"Today, it is being speculated that perhaps the Global Financial Crisis was merely the tip of the iceberg, and that there is a deeper and much more pervasive underlying problem that the general public might be unaware of."
The Global Financial Crisis of 2008 is considered to be one of the worst financial disasters to hit the world since the Great Depression of the 1930s. As the markets crashed, stock prices plummeted and financial institutions collapsed, governments all across the globe issued massive bailouts and stimulus packages to stabilise their economies. Although the measures taken by the governments appeared to aid the financial rehabilitation, they also created a sense of doubt and unease in the public mind.
Today, it is being speculated that perhaps the Global Financial Crisis was merely the tip of the iceberg, and that there is a deeper and much more pervasive underlying problem that the general public might be unaware of.
The story of this problem dates back to 1944 with the Bretton Woods Conference in the United States. During this conference, the countries decided to fix and adjust their exchange rates to the U.S. Dollar. The dollar on the other hand fixed itself to gold at the existing parity of US$35 per ounce. This system was established with a motive to overcome the rigidities of existing international monetary systems, promote economic growth, and exchange rates stability. It allowed countries to trade their currencies for the U.S. Dollar which they could then exchange for gold. Precisely, this meant that all the currencies were backed by gold. To avoid the logistics of physically transporting gold across the globe, when countries exchanged their currency for gold it was usually stored safely in the United States. The trouble was that this exchanging policy only applied to foreign governments and central banks causing budget deficits for the U.S.
By the 1960s, commitment towards the Vietnam war and the space race further added to the budget deficit of the U.S, making other countries suspect that the U.S. was spending more money than the corresponding gold reserves it had- more dollars were being printed with a lack of physical gold to support it. As a result, other countries began demanding to exchange their U.S. dollars for gold and physical delivery of the gold.
This was the first sign of a crisis. To prevent the outflow of gold from the United States, President Nixon temporarily halted the USD to Gold conversion system, in 1971. The explanation given for this action was that it would “defend the dollar against speculators”.
Since then, the U.S. has mostly had a budget deficit, as there was no longer a connection between the USD and gold. Reason being that under the old system, should a country face budget deficits the gold would flow out of the country until a balance is struck. However, without any gold backing, the country would run perpetual deficits.
By abandoning the gold standard President Nixon created a fiat currency where all currencies were backed by nothing but government promises. A fiat currency essentially operates on the public’s confidence in the currency and the government’s force. It remains in circulation for a period of time, until people start losing their confidence in it.
With currencies no longer backed by anything tangible with intrinsic value, their value was measured only in relation to each other. Therefore, countries started to devalue their currencies deliberately to produce goods and services cheaply, and become favourable trading partners.
It does not seem like a great problem until now but the tables turn when we bring into the picture the Ponzi scheme. It is essentially an investment scheme where the organisers promise the investors massive returns with negligible risk, and quickly. Sounds too good to be true? Well, it indeed is the case, Ponzi is a fraudulent scheme that pays its existing customers from the funds collected from the new customers. It does not use the money invested to build wealth but to only attract new customers. Therefore, in the long run, a Ponzi scheme must constantly bring in a larger and larger number of customers to pay off the old customers and continue functioning.
Eventually, the scheme collapses if a large number of customers cash out together or no new customers can be found. What is left behind are the customers who did not cash out at the right time and lost their money to the perpetrators of the scheme.
The U.S. is running a similar kind of Ponzi scheme, but the scale of it is huge. With no links to the gold, the U.S. Treasury has been able to borrow and spend as much as it wants. Thus, when the U.S. government requires money it takes out a loan from the Federal Reserve, which prints the currency required for the loan. In return, the Federal Reserve (which is the central bank of the U.S. and arguably one the most influential financial institutions of the world) receives an I.O.U. or government bond from the U.S. Treasury. A government bond represents the government’s debt that is issued and sold to support the government expenditure.
With the money received from the loan, the U.S. government pays its bills and obligations. Simultaneously, the Federal Reserve and U.S. Treasury work in tandem to sell these bonds at auctions, where foreign central banks, pension banks and individuals purchase these U.S. government loans because they are virtually assumed to be a risk-free investment.
However, if the money received by the U.S. government is spent on bills and previous loans, where does the money to pay back the current loan with interest comes from? To pay off the current loan plus the interest charged on it, more money is borrowed. Imagine a hypothetical scenario where the government borrows the U.S.$1 from the federal reserve, now to pay back that dollar with interest is impossible unless more money is borrowed since there was originally only one dollar created. Hence, the debt keeps augmenting.
As mentioned before, the U.S. has been running trade deficits ever since 1971, which suggests that the U.S. is importing more than it exports, more USD is going out of the country. If other countries like South Korea, China et cetera convert the USD they receive from exporting it would inflate their currencies, making them less suitable trading partners. Therefore, even the other countries prefer buying I.O.Us instead, without realising that the more they lend today the higher they would have to lend to the U.S. tomorrow, and if it is stopped, the whole system would collapse. Just like the Ponzi scheme, if it fails to attract larger and larger investments over time, it collapses.
Being set up as a huge Ponzi scheme, the global economy is dependent on more and larger debt to keep functioning. Even if the U.S. today decides to take out loans and live within its means, paying the interest on the borrowed money collapses the currency supply. They must continuously borrow more and bring more money to existence than the money they extinguish by paying off the debt. The politicians are in a situation where if they do not come to the rescue, the U.S. can have an overnight shutdown. They cannot afford to let such a crisis happen when they are in power which is why they are kicking the can down the road.
For a couple of years after 2008, the economy was patched up by the expansion of the money supply. This was indeed impactful in the short run but cracks started appearing in the long run. The bad debt, insolvent banks, stagnant economic growth et cetera persisted. Buying the way out was not the solution to the problem but governments nevertheless opted to do it to push the problem further in future and make it worse.
The end game for this Ponzi scheme would be just like any other classic Ponzi scheme. When the participants (countries) finally wake up to the con, they would not want to participate anymore. As foreign investors stop buying I.O.Us, the Federal Reserve may step up and supply the demand of the people realising the cons, but once the Federal Reserve becomes the only buyer the entire system is doomed to implode and hyperinflation would creep in. Hyperinflation is a rapid increase in the inflation rate to an extent that money loses its value and people lose faith in it. If the U.S. economy suffers from hyperinflation all of the other economies in the world would suffer a severe economic crisis because, in the end, the reserves of the other currencies are basically USD.
At this point, it is logical to question why there has not been much discussion about this pressing issue. It is suggested that this is due to the higher positions being held by the perpetrators or the beneficiaries of the current monetary system, who do not want this system to cease. Many now believe that the price of gold and silver have been artificially suppressed to make them seem less desirable as a medium of global exchange. Gold specifically is the only strong competitor of a national currency-while gold is the money; the national currencies are merely the money substitutes. As Peter Schiff, an American stockbroker puts it, “Gold is an enemy of big government, but is a friend of freedom”.
Fiat currencies are destined to fail and if the world is to extricate itself from the current monetary system we have to back the currencies up again with something that holds intrinsic value like gold, silver, et cetera.
It is time we learnt the difference between money and currency. It is time we reverted to the gold standard.
By Shaily Birla
shailybirla1882@hinducollege.ac.in
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