Money - Part 4

The fact that the value of dollars and the supply of dollars are two completely different things is a very hard pill to swallow. For example, during the past period of quantitative easing, the USD has functionally not budged. It's sat right around the CAD, and the Euro has been volatile against the dollar which has actually created periods of flight to the USD, increasing its value. The USD is a reserve currency. Economists like to state that "The demand generated from its prime reserve currency status has added significantly to the value of the U.S. dollar over the past several decades." Now I'd like to say something about that last linked article... it's another one of the "scare you into buying my favourite investment" sites, so take it all with another mound of salt. Also notice that they talk extensively about the Euro becoming a more important reserve currency than the USD. Well, given the recent trouble in the Eurozone, the Euro's status as a reserve currency has become somewhat dimmed. The question is - how much value does being the world's reserve currency grant you? I wager it's actually one of the single most powerful tools in a state's arsenal for maintaining a steady currency value: has printing more money had an overall negative effect on the USD? Absolutely not. It hasn't because the supply of dollars doesn't matter. People who want the gold standard back, or who want to scare you into trying to buy gold, will tell you that the supply devalues the currency... but it hasn't. Neither has the creation of money out of nothing that private banks perform on a daily basis.


So what is it that people are buying in USD that they can't get in other currencies? Well, lots of stuff. The USA is still a massive producer of really really sweet and awesome stuff. The classical American of yesteryear was a successful entrepreneur, building cars, computers, and toilet seats. Nowadays, though, a major contributor to the price of the dollar is the global demand for oil. That's something rather major, and it's denominated in USD. Buyt that's not all. Lots of stuff is denominated in USD even though it has nothing to do with the USA! A fully 85% of transactions, to be specific.

Furthermore, sins against supply and demand are possible by fiat: the Yuan, for example, is pegged to a "basket" of currencies... because the Chinese government says so. Yes, it has adequate reserves to fend off any form of speculation that could change the Yuan's government-controlled value... but the important thing is that the yuan's value has nothing to do with anything... it's just set where the Chinese government wants it. Fine, you may say... a central government of a well-known authoritarian state can control its currency's value by fiat, but thats not possible in a democratic free market econom... oops. Switzerland.

...so, as we were saying, some government simply has to say "we'll buy or sell our currency as much as needed to make certain it stays at a give value", and the currency is pegged. They don't HAVE to do any buying and selling, just threaten... and speculators will keep the peace for fear of getting burned. It's like having a financial nuclear arsenal: I'm a country, I can tax, offer bonds, and even print this stuff if I need to, and I will use it to enforce my fiduciary will.


What's the situation then? We can say the following things are probably true:
1) Currency values are not based on their money supply versus their reserves. We know this theoretically because banks are allowed to create money out of nothing, and that money does not affect currency values. We know this practically, because the USD went through a significant period of quantitative easing and came through more or less unchanged in value.
2) Some currencies are "reserve currencies", and these currencies gain value by this status alone. The USD has certainly benefited from this situation, as has the Euro, which has, many have complained, been artificially inflated against the dollar.
3) States can peg their currency by fiat. They may use tools like China or like Switzerland, but it remains a fact that state actors have the ability to exercise the muscle of their reserves in order to maintain the value of their currency at a given level. Canada even did this for a long time, and Hong Kong still does.
4) The currency supply does not influence currency value so long as there is a demand for the currency in business transactions. The strength of a currency is therefore more linked to how much business is being done with that currency than how much of that currency exists. This explains why it is in China's long-term interest to keep propping up the US through loans, because a majority of their reserves are held in USD, and a huge number of USD flow to China to purchase goods. If we look at this loop backwards, we see that since the majority of China's foreign currency reserves are held in USD, and their ability to peg their currency depends on the USD's ability to maintain value. They loan cash to the US so that the US will continue to buy Chinese goods, which increases the Chinese USD reserve, which further ties China to the fate of the USD. If they would let their currency float, they would actually be able to unhinge themselves from the dollar and let it drop; sadly for them, they believe it necessary to peg for the good of their manufacturing sector.

Perhaps the greatest example of supply and demand in currency values being completely unhinged is the most recent (and oft-mentioned) episode of quantitative easing the US unleashed. Important to understand is that we would never have known how much money the US Treasury created out of thin air unless Sens. Paul, DeMint, Sander, and Grayson chased down the Fed and forced it to produce a reckoning of the full amount. It was the first ever audit of the Fed in its close to one century of operation. That, in itself, is huge news. The full audit report is here and the recommendations here, but the main feature is the full amount of the bailout.

To put things in perspective, Canada's annual governmental operating budget - to run the entire country in 2011 - is:
$235,600,000,000 CAD ($235 billion)
Canada's national debt is:
$586,000,000,000 CAD ($586 billion)
The amount that the American congress' Supercommittee failed to address is:
$1,200,000,000,000 USD ($1.2 trillion)
The USA's current debt - that is to say, all the money that the USA owes to everybody, is (at the current second):
$15,094,945,129,699 USD ($15 trillion)

The amount given to banks by the fed in the aftermath of the global financial crisis was:
$16,000,000,000,000 ($16 trillion)

Again, to put this in perspective - they could have paid off the entire US debt.
The amount given to CITIGROUP ALONE (2.5 trillion dollars) could have run Canada for ten years without any taxes on our population whatsoever. It was not voted upon, it came from nowhere, and it was simply dumped into the global economy without so much as a blip in the value of the USD that could be attributed to it. This is perhaps one of the most exasperatingly obvious examples of the failure of the international monetary system. While a bunch of senators argue about 1.2 trillion dollars and don't come to an agreement about what to cut, the Fed can print more than 10 times that and not be brought to task. The more you think of it, the more absurd it becomes.

Have you seen it in the news? No?

I might wonder why that is.

At the end of all this, what can we say money is? I think we can classify it more for what it does: it's a tool for the redistribution of wealth. Wealth, of course, is all the stuff in the world that lets us live happy and healthy lives. Here's the rub: there's only a finite world with a finite amount of wealth, and we've already seen that there is a functionally infinite money supply. Economic growth is great, but the planet isn't getting any bigger, and there quite simply isn't enough wealth in the world to be bought by all those dollars. If all the wealth in the world was worth a quadrillion dollars, and we could print ten quadrillion (which we can), would that mean there was all of a sudden ten times more wealth? No. It would simply mean there would be nine quadrillion dollars with nothing to buy, or everything would have to be priced 10 times greater. Money supply is not simply unhinged from its value; it's unhinged from the amount of food in the world. It's unhinged from our health. It's unhinged from our ability to access an education. It's unhinged from our ability to maintain the vital environmental services that protect our ability to live on this planet. The travesty of creating money does not rest with the simple lack of correspondence between the market forces of supply and demand on currency value. It lies in the fact that money is simply a tool to redistribute wealth in an economy, and we can't eat it. When the amount of money in circulation doesn't have anything to do with the amount of real wealth in circulation, wealth is not being distributed correctly. There's a problem here, and it isn't going to be solved by quantitative easing.

Money - Part 3

Money has several very interesting facets. One of the facets is that - due to the odd current system we live in where private banks (not the mint or Bank of Canada) can create money on a whim - demand and supply are more or less completely unhinged. Your eyes perhaps rested on the part of that sentence where I said "banks create money on a whim", right? Well, more accurately, private banks actually create money out of nothing. If you click the link that I referenced just there, you'll note it goes to the Bank of Canada website. On the Bank of Canada website, it says:

Commercial banks and other financial institutions provide most of the assets used as money through loans made to individuals and businesses. In that sense, financial institutions create, or can create money.
The Bank of Canada manages the rate of money growth indirectly through its influence on short-term interest rates, or through the reserves provided to large deposit-taking institutions.

Which is interesting, because it basically means Canada has no real control over its money supply: money is created and destroyed by banks and other financial institutions. In a way, this makes sense: in order to make money on deposits, a bank must invest those deposits. The problem is that a bank cannot have money in two places at once. If it wants to make money on deposits, it must take the deposits out and put them into loans or the market. It can't leave them in a vault and hope the pennies have copious sex with one another. What is a bank to do? It writes your account balance on a piece of paper, and loans the money you gave them out to someone else. The person who took the loan got real money - you get an I.O.U. Poof! The bank just created money!

Perhaps this is a bit hard to take. Let's make it more concrete: you have $100. You invest it in the Bank of Bob (the initials of which, conveniently, are also BOB). I need a $100 loan from the BOB. BOB writes in your account book that you hold $100 in their accounts. BOB then gives me $100. In effect, we both have the same hundred bucks. I hold the real currency, and you have a piece of paper that says the bank will render you $100 upon demand. Let's say you leave the money there until I pay back the loan. I pay back $100 plus $5 interest. You close your account and take your $100 back, which gained $2 interest. The bank pockets the $3 difference. The $100 IOU is discharged, and the money supply effectively shrinks again. I say that the money supply "shrinks" because really, at the time the loan was created, you had $100 and I had $100, and it meant that our little economy held $200. When the loan is repaid, the bank receives $105, gives you back $102, and keeps $3.

The cozy thing about this is that the math all works out - no money is created or destroyed. The I.O.U. is discharged when I wish to take my money out... but something isn't right. We have an economy of three entities here: you, me, and BOB. You give $100 bucks you have in hand to BOB. BOB invents another $100 bucks out of it (which we can accept, it's actually an I.O.U, not real money) and gives me $100. The economy is operating with $100 real dollars still and $100 "owed" dollars: a promissory note for a hundred bucks. At the end of the loan the economy once again contains just the... hey! Wait a minute! Where did that extra $5 come from? In effect, it has to come from outside the economy, or be created someplace, or... or it is loaned by someone else to pay the debt.

Hmm. In a closed system like this, the only way for debt to be paid is further debt from other banks, which itself leads to further debt. Well, one way to make up the money is something called "quantitative easing", which is really just a fancy name for "making it up out of nothing". A lot of the extra cash that society needs to pay off debt actually comes, one way or another, from the government going deeper into debt; either through bond issue (which is to say, going into debt where the creditor is the public itself), quantitative easing, or just changing the interest rate. We discovered in the 80s that the high interest rates didn't make the money supply heed the helmsman, so I'm consistently wondering why we think lowering the yield curve will in any way correct the financial troubles of the current US economy... but I digress. My main point here is that the government makes money. Out. Of. Nothing.

In a reserve system, the supply of money versus the commodities and currencies held in reserve should devalue the currency. As I said before, however, the supply and demand of currencies are no longer correlated. Supply is just supply: it is created out of thin air by banks, by the government through quantitative easing, through bond issue, fairies, whatever. Demand relates to what the money is used to buy, not with how big the money supply is. Dollars buy you iPhones. Dollars buy you oil.

On to part 4.

Money - Part 2

The only reason people buy currency is because they need to use that currency for something. Just like people buy soybeans because they want to make tofu. The forex, however, has turned into a market where I would imagine a majority of the trades are now speculation. Real money has real use, and I have to use Canadian dollars to buy Canadian bonds, just as real soybeans have real use, and I need soybeans to make tofu. There are speculators who bet on the market that there will be high demand for soybeans due to a drought, blight, or rising demand for tofu. This is no different from speculators who purchase the Canadian dollars because Canadian bonds are a good buy and they feel the dollar is under-priced. People who speculate on gold, silver, and platinum are also betting on commodities, not articles with intrinsic value. Silver and gold have skyrocketed in value in part because of the perception that they are shelters from the storm, but this is something of a false perception: gold and silver are beneficiaries of demand - in part driven by the speculation that they are a good place to shelter money. Did you follow that? Gold is benefiting from the financial uncertainty of the markets, and the fact that people think it is a good place to shelter their money. It's got value primarily because it is a catch-22 of perceived value: I think it's a shelter so I buy it so it goes up in value so its a shelter.

Precious metals are not immune to demand-driven shocks. Their value does not track inflation. They do not have a guaranteed increase in value over all time periods. I'll cite one case in point: platinum's market crash in late 2008. An article makes it clear why platinum has value: it's used in car catalytic converters. Why does gold have value even when years worth of gold stock is above-ground? I love this quote:

Why is gold produced?  There are plenty of tons of it in aboveground stockpiles, decades based on annual consumption, so why burrow miles into the earth to bury it in a vault?
The value gold adds to society is in its ability to assist us in performing mental calculations of value.  When using gold as the numeraire a much more accurate assessment can be made when allocating capital.

Soooooo... what the author is saying is that platinum has a price based in demand for automobiles. The value of gold is that it helps us with math. IT HELPS US WITH MATH. She openly stated that there is a glut of unused gold above ground that is doing sweet nothing, which smells of bubble to me. Here's more to love, from the Economic Times of India:

Central banks in emerging nations have been buying more of the metal to diversify their reserves. Most central banks hold their reserves in currency, and mostly in dollars. While many have diversified to increase their holding of other currencies such as the euro, economic troubles have meant the value of the currency holdings has depreciated vis-a-vis the domestic currency. In comparison, gold has been rising, and central banks holding big quantities of the metal managed to protect themselves from losses due to erosion of reserve currencies.

I'd like to point out first and foremost that many readers might have initially thought that all national reserve banks MAINLY held their reserves in gold... but it just ain't so. The Economic Times also mentions, "Gold prices are far more volatile than platinum, as has been evident during the course of this week. For that matter, over the past few days, as perception of risks eased, so did gold prices. Platinum prices draw their strength from economic cycles and industrial demand." Platinum's price is based on demand. Gold's price is based on lack of confidence in the economy. One of these things is an idea, and the other is real. A bunch of people acquiring large stockpiles of stuff and not selling it because they think it adds value to their portfolios is not a recipe for long-term growth in value: it's a recipe for a bubble bursting, just like it did on radio stocks in the 20s, tech stocks in the early 2000s, and housing at the end of 2007.

I'll take one last swipe at gold by saying that before the stock market crash in early 2000's, people bought tech stocks because hey... they were winners. The tech stocks crashed and then people ran to the only two safe bets left: gold and real property. In 2008, people fled from property, and now they only have gold to flee to. In times like these, people buy and hold. When there's a load of unused stuff out there on the market, it takes but one perception of a move from that commodity to start a flight from it, too. I would love someone to explain to me, after some financial apocalypse, how they intend to redeem their gold for useful items? It will be just as useful as money: a commodity that is neither food, nor gas, nor booze. If you want something that survives economic meltdown... build a still. But that is not what I came here to write about. I came here to write about money.

On to part 3.

Money - Part 1

It seems many people are not quite fully informed about what money is, where it comes from, and from where it derives its value.

There are lots of theories about what civilisations did for currency and trade in ancient times. Barter is a popular economic theory for prehistoric trading, though most peoples did not likely operate on a strictly goods-for-goods economy. Contrary to popular belief, economies as a subset of cultures are better studied by anthropologists and sociologists than economists. The models that economists have about the primordial tribal systems of trade that humanity evolved are a complete mismatch with reality. Many cultures' economies were based on gift-giving that created social debts between people rather than financial ones. Anthropologists will probably tell you that the gift was the first basis of all economies. The concept that coinage evolved to replace barter because it was more convenient is a common but almost wholly counterfeit story - it is more of a thought experiment with no basis in actual fact. Anthropologists have not found evidence this ever occurred in any civilisation, ever - the "spot trade" is not normally possible in a barter system, and not typically practiced. It's easier for a pre-literate society to handle "trade" as a subset of politeness than it is to handle it as a subset of maths and statistics.

The development of currency was neither uniform nor widespread in early civilisations, and coinage did not invariably develop for the purposes of trade. Germanic tribes in the times of Tacitus used gold coins as one of many items of trade, but they were a fundamentally gift-giving culture. Tacitus writes that in German tribes, if a guest's eye rested too longingly on another person's possession, it behoved the owner to give it over immediately. Coins, as useful as they might have been to the Germans, were, more often than not, sunk in a bog for the Gods' gift of victory in the next battle than used in trade. So much for a clean theory on where money came from or what it was used for. The myth about barter and the convenience of coin is actually a convenience for economists. When it comes to the actual history of the matter, I would prefer to trust archaeologists, sociologists, ancient historians, and anthropologists, thank you.

Money was based on precious metals for a long period of time. The link cited there on wikipedia has a good quick reference chart on what has been used as the "reserve" at any given time in history. We became accustomed to money being valued against something. The adage that paper money and fractional reserve banking evolving from goldsmiths' proto-banks is apocryphal, (and I recommend you take the linked movie with a mound of salt) but it can serve a purpose of understanding how we may have been able to reason the need for paper money versus coinage. The Goldsmith's story is an oft-repeated example of fractional reserve banking and it does at least make the concept somewhat accessible. Again, I stress - this isn't historical fact, it's just an illustration. Take from it what you will. Here is something a little more factual.

The issue is that since 1971, money has been traded without being based on anything except demand. Nixon eliminated the gold standard, and ever since, currency has been traded like a commodity. If you've ever traded currency on the foreign exchange (forex), or tried one of those free accounts the brokers give you (try it, it's fun and you learn a lot by doing), you know that currencies don't have value except against other currencies. In order to trade, you must purchase a currency "pair". That means you buy one currency with another currency. For example, I could go long on the Aussiedollar versus the Swiss Franc which means I take my own currency, and purchase Swiss Francs to buy Australian dollars. A long position implies a short position: I believe the Aussiedollar will increase in value versus the Franc. In effect, you could also say I'm shorting the Franc with Aussiedollars just as much as you could say I'm going long on Aussiedollars against the Franc.

On to part 2.

Revisiting the Open Letter to Mom and Dad

Well, here we are. The Spring has come home, and Europe and North America are finally waking up to the paradigm-ending economic shocks we had back in 2008. When the Guardian ran a piece recently about the Occupy Wall Street movement, what it had this to say about the current crisis:

What we've learned now is that the economic crisis of the 1970s never really went away. It was fobbed off by cheap credit at home and massive plunder abroad – the latter, in the name of the "third world debt crisis". But the global south fought back. The "alter-globalisation movement", was in the end, successful: the IMF has been driven out of East Asia and Latin America, just as it is now being driven from the Middle East. As a result, the debt crisis has come home to Europe and North America, replete with the exact same approach: declare a financial crisis, appoint supposedly neutral technocrats to manage it, and then engage in an orgy of plunder in the name of "austerity".

Echoed my own sentiments so closely that I was relieved to know at least one other person was thinking the same way as I: that this is the fight our parents failed to finish in the 70s. They failed to finish it because the oil taps opened up again, credit began to flow, and stagflation made them hold on to their jobs. It was a perfect storm of threats and inducements to maintain the established economic order.

Thankfully, people are standing up and calling a spade a spade. On the 6th of March this year, I said:

We're at a historical tipping point. There is still time to do something about it, but the job of my generation now is to force [your generation] to care. We've got to snap you out of this late-life reverie of a paradisiacal post-employment existence in the south of France, sipping wine. The economic system is buckling. If we keep thinking of things in the terms of well-worn economic adages (you know, the same theories that said such a thing as stagflation couldn't exist - the same stagflation you lived through?) we will keep getting the same economic results. We need a change. We need you to wake up that dormant war-resisting flower child. We need to pull the cobwebs off your sleeping inner homesteader. Didn't you notice that the American boomers - the ones who grew up as flower children - were the same parents who proudly sent their kids off to war in the Middle East?

Well, here we are.

Coppice Agroforestry

I am very keen on the forthcoming book Coppice Agroforestry as it is right up the alley of what my thought experiments have been leading into. A sustainable resource stream from a relatively low-maintenance and versatile crop. Coppicing (called pollarding when stems of trees are cut higher) can do everything from providing leafy fodder for animals to providing switches for basketweaving to beanpoles to firewood. It's a sustainable mode of agroforestry that keeps the landscape in a constant state of renewal, which fosters a diverse and varied ecosystem. The guys who are writing this book are the ones who wrote the two-volume set Edible Forest Gardens, veritable bibles of the practical side of Permaculture.

Others are involved in the sustainable silviculture revolution. World Agroforestry Centre promotes sustainable use of forest resources and provides plenty of data on sustainable silviculture - specifically geared at releasing products to market. This, along wth the UN's recent (finally!!) interest in sustainable organic agriculture and food security, should go a long way to promoting sustainable farming practices and ensure livelihoods for lots more small-holding permaculturalists.