheme of floating exchange rates certainly did not fix the problem of wage and other price inflexibility. It did cause several others.
One side effect was to loot people's savings and thereby teach them not to save, because the word "floating" is disingenuous. The paper currencies all sink. There is no mechanism, nor desire on the part of the central bank, to increase the value of the currency.
The floating currency regime is a regime of sometimes-slower and sometimes-faster currency debasement. Each government engages in a race to zero. Sometimes one currency is sinking relative to the others, and sometimes others are sinking relative to it. This is enormously destructive.
The never-ending process of currency devaluation has a follow-on effect: reduced investment. This of course reduces growth. This premise must be taken to its logical conclusion.
Savings, as such, is not possible using irredeemable paper.
When saving, the wage earner sets aside a portion of his wage; he consumes less than he produces. His basic intent is to hoard this value until he retires and needs to exchange it for food and other goods when he can no longer work. It is advantageous to lend to a productive enterprise to increase his quantity of money, but this is not essential to the concept. The key is that he can carry value over time. Gold and silver do this, but paper does not.
Fundamentally, paper currency is a loan to the government. Unlike a productive enterprise, government is not borrowing to increase production. Government does not produce anything; it consumes. Government is borrowing to consume with neither the intent nor the means to ever repay. And therefore the "loan" is counterfeit (http://keithweiner.posterous.com/inflation-an-expansion-of-counterfeit-credit). It will not be repaid.
Gold and silver are positive values. One can hoard them, as one can hoard any tangible commodity. Paper currency is a negative value. It is debt. There is no way to "hoard" it, its value is always falling, and in the end it will default to zero.
The government's paper scrip loses value gradually, and then suddenly. We are in the gradual phase now. This phase will end without much warning (other than permanent gold backwardation).
Savings, under irredeemable paper is perverted into speculation. People are forced to crowd into one asset bubble after another. Those who blindly follow always end up transferring wealth to those who lead. People who bought houses between 2004 and 2008 in the USA still have not recovered. At least those who deposited dollars into a bank account have not lost as much, yet. When the markets finally become aware that the banking deposits are backed by mortgages on homes which are worth 25% to 50% less than their mortgage values, bank depositors will lose more.
Eventually, people will discover that they cannot save in terms of dollars (those who don't figure it out will be rendered economically irrelevant as their wealth is removed from their hands). Savings is a necessary prerequisite for investment. Investment is necessary for companies to grow, to develop new technologies, products, and markets. Growth is necessary to hire new workers.
As existing companies achieve higher productivity of labor, and do not need as many workers to perform the same work, they lay off unneeded people. In a free market, the unemployed would quickly be hired by growing companies that expand and develop new businesses. But today's structurally high unemployment can be traced back to Friedman's quack prescription (among other government interference).
Weakening the currency not only discourages savings, it also weakens businesses who have to keep the currency on their balance sheet and who have to import some of their inputs.
When a currency loses value, then all who hold it incur a loss. It is not possible to employ workers and run a business in a country without holding significant amounts of its currency. Currency debasement therefore imposes constant losses on enterprises that try to operate in such an environment.
Combined with the fact that imported supplies, ingredients, parts, software, and other inputs are constantly rising in cost in terms of the falling currency, and one can see another reason why Friedman's assertion is false. In many cases, especially modern products, the cost of the labor input into a product is a small percentage of total cost.
Save your lunch money in gold and silver, the best way to protect yourself against our mad regime. If you want to speculate, make sure you risk only your beer money.
¹The Case for Flexible Exchange Rates" by Milton Friedman