In December 2014 the US Federal Reserve called for a higher core-capital requirement pertaining to the big banks, JP Morgan Chase, Citigroup and Goldman Sachs Group Inc. included. Federal Reserve Chair Janet Yellen is geared to raise the capital requirement mainly in response to the appreciated US dollar. This action has brought about a substantial amount of opposition from the banks, who are in current talks with the Fed to mitigate requirement increase repercussions for short term funding. The ‘big 8’ US banks argue that the requirement raise gives clear disadvantage to European banks, where European and Asian monetary policy is clearly becoming bullish. Naturally, the appreciated US dollar has negative implications for big US corporations with largely overseas markets.
Such is the power of currency movement. It is widespread belief among the general populace that an appreciated currency is a good thing. An appreciated currency can mean more short term spending power for citizens on both domestic and foreign goods; if used wisely, an appreciated currency can internally improve a nation’s physical and human infrastructure. However, if a sovereign with a sustained appreciated currency has a long term aggressive foreign export policy, the effects on economic growth can turn nightmarish. In the case of the US, while general exports comprise only roughly 15% of GDP, investment flow between the EU and the U.S. exceed US$3.7 trillion, approximately six times the direct investment of NAFTA members. The big banks may have a point to contest ongoing increases on capital requirements if the US currency value trend continues into the medium term.
We tend to pinpoint currency devaluations and revaluations as a predominant sign of economic growth or contraction, and rightly so. Yet, have we stopped to really examine the tenet of what constitutes currency in our monetary system? Fiat currency is money that is decreed by the government to act as currency, with no real or intrinsic value. Fiat currency is not a new concept; ancient kingdoms and governments have long created money with no asset backing to finance the machine of war, or to generally stimulate economic growth. It is by and large an unsecured IOU from a government’s treasury, which all players in the economy accept to be legal money for tender. Fiat currency has historically been tied to redemption by specie; where dollar bills would be primarily fiat, yet tied to a fixed collection or commodity: taxes, agricultural commodities, and of course, bullion. Both World Wars’ excessive fiat currency circulation led to a great inflationary climate, which in turned spurred the US currency to be fixed to gold for value, with other sovereign currencies fixed to the US dollar via the Breton Woods Agreement of 1944. The monetary system remained collateralized to bullion until 1971, with Nixon’s dismantling of the Breton Wood’s Agreement by removing the US’s conversion to gold. The global monetary system generally became a free float once more.
Pascal Emmanuel Gobry, Forbes contributor and HEC Paris economic lecturer, has argued that there is no distinguishing between fiat and commodity backed currencies. That, in essence, all means of tender can be considered fiat, inclusive of hard commodities. His theory is an interesting one – since we are the initial creators and consumers of currency, anything we use as currency, say cigarettes in prison or Tide detergent for drugs (real life cases) will be given ‘intrinsic’ value in that environment. Even bullion he considers to be fiat, since at some point in the juncture of human evolution we unanimously decided that gold was one of the most valuable commodities. Even ex Fed Chair Ben Bernanke called holding gold as bank reserves a mere “tradition” in a 2011 Economic and Monetary Outlook session. Yet, many economists swear by gold’s intrinsic value as reserves and as commodity currency. We quote Alan Greenspan at the 2014 Council of Foreign Relations:
“Gold is a currency. It is still, by all evidence, a premier currency. No fiat currency, including the dollar, can match it.”
In the ultimate analysis, trust is the ultimate point behind our monetary system. We the people have put our full trust in fiat money. The monetary system has no recourse but to oblige. If we blame our central banking and monetary system, it is only because we have decided to stay unaware of paper money as a debt-based IOU without intrinsic value. Our global paper money is by and large no different than Monopoly™ money. Actually, we can even go as far to say that Monopoly™ players place more present value on the play money, since in the moment they may feel in control of their decisions to buy, to sell, or to hold, then in our own created monetary system. At the end of it all, we can ‘occupy’ Wall Street, and cry foul on the motives of the big bankers and central banks. However, until the populace takes ownership of its part in the creation of this system by becoming aware of its constructs, full blame cannot be shed on the big players in the system.
Our monetary system has its faults, and the big players in the game can alter the market at will, since they have the most intrinsic asset values, allowed by the blind dependence of the populace. Until the populace trusts itself to make informed decisions independent of external ‘pushes’, then in fiat currency and our current monetary system we trust, possibly to our detriment.
This post was originally published by the Financial Policy Council, February 14, 2015.