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FIAT
MONEY AND CREDIT
by David Shvartsman
Finance Trends Matter
December 23, 2006
Being an essay on the nature of fiat
money and credit...
Okay: some items I wanted to share with you about our modern financial
economy.
A few insights into how fiat money and central banking systems make the
modern world go 'round. I thought this might make for good background
reading on a subject that is rarely broached in mainstream media and
daily public conversation.
It will also help us understand the greater forces at work in our
modern, "hot money"-driven financial markets. Especially given
the focus we've put on this week's events in Thailand and the emerging
markets arena.
What is driving the rising tide of global liquidity that is fueling all
the fast-paced investment flows and speculation? What is it about this
environment that's driving deal-making and acquisitiveness to such great
heights?
I spoke briefly with Dr.
Marc Faber by email this week and I asked him about what had
happened in the Thailand stock market.
The panic in that market (as reflected in a one day 15 percent drop in
the SET index) had been set off by the announcement of capital
controls on foreign share investments. Following these
announcements, investment money raced for the exits as soon as the
markets opened, but rebounded somewhat the next day as decisions
relating to foreign share investment were quickly overturned.
I asked Dr. Faber if the credibility of the Thailand market and its
policy makers had been seriously damaged by these events. Here is his
response:
Sure, credibility has been shattered. But
the real problem is that financial markets (excess liquidity) have
outgrown the real economy and so can do things damaging to the stability
of real economy. As an example: borrow yen at 1.5% and invest in Thai
bills at 6%....
This is the point he made to me, and I had to stop for a minute and
reflect. I was aware of the argument that he made, but I realized that
this larger issue had been greatly overlooked in the coverage of this
event (and other similar events).
Where was all this excess liquidity coming from? How did this flood of
money and credit find its way to these varied arenas? Were market
participants and outside observers missing the significance of these
broader issues?
For those of us not involved in the stewardship and transfer of vast
sums, we can still look to our own pockets and tabletops to see how
these trends are affecting us.
Another symptom of excess liquidity or
money dwarfing the real economy is that nickels and pennies can no
longer be exported....
Yes, that's right! As many of you have probably heard/read, the export
and melting of small change has
been banned now that the value of base metals contained therein
exceeds the monetary face value of the coins.
Of course, there is also the ongoing inflation that is always with us.
Slowly but surely (except in times of hyperinflation when the process
unfolds at a rapid pace), this phenomenon devalues the currency we hold
and save. Not to mention the dislocations in economies that this process
brings with it.
I asked Dr. Faber how this could continue to go on. With all we've
described here, is this situation sustainable? How would it all end? His
response:
Surely it will not end well in terms of
social implications.
As he has mentioned before, the dislocation of the financial economy
from the real economy has fostered great imbalances and a growing
disparity of wealth. There are bound to be serious widespread social
implications arising out of this situation.
So what can we do about all this? At the very least, we should learn and
prepare for these events. It is quite possible that we are dealing with
trends that will shape our world in myriad ways in the not too distant
future. I don't know whether or not we can change the course that we're
on, but we should certainly inform ourselves about where we stand.
With that in mind, may I suggest the following essays as a useful
starting point on these issues.
Background on "hot money" flows and a discussion of Thailand's
recent policy moves in, "Thailand's
Rash 'Lock Up' Move", by George Friedman of Stratfor (via John
Mauldin's "Outside The Box" e-letter).
A very commonsense and plain-English view of how rampant money creation
affects us in our daily lives. "The
Mischief of Cheap Money", by Adrian Ash.
An excellent overview on the life of Milton Friedman, with an
uncompromising critique of Friedman's theories regarding issuance of
money and credit. "Milton
Friedman, 1912-2006", by Hans F. Sennholz.
And an interesting bit of economic history. "The
Saga of John Law and Richard Cantillon", by Sean Corrigan.
© 2006 David Shvartsman
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INFORMATION
David
Shvartsman
Finance Trends Matter
Chicago, IL USA
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