12 Jun What is Money?*
What is Money?
Money is an alternative to barter. It serves as a medium of exchange. In order to be functional (especially in today’s global economy) it must be (1) widely used, (2) accepted in transactions involving the transfer of goods and services from one person to another, and (3) a store of measurable value.
The US Dollar is money the world over. So is the Euro, the Swiss Franc, and the Japanese Yen. The Venezuelan Bolivar is not … even though it’s a currency. Nor is the Congolese Franc, the Iranian Rial or the Icelandic Krona. Crypto-currencies, such as Bitcoin and Ether, aren’t “money” either. They aren’t widely accepted and few people use them for the purchase of goods and services. They also lack the necessary requirement of measurable value because of their volatility. Gold and silver are not “money” either. There are stores of measurable value, but are not used in day-to-day commerce.
The Dollar, Euro, Franc and Yen, on the other hand, are widely used, accepted in transactions involving the transfer of goods and services, and today appear to be are a store of measurable value. Yet they’re only pieces of paper. They have no intrinsic value, no permanence – anyone can put a match to them. Each has had a relatively short history. And throughout history a good many currencies that appeared sound have disappeared become worthless disappeared. It used to be that the value of currencies was backed by gold bullion, but there isn’t enough gold in the world to backstop all of today’s paper currencies. What therefore gives currencies value? Why do people put their trust in them? Why do they continue to be treated as “money”?
The value of fiat currencies – that is, government-issued paper that is not fully backed by a physical commodity – is based on faith the belief that the governments issuing them are legitimate, that those governments will continue to pursue sound fiscal policies, and that those governments’ political and military policies will be supportive of their currencies. Importantly for the Dollar, Euro, Franc and Yen, each also is backed by at least a modest amount of gold bullion. Each has been issued by a sovereign nation that has a strong economy, respects the Rule of Law and due process, and has clear and consistent property rights. Until recently, the amount of each nation’s debt also was within a reasonable comfort-zone.
A dominant currency is called a Reserve Currency. In a globalized economy, governments and institutions look to that Currency as the primary means of settling international accounts and as a tool in pricing their own currencies – that is, by holding a sufficient quantity of Reserve Currency, countries can buy and sell their fiat currency to raise and lower its value, either to stabilize it in international trade or to make exports cheaper or imports more expensive. The British Pound was the first modern Reserve Currency. It slowly began to be replaced by the US Dollar after WWI … and quickly after WWII.
Today’s Dollar is the world’s dominant currency in part because the U.S. has the world’s largest and most successful economy. That means it’s the destination of an outsized share of the world’s products and services … which necessarily must be paid-for in Dollars. The U.S. also has the world’s most powerful military – an essential element for a Reserve Currency – and has pursued consistent, stable growth and governance. Other countries, and their peoples, therefore look to the US Dollar for stability and leadership and accordingly value the Dollar above all other currencies. The benefit of having the world’s Reserve Currency is that it supercharges the Reserve Currency’s country’s economy. Everything of global importance currently is denominated in Dollars – including oil, gold, and the world’s leading stocks and bonds. America is the financial capital of the world, with the world’s leading stock and bond markets, for precisely that reason. Americans incur no currency conversion costs – they buy in Dollars and sell in Dollars. People in other countries pay more and receive less because their goods and services are denominated in their local currencies, giving Americans a destination advantage. That has the added benefit of making America a magnet not only for goods and services, but also for immigrants, education and innovation.
The fact that other countries must hold Dollars in their national treasuries enables the U.S. to import goods and services and pay for them with mere pieces of paper that the U.S. Treasury simply prints. Other countries therefore hold Dollars while the U.S. consumes the goods and services purchased with those printed Dollars. Having the world’s Reserve Currency also makes US Treasury securities the most desirable of investible fixed income instruments, enabling the U.S. to borrow enormous amounts. As long as the Dollar continues as the world’s Reserve Currency, Americans will continue to enjoy these advantages. While it is true that this is equivalent to buying other countries’ goods and services with an IOU having no fixed maturity – those printed Dollars are promises to pay that rely on faith in the credit of the U.S. – America’s enormous national debt will only become an issue if the Dollar ceases to be the Reserve Currency. When If that time comes, the debt will be impossible challenging to repay.
That’s becoming an important “if and when.” The Dollar’s advantages are very slowly eroding, though America appears to be many years away from a possible debt crisis. One reason for the erosion is that other countries are fully aware of the advantages that would accrue to them from a less one-sided Reserve Currency. Some have been taking steps to boost the stability and value of their own currencies and, at the same time, reduce the universality of the Dollar. The leading holders of the Dollar are China (by a lot!), Japan, the European Central Bank, Switzerland and Saudi Arabia. Among other things, that gives them, both separately and acting together, a degree of leverage over the global economy (China increasingly so by reason of the size and growth of its economy and its continuing stockpiling of gold bullion, a policy also being pursued by Russia). All aspire for their currencies to be included among those treated as Reserve Currencies … and the Euro, Yen, Franc and Chinese Yuan each are now included in the International Monetary Fund’s basket of designated Reserve Currencies which together are intended, someday, to replace serve as an alternative to the Dollar.
With declining interest rates in the EU, Japan, and elsewhere, the Dollar nevertheless has been getting stronger, to the detriment of those countries’ currencies – that is, because a higher interest rate is paid on Dollar holdings, international investors realize an economic benefit by owning American-issued debt instruments over debt instruments denominated in non-Dollar currencies. They therefore have been selling Euros, Yen, etc., and buying Dollars. A strengthening Dollar reinforces American power to the detriment of America’s enemies competitors countries that haven’t pegged their currencies to the Dollar. Those countries consequently are motivated to structure workarounds.
One potential workaround has involved the global payments system, called SWIFT, that controls the wire transfer of Dollars – an essential component in international commerce. SWIFT has been amazingly useful to the U.S. government in enforcing trading sanctions, particularly against Iran. Europe – which has not supported America’s renunciation of the 2015 Iran accord – is working with Iran to forge an alternative payments system, called INSTEX, that would skirt American sanctions. INSTEX reportedly is about to become operational and, if successful, would deal a serious blow to the Reserve Currency status of the Dollar. Another workaround, this to skirt American sanctions against Russia, has been more successful – a barter exchange of Russian oil for Chinese Yuan. Russia also is building pipelines to deliver oil and natural gas to Europe for which it will be paid in Euros.
America’s enemies competitors have any number of reasons to attack the Dollar’s Reserve Currency status. As targets of American sanctions, an increasing number of nations are highlighting recent American actions in an effort to build a global alliance. America’s Tariff Wars, its treatment of foreign students and its demands on allies are raising questions about the benefits of holding Dollars above all other currencies. Vladimir Putin recently took the podium to criticize the Dollar: “The world economy is entering a period of trade wars and growing protectionismÔÇöovert and indirect…. Deep changes require adaptation of international financial organizations, reconsidering the role of the dollar, which after it became the international reserve currency, turned into the tool of pressure [by the United States] on the rest of the world …. [Thus,] trust in the US dollar is falling…. States that previously advocated the principles of freedom of trade, fair and open competition, started speaking the language of trade wars and sanctions, blatant economic raiding, arm twisting, intimidation, eliminating competitors by so-called non-market methods.” Putin’s comments were made during his recent summit with China’s leader, Xi Jinping, who seconded Putin’s condemnation of America’s “increasing anti-globalism and hegemony.”
Russia and China and Iran, Syria, Cuba, Venezuela, North Korea, etc., etc., etc., have become natural economic and political allies because the enemy of my enemy is my friend.
Should the Dollar ever lose its Reserve Currency status, it would compel America to resolve confront its enormous overspending debt deficit. Doing so would require a drastic reduction in government spending as well as significant tax increases. It would mark an end to America’s global hegemony, pressuring the financial ability of the U.S. to maintain military and economic competitiveness. It could lead to a global tsunami …. It is a future very much to be avoided.
Finally (from a good friend)
*┬® Copyright 2019 by William Natbony. All rights reserved.