A Silver Lining (Part 6)

Would it be wishful thinking to hope that that there is a silver lining to the Covid-19 cloud hanging over the world? Every event that brings about change also brings about opportunities.

1971 brought a major change to the world monetary system. Before 1971 the world had a clearly asset based monetary system, even if the asset base sometimes looked tenuous. Up to 1945 International debt was settled in gold or other precious metals, In 1945 the Bretton Woods agreement brought about a major change where debts would be settled in US$, the US guaranteeing convertibility of the US$ to gold. at a fixed exchange rate. In 1971, possibly as a result of France converting it’s US$ holdings to gold but more likely because the open market price of gold was already substantially higher than the fixed exchange rate guaranteed by the USA, Nixon suspended convertibility of the US$ and the world entered the era of free floating currencies, or  the ‘green cheese era’ as I call it.

The biggest effect of this change was to create a foreign exchange market. In London for example the value of forward exchange transactions every week exceeds the sum of total annual world trade and London is only one of several centres around the world engaging in this activity. It is effectively a betting market.

An asset based monetary system is always faced with the difficulty that increasing the money supply within a country requires either an increase in the physical quantity of the asset, through mining or exporting more than one imports, otherwise if a country runs a current account deficit (imports exceed exports) a devaluation of the internal currency against the asset is required. An asset based monetary system provides a form of self regulation to an economy, largely preventing the development of asset price bubbles spreading from one country to the next (the 2008 credit crunch). It also provides for much more stable exchange rates making longer term investment decisions based on export potential, much easier to make. Free floating currencies have on the other hand, tended to result in businesses instead of expanding locally choosing to invest in the countries which are in fact their target markets, increasing the globalisation effect referred to in part 3.

What most have failed to realise is that the Nixon action in 1971 actually returned the world to a barter system.  For example when we pay for an import, we are paying with a promissory note, a promise to pay. Whether we buy forward currency or not it is still a promise to pay that is received. The transaction only completes when that promissory note is used to buy something from us. For this reason we see this money being used to buy businesses in our own country, our politicians call this ‘inward investment’ in truth it is extraction of payment for our past imports.

If we look at ownership of business in the UK we see a large number of iconic British names that are actually foreign owned. Each time there is a foreign takeover of a British business there is a weakening of our economy in that the future profits of that business instead of flowing back into our economy strengthening it, they will flow into a foreign country and strengthen that instead.

Perhaps this article on sterling will help to understand what has happened and why I call this the ‘green cheese era’.

It is my hope that the world takes a serious look at our global monetary system, perhaps taking a new look at Keynes; ‘Bancor’ proposed at Bretton Woods. This proposal was over ruled by the USA on the grounds that both debtor and creditor nations would carry part of the cost of adjusting imbalances, while the Americans believed it should be the sole responsibility of the debtor nation. The ‘Bancor’ idea can be improved so as to ensure capital flows into the less developed countries without necessarily enslaving them to the World Bank or IMF.


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