Index
1. Presentation
2. What is the support or the real value of the dollar
and gold?
3. The exchange rate
4. What is the
utility of to support the currencies in dollars and gold?
5. Is there a limit to the amount of money that
countries can issue?
6. Does the growth of liquidity cause a bank run?
7. How to face
the danger of a run on banks
8. Exchange control
9. The ideal level of liquidity
10.
Fiscal deficit and austerity
11.
Conclusions
1. Presentation
Gold was the backing of currencies and Sterling Pound the
world trade coin until the end of World War II. From that time (Bretton Woods
Agreement 1946), emerged a new economic order in which the dollar of the United
States of America became the currency of support from other world currencies and,
in turn, in the money of international trade, while gold and Sterling Pound
went to play a secondary role. This placed the United States as the leading
economic power in the world.
Since then, the world accepts as an axiom, as indisputable,
the dollar of the United States of America and gold, in second place, as the backing
of the countries’ currencies. Consequently, the coins must have a backup value with
both instruments.
I make these reflections because I have seen how some
economists in Latin American countries such as Venezuela, talk about inorganic money
or unbacked money as a cause of inflation and not sufficiently explain what
these concepts mean. I imagine that they refer to money without enough support
in dollars or gold. In this work I will explain why a full backing in dollars or
gold is relative and not a vital or essential condition for the good development
of currencies.
2. What is the
backrest or the real value of the dollar and gold? That is the key question.
The answer to the question is very simple: the money
circulating in the world, including the U.S. dollar has no intrinsic value or
tangible support and its only value is its acceptance as a mean of payment, i.e.
a fiduciary value, it means based on the confidence of the giver and the
recipient. Gold, in turn, despite being something tangible, has a relative
value, especially given because it is used as an instrument of reserves by
central banks of the world countries but, in reality, gold has too few practical
applications. Hence we can infer that the world's currencies that sustain its
value in gold have no solid backing, but only the good faith of issuers and
users of these currencies, because none person can eat or drink gold and, as was
said before, its use in other economic activities is also restricted. We can
say, then, in the form of metaphor, that gold is also a fiduciary instrument.
3. The exchange
rate
Governments set the exchange rate regarding the dollar
according to their political interests and its position in the international economy.
Some countries keep their currencies at par with the dollar while others
depreciate to improve their competitiveness in international markets. Britain
and the European Union do the contrary; they maintain their currencies revalued
regarding the dollar and, however, have a privileged position in the
international trade; this fact demonstrate that a depreciated exchange rate is
not the key determinant of the position in the world trade.
4. What is
the utility of to support the currencies in dollars and gold?
The backing of currencies in dollars or gold serves theoretically
for two purposes: a) to limit the amount of money in circulation and b) to ensure
the conversion of national currencies into dollars or other currencies to buy
or pay in external markets.
5. Is there a
limit to the amount of money that countries can issue?
Theoretically, the amount of money in circulation in a
country must be related to the amount of foreign reserves accumulated in its Central
Bank. The implicit exchange rate of a currency is determined by dividing the
monetary liquidity between the total of the international reserves.
Nevertheless, it is necessary to underline that the implied exchange rate is not
always fulfilled in reality; it may be less, equal to or greater than the ideal
figure.
The truth is that governments can issue all the money
they need in their local currencies, i.e., increase liquidity to meet the
internal needs of the economy with no limitations but those that suggest
prudence and good sense, without altering the official rate of the national
currency regarding the dollar. This means that the implicit exchange rate does
not necessarily have to be the rate of change in the market. The reason will be
explained in the next paragraph.
6. Does the
growth of liquidity may cause a bank run?
Under normal economic conditions, it is assumed that
all citizens of a country are not going to present in the banks on the same day
and same time to withdraw their money in national currency or change the
currency for dollars or other currencies. That is the principle on which is
based the existence of banking and insurance, because all depositors do not draw
back its money simultaneously neither all people insured suffer mishaps at the
same time. For the reason explained above, in a situation of relative stable
economic conditions the implied exchange rate does not necessarily have to
match with the rate of change of the market.
The situation
is different when the economy suffers a currency crisis or instability that
makes economic actors seek refuge in hard currencies. In that case may appear
the phenomenon of bank runs, i.e. the massive withdrawal of funds in domestic
and / or foreign exchange. But this does not happen as a surprise. The behaviors
of economic agents always give signs that allow foreseeing the storm.
7. How to face the
danger of a run on banks and / or foreign currency
There are three alternatives: a) to establish a strict
exchange control before occur the run and / or b) accumulate a high level of
foreign exchange to meet the emergency, and c) to set limits to the withdraw of
money in national currency. Note that in
either case we must bear in mind the figure of the lender of last resort; in
the case of dollarized countries is the Treasury of the United States and in
non-dollarized countries is the respective Central Bank in each country, which
is responsible for issuing money to meet the contingency. A bank run is a money
problem and is solved with money. Different is a natural disaster that is not
solved with money.
8. Exchange
control
In extreme situations of weakness in the money market
and foreign exchange, the countries sometimes have no other choice but to
impose an exchange control. This measure
may be a temporary solution but at long term usually the exchange control
creates other distortions that prevent the normal development of the economy,
like the emergence of parallel currency markets that exceed many times the
official rate of exchange.
9. The ideal
level of liquidity
Money is the instrument that drives the economy of a country,
therefore, what determines the recession or expansion. The growth of the amount
of money in the economy must be related to the behavior of the economic
activities.
10. Fiscal deficit and austerity
In recent times, the deficit of the public finance of nations
has become the great sin to atone. That is what has happened in the United
States where some institutions of the government suspended its activities in
October 2013 because the Congress did not authorized an increase in public
spending and debt levels. Europe, since 2008, also has implemented a strict
austerity program to reduce or eliminate the public finance deficit of the countries,
especially the least developed nations such as Greece, Iceland, Portugal, Spain
and Italy. These austerity measures have led to increased unemployment levels and
reductions in the quality of the public services that hurt the vast majority of
the population of these countries.
The public finance deficit should not exist, neither the
policy of austerity; the reason is very simple: because governments have the
sovereign power to issue money to meet the needs of its domestic economy. But, usually,
governments choose the hard way: cut public spending, thus causing recession
and unemployment of millions of people.
What does constitute a real problem for governments is
when the country has not enough foreign exchange to buy or attend international
commitments. In that case, there are two ways: a) produce more to sell more in
international markets and obtain more foreign currency and/or b) borrows
dollars from international banks.
11. Conclusions
- Money circulating in the world, including the dollar
has neither intrinsic value nor enough support in gold.
- The value of gold is relative because their value of
use is limited.
- The only value of money is its acceptance as payment
means, it is therefore, a fiduciary instrument.
- The concepts exposed in this work have demonstrated
why the backing in dollars or gold is something relative and not a vital or
essential condition to fulfill the role of currencies as mean of payment inside
the borders of each country.
Entradas
