GUEST BLOG: Ross Meurant – WHAT IS MONEY? WHERE DOES IT COME FROM? DO CRISES PRODUCE SOLUTIONS?

Coronavirus is a Crisis.

“Leaders in the United States Senate raced to unravel last-minute snags Wednesday and win passage of an unparalleled $2 trillion economic rescue package steering aid to businesses, workers and healthcare systems engulfed by the coronavirus pandemic.”

Question is; Where is the money coming from?

They are going to create the money with the click of a computer mouse somewhere in the bowels of the US Federal Reserve Building in New York. The 2 trillion will in fact be a lot more because the principals of fractional reserve banking will be applied to that figure, giving the potential of somewhere around 20 trillion dollars. Pure alchemy.   [A well-known cynic]

To criticisms, that the Keynesian policy of stimulating “aggregate demand” via budget deficits, may have positive effects in the short term but must necessarily have nefarious long-term results, Keynes, famously answered his critics; “In the long term we are all dead.”

So! What, is money?

Ancient societies started using gold as a means of economic exchange in lieu of barter. Gradually more countries adopted gold, usually in the form of coins or bullion, and this international monetary system became known as the gold standard.

The gold standard, created a fixed exchange rate system (i.e. the price of one currency in terms of a second currency).  In the gold standard system, each country sets the price of its currency to an ounce of gold. A fixed exchange rate stabilizes the value of one currency vis-à-vis another and makes trade and investment easier. 

CRISIS INTERVENES. 

The gold standard eventually collapsed from the impact of a Crisis:  World War I.  

During the war, nations on both sides had to finance their huge military expenses and did so by printing more paper currency. As the currency in circulation exceeded each country’s gold reserves, many countries were forced to abandon the gold standard.

In the 1920s, most countries, returned to the gold standard at the same price level, despite the political instability, high unemployment, and inflation that were spread throughout Europe. United Kingdom, the United States, Russia, and France, participated.

However, the revival of the gold standard was short-lived due to another Crisis: The Great Depression, a world wife phenomenon which began in the late 1920s. 

Under the gold standard, countries could not expand their money supply beyond what was allowed by the gold reserves held in their vaults. By 1931, the United Kingdom had to officially abandon its commitment to maintain the value of the British pound. The currency was allowed to float, which meant that its value would increase or decrease based on demand and supply. Other nations followed and by 1939, the gold standard was dead; it was no longer an accurate indicator of a currency’s real value.

Another Crisis arrived!  World War 2 and with it, Another Solution: Bretton Woods.

In 1944, embracing representatives from forty-four countries, John Maynard Keynes, a highly influential British economic thinker, paved the way to create a new monetary system. The resulting Bretton Woods Agreement (BWA) created a new dollar-based monetary system, which incorporated some of the disciplinary advantages of the gold system while giving countries the flexibility they needed to manage temporary economic setbacks, which had led to the fall of the gold standard. 

To enable countries to manage temporary but serious downturns, the BWA provided for a devaluation of a currency—more than 10 percent if needed. Countries could not use this tool to competitively manipulate imports and exports. Yet, despite a fixed exchange rate based on the US dollar and more national flexibility, the BWA ran into challenges in the early 1970s. 

The US trade balance had turned to a deficit as Americans were importing more than they were exporting. Throughout the 1950s and 1960s, countries had substantially increased their holdings of US dollars, which was the only currency pegged to gold. By the late 1960s, many of these countries expressed concern that the US did not have enough gold reserves to exchange all of the US dollars in global circulation.

Banks, like countries do not keep enough gold or cash on hand to honour all of their liabilities. They maintain a percentage, called a reserve. Bank reserve ratios are usually 10 percent or less. (The low reserve ratio has been blamed by many as a cause of the 2008 financial crisis.) 

As a consequence of the expense of a war America was losing in Vietnam War and increased domestic spending, the US government began to run huge budget deficits, further weakening global confidence in the US dollar. When nations began demanding gold in exchange for their dollars, there was a huge global sell-off of the US dollar, resulting in the Nixon Shock in 1971.

The Nixon Shock?  Another Crisis!   

A series of economic decisions made by US President Richard Nixon in 1971 led to the demise of the BWA. Without consulting the other member countries, in August 1971, Nixon ended the free convertibility of the US dollar into gold.

Before moving on, recall that the major significance of the BWA was that it was the first formal institution that governed international monetary systems. By having a formal set of rules, regulations, and guidelines for decision making, the BWA established a higher level of economic stability.  Nothing has fully replaced Bretton Woods to this day, despite extensive efforts.

The did US dollar emerge as the” reserve currency” i.e. is a currency that many countries and institutions hold as part of their foreign exchange reserves.  The extent to which this de facto arrangement of floating exchange rates, may have provided some temporary stability and flexibility to adjust to oil prices, is debatable. 

Temporary?  Remember also, about this time when Nixon dropped the gold standard, the Petro dollar was born where Saudi agreed to sell their oil in US$. This increased both demand and the value of the dollar.  Many would argue that his monopoly over price control, precipitated another World Crisis: In 1973, Oil Prices, elevated rapidly.   

In 1976, countries met to formalize a floating exchange rate system as the new international monetary system.  The Jamaica Agreement established a system of exchange rates, in which currencies float against one another with governments intervening only to stabilize their currencies at set target exchange rates.  Another Solution?  

Additionally, the purpose of the IMF was expanded to include lending money as a last resort to countries with balance-of-payment challenges.  Another solution? Ask Greece.

The G5, later expanded in 1997 to G7 and later to include G20, which all becomes very confusing, nevertheless, survives as a grouping of nations consisting of finance ministers and governors of central banks, meeting to discuss matters related to cooperating on an international monetary system and key issues in the global economy.   The Final Solution?

WHERE DOES THIS GET US?

What is money?  Well, today it is not gold backed currency.  Today it is, fiat money! 

Fiat money is government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it. The value of fiat money is derived from the relationship between supply and demand and the stability of the issuing government, rather than the worth of a commodity backing it as is the case for commodity money. Most modern paper currencies are fiat currencies, including the U.S. dollar, the euro and other major global currencies.

Which may validate the opinion expressed by “A well-known cynic” at paragraph 2. 

Or to resort to a less mystical analogy than alchemy; ‘Based on the above assessments of fiat money or alchemy, perhaps the notes could also be used for that highly sought-after commodity, toilet paper’

In his book, “The Great Deformation”, David Stockman laments the impossibility of rational economic allocation within the framework of fiat paper money, deprived of any anchor in gold and where the interest rate is discretionally determined by the Central Bank.  This, he says, is “characteristic of the war economy”.

CONCLUSION

So, as America declares war on a, Virus Crisis they insist they did not hatch in Fort Detrick,  according Stockman’s theory,  their, New Solution for the virus may amount to a declaring war on the economy?

Ross Meurant; a former high-ranking police officer, former Member of Parliament, formerly with commercial interests in Syria and Iran and  currently Honorary Consul for an African state.