Saturday, August 28, 2010

Currency: A History & the Future



The first currency system developed in the region known as the Fertile Crescent; the Babylonians, Assyrians and Persians developed metal coins as a means of exchange and store of value in and around 1,000bc. This advance led to trade, increased prosperity.. and a better form of taxation. But flaws appeared in each of these Imperial systems.. over time, debasement of the coins by unscrupulous rulers occured. Also, in an era where there was no place that was safe to store value, the value of a circulating medium could only be as sound as the army that defended that store. Trade could only reach as far as the credibility of that military. When the Empires fell, so went the wealth one tried to store. By the late Bronze Age however, a series of international treaties had established safe passage for merchants around the Eastern Mediterranean, spreading from Minoan Crete and Mycenae in the northwest to Bahrain in the southeast. Although it is not known what functioned as a currency to facilitate these exchanges, it is thought that ox-hide shaped ingots of copper, produced in Cyprus may have functioned as a currency. In Africa, ivory was used as a currency. This developed in the age of Athens and Sparta into a system of gold, silver and copper coins, which continued throughout the end of the Roman Empire.

Paper money was first used by China's Tang Dynasty {610ad} as these banknotes authorized by the Imperial government were used essentially as letters of credit in place of large amounts of coinage by larger merchants and others such as shipbuilders. The medieval Muslim nations took it a step further, recording the first uses of credit, cheques, promissory notes, savings accounts and loans. In Europe, the first use of paper money was introduced by Sweden in 1661, which issued copper and iron ore notes. They were also the first to bring the sale of stocks to the public.

The problem with several of these attempts, beginning with the ancient Chinese, was the same as today.. the reliability {and corruptability} of those issuing these notes. In Rome, the amount of silver in the dinari was time and again reduced and replaced with base metals. During the Middle Ages, it was a real crap shoot using coin.. one never really knew it's complete content, hence the practice began of actually biting the coin itself. Political changes usually also brought with it the demise of a paper currency or the debasement of coinage.

By 1900, most industrialized nations were on some form of gold standard, where the paper currency could be exchanged for gold. President McKinley signed the Gold Standard Act in 1900 here in the States. This proved a reliable form of currency as well as a store of value. The Federal Reserve Act of 1913 was enacted here in the States, and so began the practice known today as fractional reserve banking, whereby a bank could loan out roughly ten times the amount of cash it had on hand. It was thought at the time that this increase in liquidity would lead to an increase in trade and expansion of the economy, and indeed it worked well for a time. The idea was that there would be enough gold to ensure the value of the physical currency in circulation, if not the entire amount in the credit system, and that this would act as a restraint on Central Bank authorities from printing too much paper money.

Unfortunately for the United States, we began to do just that.. print too much money. By the late 1960s, many investors worldwide {notably Arab states} began exchanging US Dollars for gold in vast sums. President Nixon ended the "gold standard" in 1971 and let the dollar "float".. ie.. letting the markets determine the value of the currency. This came to be known as FIAT money {from the Latin word fiat, meaning "let it be done"} The US was actually one of the last to do this; Britain, Japan and others had long since abandoned the gold standard. Currency markets arose during this period as a way of determining the fair value of a particular currency vs other currencies and commodities. In 1988, the Royal Bank of Australia introduced the first polymer currency {as opposed to paper} with the idea that it would last longer than paper and be much harder to counterfeit. Most industrialized nations quickly followed suit.


In the 1980s, the United States began printing and loaning out vast sums of money; the old ten to one peg of loans to deposits went out the door. Europe and others soon replicated the process, leading to a vast expansion of debt in industrialized societies and the slow but sure degradation in the value of the currency versus finite commodities. Today, big American banks are leveraged around thirty to one; European banks, not to be outdone by the evil Yankees, leveraged themselves up in some cases to sixty to one. In the early 2000s, the price of silver and gold began to rise precipitously versus all fiat currencies. It is, simply put, a debasement of the currency. Some have begun to openly question the worth of this type of currency and are calling for a return of the Gold Standard. Taken to an extreme, the debasement of the currency leads to hyperinflation. The most recent example of this was Zimbabwe, which issued the 100 trillion Z-Dollar note in 2008. Germany, which had been supplying them with the polymer with which to print this, simply stopped selling them the paper.



In all currencies, especially paper, the same problem exists today as did in ancient times.. the percieved value of the currency is only as strong as the nation who does the printing. Confidence is the key to any currency system; as I write this, the confidence of most of the world's fiat currencies is badly flagging due to the banking crisis of 2008 and subsequent Central Bank printing.

At it's heart, the Federal Reserve and other central banking fiat currency systems are, whether intentional or not, a way in which all of a nation's currency in introduced into the system as debt owed to banks, thus empowering banks. It's no coincidence that the biggest buildings in any big city are banks and the wealthiest members of the community are bankers. In my opinion, this is a system {unjustly} designed to give the banks a slice of all transactions in a nation. In short, it's a parasitic system that robs working people of a part of the fruit of their labors. Woodrow Wilson, who signed the Federal Reserve Act under intense pressure, came to regret this act. Well he should. Worse, the system has a very basic flaw; it needs to have an ever increasing amount of debt and currency to function. It's rather like a pyramid scheme; it works well so long as there are more and more people entering the system. The problem is, today this is going in reverse; the system seems to have begun it's final implosion. Texas Reprersentative Ron Paul has been warning us of the flaws of this system and passes up no chance to warn Congress and the people, most of whom have simply tuned him out as a whack job. Until 2008, that is.

In my very humble opinion, this is a currency and financial system who's days are numbered, and well they should be.When this happens, it will happen ungodly fast and the entire financial system will crash, likely leading to Martial Law and a Depression to end all depressions.

In my opinion we need to go back to a simpler system, one where all leveraged transactions are prohibited under pain of prison. One in which the currency is introduced into the system in a manner other than thru banks as debt. One in which the currency itself can reliably store value and would thus be accepted by merchants. If merchants do not trust a currency, they will refuse to accept it in exchange for their goods.We simply cannot allow another parasitic currency system.

So.. what exactly is the future of currency, given that the current system is fatally flawed ? What will be accepted by the people and merchants ?

John Maynard Keynes, the father of an economic school of thought known as Keynesianism who believed that government intervention in the market system made it better, came to the Bretton Woods economic conference in 1944 and attempted to persuade the leaders to introduce a global currency known as the "Bancor". The United States countered with an idea known as the "Unita". Neither came into place. Of late, the IMF has issued what's called SDR's {special drawing rights} against the IMF. It's the first attempt at a currency not under the direct control of a government. Many would like to see this expanded. Many others believe the answer lies in a return to the Gold Standard. In a way, the US Dollar has essentially become an international currency accepted by nearly all nations. But will this last ? I doubt it. Some believe that in this digital age, physical money itself is simply outdated.

In my opinion, what will have to come first is a coin system; copper, silver and gold. After the debacle of paper money and central bankers, most people and merchants will be very hesitant to part with their goods and labors in exchange for some paper with a history of failure. The government might attempt another paper currency, but without the confidence of the people it will in the end fail. I believe that a coin system will come into place in combination with a 'letter of credit" system with a central exchange.. a bonded clearing house perhaps. In the middle ages, the term guilder {later to become the Dutch currency} was used to describe a letter of credit upon a guild {a group of shipbuilders, for example}. Slowly but surely another more advanced system is likely to develop, but it will take decades to rebuild confidence in any paper system, and rightly so. This puts some nations in good positions; others in a weaker position, depending on how much copper, silver and gold one produces. I can see in other nations a coin system where something akin to the gold standard is used, only instead of gold it'll be whatever commodity is locally produced. A "lumber dollar" coin which would be guaranteed by a certain amount of lumber as opposed to gold; even evolving into a basket of commodities envisioned by Keynes. A reputable clearing house could be used for oversight purposes to guard against overproduction in these cases. Clumsy as it is in the beginning, it is at least trustworthy. In other words, a far cry from today's paper notes.

5 comments:

  1. Excellent article, looks like we are moving in a perilous direction with SDR's and Keyenes BANCOR:
    http://en.wikipedia.org/wiki/Bancor

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  2. Good article, but fractional reserve banking began long before 1913. It actually goes back to medieval...forget the name...goldsmiths? Anyway, you'd deposit gold coin with these guys, and they'd lend a chunk of it back out, keeping enough on hand to satisfy immediate demand. My memory's fuzzy, but there was a lawsuit over this I believe in England, and the court ruled that the fungibility of coin means that a deposit with the goldsmith is not a claim to a specific piece of gold, like it is when you pawn a ring. Anyway, the history is all in Economics of a Pure Gold Standard. The purpose of the Federal Reserve was not to introduce fractional reserve banking, but to stop FR banking from causing bank runs.

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  3. Tycoon..interesting about how the Fed came about. My understanding is that there was terrific pressure put on Wilson by banking interests, but the reason behind it is unknown to me. I'll dig a little further.

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  4. Well, being insulated from a run is obviously in the banks' interest, as is being able to raise capital at below-market interest rates. You might try What Has the Government Done to Our Money by Rothbard. You can read it for free here:

    http://mises.org/resources/617

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