Tuesday, 13 September 2011

The ‘money’ is broken

Business Mirror

THE financial disaster that is affecting the world is complex and complicated. However, it is important to realize that the “disaster” is only the symptom of the disease that has been growing for nearly 40 years. The disease is that globally, money is broken.

Perhaps I can put it all together in a sensible way to help you understand why the idea that soon we will return to “normal” is a lie.

We think of money as a storage of wealth and a medium of exchange. Many things through the ages from golden Cowry shells in Fiji to wild boar tusks in Papua New Guinea were accepted as both. However, precious metals and copper were the items that met all the standards as money through virtually all civilizations.

Gold, like silver and copper, is intrinsically useful. It is in limited supply and difficult to obtain.

However, do not think that the average person ever used gold for trade transactions. Even as early as 700 BC during the Mahajanapadas period in ancient India, gold coins were for large purchases, silver coins for taxes and contracts, while copper coins were used by the people. These practices continued through medieval times in Europe.

Currency as we know it started even earlier as a form of deposit or receipt for grain stored in government granaries recorded as far back as 2000 BC in Egypt and Sumer. A farmer would deposit his grain and then could barter the receipt.

By the 1600s, paper currency was almost universally accepted because it theoretically represented a form of deposit against a nation’s metal supply. Granted, often governments cheated by printing more money than they had gold to back it with.

However, gold or silver was the reserve currency of global money because the paper could be converted to metal.

Most international trade was a form of barter. Country “A” sells bananas to country “B” in exchange for the cloth “B” produces. But if “B” wanted bananas and “A” did not want cloth, the trade would be settled in gold by “B” physically sending gold to country “A”.

With an internationally accepted reserve currency, eventually everything balanced out. If country “B” spent all its gold for the bananas, they could not buy anymore. So “B” would reduce the price of its cloth in gold terms to attract buyers and, therefore, gold.

If previously one gold bought one cloth, now one gold would buy three cloths. However, that creates domestic inflation. Why? Assume previously the exchange rate was one gold equals one cloth equals one “B” dollar and equals one “A” banana. But now the ratio is one gold equals three cloths. Therefore, one gold equals three cloths means that one banana equals three “B” dollars since “A” would not reduce the price of bananas to three bananas equals one gold.

In order to have gold flow back into country “B,” its citizens would have to face inflation until there was a better balance and they could raise the price of their exported cloth.

Governments have always played games with their currency. In ancient Rome, one emperor gave the military a 50-percent pay raise. In order to pay for it, the silver in the coins was reduced by 50 percent. That caused inflation because merchants raised prices by, you guessed it, 50 percent to receive the original amount of silver.

If you did that with your international trading partners, either they stop trading or go to war.

In 1974 the world decided to remove precious metal as the world’s reserve currency and replace it with the US dollar.

The same imbalances occur now as in the silly example of cloth and bananas above. But they cannot be worked out because there is a virtual unlimited supply of dollars and those dollars are created out of thin air, not because of the US simply shipping dollars out to buy goods. The US borrowed the money to pay for Chinese imports and printed the dollars to pay the debt.

The US dollar does not meet any of the standards of a reserve currency and causes broken money. Look at the enormous rise in the Philippine international reserves. But a very large portion of that dollar inflow is not working in this economy. You can borrow dollars for almost nothing in the US and use them to open a peso account here and make five times the amount of interest as you would in the US. That is why Brazil taxes inflowing dollars that are put in bank deposits.

The dollar has fallen 37 percent in the past decade. Gold has increased 500 percent.

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

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