It all started…
In ancient times precious metals like Gold and Silver
acted as the currency. Which is why we see that the ancient coins were made of
precious metals. And there was no need for anybody to make a promise about the
value of a Gold coin because the coin in itself contained precious Gold, unlike
today’s paper currency.
I promise to pay…
And then came the promissory notes, which were the
ancestors of today’s currency notes. Here, people used to deposit the precious
metals they had with a trustee who in turn used to issue them a promissory note
mentioning in it the worth of the Gold it represented. Then anybody who gave
this note to the trustee would get back Gold worth the value mentioned in that
promissory note. The trustee in turn would charge a small amount to the people
for safeguarding their Gold assets.
Slowly instead of using actual Gold to purchase goods
people started using these promissory notes instead. Different denominations of
these notes came into existence. These were the initial days of currency notes,
which is why even today you see on our notes a promise by the reserve bank
(today’s trustee) about the value of that currency note. But then today these
notes are NOT supported by Gold or any other precious metal. Howz that
possible? Read on…
The promissory notes became popular because it meant
carrying a simple piece of paper instead of heavy metals. It not only reduced
the carrying burden, but also protected people from thieves who could otherwise
easily detect that you were carrying Gold/Silver.
Over a period of time the trustees observed that most of
the people who had deposited the Gold with them were not coming back to take
back the Gold, and instead simply kept circulating the promissory notes, much
like today’s currency notes. So the trustees thought why not issue more
promissory notes than the amount of the Gold reserves they had? And thus was
born the concept of modern currencies and the banking system.
Deposited money exits through backdoors
Banks in those days simply issued more promissory notes
than the amount of Gold they had, based on a simple faith that all their
depositors wont come and demand their Gold back all at the same time! Imagine a
bank which had 100 kg Gold in deposits and which had issued promissory notes
for 200 kg of Gold. If all its customers came at the same time demanding their
Gold back, then the bank would go bankrupt! But that doesn’t happen unless and
until the bank loses the faith of its customers. So based on the faith that the
overall amount of Gold withdrawn would always be little comapred to the overall
amount of Gold deposited, Banks started overstating their Gold deposits.
What the banks did with those extra promissory notes was
to lend loans and earn interest. This is how the banking systems as we know
today came into existence. And this is what is practised by banks today in the
name of fractional reserve banking . In other words, the banks today keep only
a fraction of the customer deposits in reserves, and lend out all remaining
money as loans to earn interest. The interest on the loans would be more than
the interest paid by the banks for your deposits and thats how banks make
profit. Your deposits are nothing but loan offered by you to bank for which
bank pays a small interest, and in turn lends that money to others for a higher
interst rate.
So if the borrowers don’t pay back the loan amount, then
your money is gone! And that is what is exactly happening in US today in the
name of Sub-prime crisis. Borrowers have defaulted, banks have gone bankrupt
and so have the investors! Lehman brothers was just an example, and AIG was
bailed out by the US Government because it was too big to be allowed to go
bankrupt! The current US subprime crisis threatening the global economy is
nothing but Banks being unable to recover the billions of dollars of
depositors’ money which it had given out in the form of Bad loans.
And how does the US Government bail out big bankruptcies?
Simply by printing more dollars !In fact Billions of it!
The question is why can’t other countries simply print
more of their currencies and be rich? Because there will be no takers for mere
paper. Currency being a piece of paper has to be supported by something which
is really valuable, like the earlier Gold system. So what is supporting the US
dollar then? Read on…
Post World War II – US Strategy
After the second world war most of the world economy was
devastated. Most of the world’s Gold reserves had ended up in US as all
countries required US help to rebuild themselves, the same way they needed US
weapons prior to that. It should be noted that US mainland was not at all
affected by the second world war and there have been conspiracy theories about Pearl
Harbor, the same way there have been conspiracy theories about 9/11 . UK had
been the world leader till then, but now was desperate for help after the
devastating world war. It had enough of its own business to mind and hence
declared independence to countries like India which were becoming unmanageable
and which had already been looted to its core by the British. The empire on
which the Sun never set had started shrinking to see its Sun setting. Britain’s
prominent industries had been destroyed by the war and it badly needed aid. It
wasn’t able to import more than half of its food and all raw materials,
probably except Coal.
At the same time US had the ambition to replace UK as the
world economic power. At the end of second world war there was already great
inflation in US and there were strikes in all major US industries like
automobiles, steel etc. So US desparately wanted unhindered access to markets
across the world to get cheap stuff to fuel its own economy. US agreed to give
a loan worth 3.8$ dollar to UK provided it entered into a new trade agreement
with US. And thus was born the Bretton Woods agreement which paved way for the
creation of
IMF, World Bank and laid foundation for the world
domination of the US dollar. Prior to this agreement US and UK combined
controlled over half of the world’s trade, and this agreement ensured that US
entered UK markets. It should be noted that if not for the devastating effects
of world war II on british economy, the british pound would have been today’s
dominant currency. It was infact a dominant currency in the world prior to
world war II.
Bretton Woods Agreement
US entered into this Bretton Woods agreement with UK and
rest of the world nations after the world war in 1945. According to this
agreement all member countries had to trade their currencies against US dollar
instead of against Gold or other currencies, and US dollar itself was promised
to have a fixed value in terms of Gold. In other words, by this agreement US
dollars became the new promissory notes of the world economy! So a country need
not worry if it didn’t have enough Gold to support its currency, all it had to
do was to buy US dollars, because US promised its dollars to be supported by
Gold!
Now, what would a country do when it had a currency deficit?
Well, it can take loans from the newly formed IMF and World bank(then known as
IBRD), which would obviously be in terms of US dollars. In return for this loan
IMF (on behalf of US) would set up rules and regulations on that country’s
economy, so as to favor the US (in the disguise of helping that country
overcome its crisis) and would put that country’s economy under IMF
surveillance. The US owned one-third of all IMF quotas, more than enough to
impose its rules and to veto any change it disliked in the IMF.
To pay back the IMF loans (in US dollars) a country had
to export its goods and services to US so as to earn US dollars. Even
otherwise, countries wanted to earn US dollars since it was the default global
currency for international trade in the non-communist (non-soviet) block. So
all countries started selling their products to US for cheap prices, since they
had competition amongst themselves. This ensured that US got best of the world
products for lowest prices. And in the process US economy and consumerism
boomed because they got cheap goods of great quality from all across the world!
Pegging of world currencies to US dollar ensured that the value of US currency
remained stable and hence there was no inflation in US and things became
available for throw away prices. That’s how US consumerism was fuelled and
continues to be fuelled even today.
While in the third world countries people think a
thousand times before throwing out something, in US it is the world’s largest
amount of garbage produced everyday, simply because in US its cheaper to buy
than to reuse. Things are(were) cheap in US at the cost of the rest of the
world because rest of the world compete(d)s to sell their goods to US, just to
earn US dollars, since it was supported by Gold. In other words US dollars had
the greatest purchasing power, thanks to the Bretton Woods system. In return
for making this agreement happen, US gifted its european friends with its
Marshall Plan , where in the european countries received aid in terms of grants
instead of loans to rebuild their economies. US offered a similar Marshall plan
to the communist states led by USSR but was rejected by the Soviets who were
well aware of US ambitions to dominate the world economy.
Nixon Shock
All this went fine till one day the flaw in the system
came out. US had created a Pax Americana system in the world, where every
developing economy had this goal of exporting its goods and services to US to
earn more dollars. US continued to print dollars left and right and kept distributing
it to all countries to fuel its hungry consumers. But then according to the
agreement the dollar was being supported by a promised denomination of Gold.
But printing more dollars is not same as mining more Gold! And hence
insufficient supply of Gold broke the system.
While US dollar had a fixed value against Gold which was
artificially set just to enable US to print more dollars, the price of the Gold
in the open market was much higher than the Gold supported by an US dollar! In
other words, if Gold of amount x was available for a dollar, the same Gold x
cost 3 dollars in the open market!
This meant countries could now use their piled up US
dollars to get back cheap Gold from US government (since US had promised fixed
amount of Gold to its dollar according to the Bretton Woods agreement), and
then sell it in the open markets for higher prices! Just imagine all the
countries that had kept piling up US dollars, now opting to give it back all,
in return for the promised Gold. Well, this happened on March 17 1968 (along
with violent protests in London the same day against US involvement in the Vietman
war) and US looked blank! Where is so much Gold? US had Gold reserves to
support only 22% of the dollars it had printed so far! What about the rest, and
obviously US cant give away all its Gold and go bankrupt on its own either.
Thus came the Nixon Shock in 1971 on 15th of August when
the then US President Nixon simply refused to pay Gold for US dollars anymore!
He didnt even consult IMF before announcing his decision. In other words,
entire world economies collapsed since their millions of dollar reserves were
worth nothing more than a bundle of paper! If any other country had done this
to US, then US would have nuked it out of existence, but since it was the great
military power of the world that had defaulted, all other countries had to keep
quiet.
Once the US refused to pay Gold for its dollars, the
world entered a floating exchange rate system, where the markets decided the
exchange rates based on demand and supply principle for currencies. While the
US dollar was supported by Gold, other currencies were held weak in respect to
US dollars so as to facilitate cheap imports to US. Now that the US refused to
pay Gold for its dollars, its economy came down as other countries stopped
buying its dollars since it was no more than a piece of paper now. So to boost
US economy, US had to now export goods instead of importing them. Gone were the
days when US could buy anything and everything just by printing more dollars.
So, Nixon heavily devalued US dollar to allow US exports to other countries, so
that US economy could get a boost. He even imposed 10% import duties so as to
discourage cheaper imports which would harm local industries.
Enter Petrodollar
But how long could US be without a strong dollar? Absence
of a strong dollar meant US would have to compete with other countries on an
equal floor and dollar would no longer be a dominating world currency. This
would remove economic US advantage in the world since there would be no demand
for US dollars across the world, and if there is no demand to US dollars then
why will countries prefer exporting their products to US only? And if that
doesnt happen then how to fuel US consumerism?
It should be noted that it is the consumerism that fuels
more buying which in turn fuels innovation, provides funds for further research
and hence leads to growth of science and technology.
So between 1972 and 1974 the then US president Nixon held
a series of meetings with Saudi Arabia, the world’s largest oil exporter, and
struck a deal where in US would provide technological and miltary assistance to
Saudi, and in return Saudi had to trade its oil exports only in terms of US
dollars. Now this resulted in two major advantages for US. One, all countries
which import oil have to pile up dollars, since only dollars are accepted by
oil exporting countries. This was because once Saudis agreed to trade oil in
terms of dollars, even OPEC (the organization of petroleum exporting countries)
agreed to trade oil only in terms of dollars. So oil importing countries again
started to trade with US and started selling their goods and services at throw
away prices just so that they could earn dollars to enable them to buy Oil. So
all oil importing countries started to build up dollar reserves, and this
boosted US consumerism, bringing back the world currency status to US dollar,
this time supported by Petroleum instead of Gold, and hence the term
Petrodollar.
The second advantage to US from the petro-dollar was it
could simply print more dollars to buy the oil it needed, and hence petroleum
became available in US at throw away prices, and this is what made owning
private cars almost one per head, cheaper in US. Without petroleum being not
just affordable, but cheaper, there was no way that a giant automobile and
airlines industry could have come up in US. Now that the US dollar is losing
its value again, the effects of increased petroleum costs on US roads is
becoming evident.
As described in earlier articles Iraq was invaded simply
because Saddam Hussein had started accepting Euros instead of dollars to sell
Iraqi Petroleum. This was a master blow to US economy and hence Iraq was
invaded. The WMD which Saddam had was none other than Oil. After US invaded
Iraq and dethroned Saddam the first thing it did was to revert back oil
exporting currency of Iraq to dollars. Similary Iran is being threatened by US
not because it has started Uranium enrichment programme but because it has
started accepting Euros instead of dollars. Similarly Russia has started
accepting its own Roubles instead of dollars to boost its own economy.
Venezuela is also switching to Euros to export its Oil.
Iran, Venezuela and Russia account for about 25% of world
oil exports, and if they do away with dollars, then there is a serious threat
to dollar stability, and would lead to serious inflation and recession in US.
UAE central bank has said that it will convert 10% of its dollar reserves to
Euros. Even Kuwait and Qatar have hinted at the same. Sweden has brought down
its dollar reserves from 37% to 20%. If there are no buyers for dollars, why
will countries export their goods to US, what will they do with the dollars
paid to them?
Biggest threat to US economy today is China which is
sitting on world’s largest dollar reserves. If it releases those billions of
dollars it holds in its reserves, then US economy will simply collapse. At the
same time, the dollar reserves are a threat to China itself, for if dollar
value comes down due to some other reasons, then Chinese collection of dollars
would be mere paper notes. Slowly the ground below the internation dollar
shaking, and shaking violently . It simply means US will have to go for a major
war to bring back the world economy into its hold again. The target can be
Iran, North Korea, Pakistan, anything and it has no ideological basis. It is the
military might which fuels the economic might and vice versa. When one is under
threat, use the other to recover. Its as simple as that.
What Promise?
By the way, today’s paper currencies have no inherent
value in them. Even though the Reserve Bank promises to pay the value mentioned
in the notes, consider inflation. What you get for 100 Rupees today, if you
have the same 100 Rupees three years from now its value will be less worth than
what it was when you earned that 100 Rupees. So where is the promise? What is
the promise all about?
Note that
your money is not supported by any Gold or Oil. Its just a piece of paper. The
moment you earn money convert it into something which has real value. For
instance, buy Gold or invest in real estate. Because these things have real
value in them. If you just end up saving your 10000 Rupees in a bank account, 5
years from now its value would have reduced due to inflation and would be worth
probably only 7000! Understand the economics of money and play safe. Dont save money
as cash, other than for the minimum amount required to face any eventual
emergencies.
