Tuesday, 23 February 2010

The end of funny money

John Mangun
Outside the Box
Business Mirror

BACK when gasoline was P7 a liter, I employed a gardener named Joe. Joe went through his day neither quite sober nor quite drunk, taking occasional sips throughout the day from his bottle of Añejo Rum.

He asked me why when he was young, the peso exchanged for $1, and now it took P20. Joe was of an age that he could remember using pesos that were made from real, valuable silver; not copper, aluminum, nickel and zinc.

We think of paper money in its current form as something that has been around a long time. Not true. Paper money has always been an easy-to-carry substitute for precious metals liker gold and silver. In fact, if you are older than 30 years, when you were born you could still have exchanged your Philippine pesos for silver or gold.

Prior to August 15, 1971, you could exchange your pesos for US dollars and then exchange those dollars for silver; real, valuable, limited-supply silver. Virtually every citizen of every country enjoyed that same silver-conversion privilege of their home currency.

In 1971 the United States, as part of the global Bretton Woods Agreement, ended the ability to convert dollars to silver or gold. The US dollar became the global substitute for gold and, as part of that agreement, countries were supposed to peg or fix their currency’s exchange rate to the dollar.

The dollar became the world’s reserve currency. The dollar took the role as the foundation of all the world’s currencies because the US economy was the largest, most stable and the US government economic/monetary policy was the most reliable.

Who needed gold or silver when you could have US dollars, the safest currency in the world?

But all the nations cheated and took advantage of the system. Since exchange rates were fixed—that is, not supposed to change except within very narrow limits—other countries figured out that they could print all the paper money they wanted to and buy all the dollars they wanted.

Imagine in 1971 that you had P100 that could be exchanged for $14 (and $14 with gold or silver). You walk over to your printing press, crank out another P200 and you now can exchange all those pesos for $42. Good deal, isn’t it?

The United States monetary people were not dumb. They figured out how they were being taken to the cleaners so they, too, started printing dollars. However, the US printers run much faster, and through the 1980s the US also borrowed trillions from the world financial institutions. Those currencies that were supposed to trade in a narrow band did not. The yen appreciated from 300 in 1971 to 120 in 1998, and the Deutsche mark from 3.67 to 1.67 because the dollars were being printed faster than those currencies.

In the last year the US government has printed and borrowed more than $2 trillion. Now, no one can trust the US dollar as the world’s reserve currency because the US economy is not the most stable, and the US government economic/monetary policy is not the most reliable.

One local financial writer said yesterday that the US was quite fortunate to have Ben Bernanke in charge of the US Federal Reserve because he was an expert on the Great Depression. I told you months ago nothing could be farther from the truth. Bernanke is using 1930s weapons against a 21st- century war. He is and will continue to be a failure, and it will only get worse because of Bernanke being an “expert” on the 1930s.

During the Great Depression the US could print money to help solve the economic crisis because it was a creditor-nation, not the largest debtor-nation in the world.

This is the bottom line.

Massive printing of money, dollars, combined with massive debt has destroyed the ability of the US dollar to be the foundation of all world currencies. Bernanke and the Obama administration have destroyed the dollar. And when the dollar finally takes its last gasp—dying as the world’s reserve currency—all other paper money will fail also. The end of funny money.

Nations will be forced to back their currencies with something of intrinsic value. All paper money must ultimately be backed with something of value. For the last 30 years, that backing, that value, has been provided by the dollar. The US dollar will not back global currencies again. For nearly 2,000 years a reliable substitute for carrying gold or silver has been in place. Then came 1971.

The 30-year experiment using valueless currency based on trusting the governments, particularly the US government, is a total failure and is coming to an end.

China has already converted billions of its paper currency (dollars) into hard assets by buying mineral production around the world. The time will come when nations that export to other nations will settle the bill in goods, a return to a form of the barter trade. Other nations will sell goods only for “commodity money,” another form of the barter trade.

And do not worry about the Philippines, either. We have abundant mineral resources, massive human- capital skill, and are not dependent on exporting hard goods for worthless paper.

E-mail comments to mangun@gmail.com. PSE stock-market information and technical analysis tools provided by CitisecOnline.com Inc.

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