Monetary Relativity — On Money-V
This, then, is the dilemma of an international monetary system—to preserve the advantages of the stability of the local currencies of the various members of the system in terms of the international standard. – JM Keynes
In a closed national or local system, the question of money is simpler than in a global system where currencies are exchanged. Over the course of history, commodities, particularly gold and silver served as monetary standards, providing objective value by which currencies could be exchanged. However, over the last four decades, a new system has evolved. In this system, money has no objective standard, but is given value by “the market”. It is a system of relative value vulnerable to profound volatility.
How does a currency derive its value when it is tied to no objective standard? The short answer is through “the market”, but that is insufficient. For thirty years, “the market” ace has trumped all questions on the economy, despite the extremely squishy understanding of just what “the market” is. To say the market defines value of contemporary currencies is at best a dodge.
Today’s currencies, tied to no objective standard, are instead valued by everything. The entire economy of any nation gives their respective currency value, while their central bank assists by controlling volume. In some nations, such as Australia, or smaller and less developed nations, currency values are greatly dependent on their natural resources, like commodities such as oil. Others, such as Japan and South Korea, gain value with their industry. Many currencies are also tied directly to the dollar, as the dollar, though no longer an objective standard, remains the main global reserve currency. A nation can keep its currency stable on global markets by keeping in their possession dollar reserves — holding onto a certain quantity of dollars.
The value of the dollar is derived from US agriculture, natural resources, industry, education, and all other aspects of our economy. The dollar’s value is also derived from the military, by far the largest on the planet, which holds together much of the global economic system as currently structured. Thus the dollar, serving as the dominant global currency reserve, also gains value from this global system as a whole.
In the present system, the day to day, or more accurately the second to second value of the currency is gained by traders, who buy and sell currencies twenty-four hours a day. Just as every other aspect of our economy has been financialized, that is made trade-able, so too has the dollar and most other currencies.
Over the last decade, the dollar undertook an almost uninterrupted steep devaluing against most other major currencies, a decline of almost 40%. This devaluing has raised increasing questions on the role of the dollar as the major global reserve currency, for if a nation is holding dollar reserves, which are incessantly losing value, it becomes a problem for your currency, particularly if you’re an exporter.
One result of the devaluing dollar global currency standard has been a massive increase in the price of commodities – agriculture goods rose 20%, metals by 300%, and fuel by 500%. Of course, there are other factors involved in the rise of commodity prices, including rising demand and tighter supply, and dysfunctional too speculative driven market structures, however, after the dollar rose in response to the Great Financial Panic and then began to fall again, the correlation between rising commodity prices and the falling dollar once again proceeded in lockstep.
In the last four decades, for the first time in history, we have created a completely relative monetary system, where currencies are untethered from any standard, and priced by being bought and sold through jokingly loose regulated trading. This creates two problems. First, as currencies become value relative, they lose their ability to provide vigorous price signals, thus undermining one of laissez faire’s cherished orthodoxies, the pricing system, and creating distortions in valuing the real economy. One only needs to look at the volatility of the commodity sector in the last ten years to understand the impact of monetary relativity. Just as all other aspects of economic financialization, monetary relativity has been advantageous for one group – traders, Wall Street. It has been harmful to the real economy.
Secondly and most urgently, the break down of, or call it the “financial innovation” of fixed currency standards, and their replacement with distorted relative values derived from a dysfunctional trading system, has created a situation of increasing currency instability, susceptible to violent swings. Just as we saw in the recent financial panic, currency markets have been deregulated and untethered, while on top of them lie trillions of dollars in derivatives tied to currency values, interest rates, government bond prices etc, in which a period of sharp currency volatility or panic could cause great damage. This volatility would not need to be instigated by a sharp decline or rise in the dollar, though that would serve the purpose, it might also be catalyzed simply by a short period of sharp fluctuating currency values, that were large enough to begin a series of events where parties could not meet their obligations, such as the recent failure of AIG, but in amounts and damages to the system that would dwarf the AIG fiasco.
Now, as stated in the beginning, central banks by controlling volume of a currency and taking active roles in buying and selling, also contribute to a currency’s value. In the last two years, we have seen unprecedented and extraordinary moves by the Fed and many other central banks to flood the system with money in an attempt to fight the deflationary results of a popped financial bubble, in part caused by the devaluing dollar. The action of the Fed has created new inflationary asset bubbles across the globe; in commodity markets, housing values in China, and stock markets. It has made the pricing mechanism already distorted from years of monetary relativity, all the more so. It is the equivalent of dumping gasoline on a thick forest with decades of dead undergrowth, all that’s missing is a spark.
Next: Rethinking Money