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Never has there been anything more widely used and increasingly more plentiful – through the avails of the printing press – but yet so completely misunderstood, than what we affectionately refer to as money. First, What Is Money?: Money is whatever serves as the "medium of exchange." That is, as the quotation from Adam Smith says, money is a commodity or token that everyone will accept in exchange for the things they have to sell. Different societies may have different monies. Some historical examples are:
The cowrie shells used in West Africa are small seashells. This may sound "quaint," but cowrie-money was very successful. It continued to be used into the twentieth century, after the West African countries had become colonies. The colonies were required to use European money, and they did -- but when the European monetary systems collapsed in hyperinflation, the West African people went back to using their cowrie-money to get past the crisis. It was the cowrie-money that proved most reliable for many years of the twentieth century. In the examples above, commodities – intrinsic value - serve as money. In the world today, commodities do not serve as money. Instead, paper and ink have been thrust into that role under a fiat regime where law makers declare by “fiat decree” – that paper with ink is legal tender. Typically, fiat currencies contain no intrinsic value. With today being March 20, 2006 – a date long held to be the proposed first day of trade on a new Iranian Oil Bourse – it seems fitting to have a review or primer if you will, as to what exactly gives a currency unit the qualities worthy of reserve status? Few would argue that the U.S. Dollar is the world’s reserve currency. Put simply, this means that the greenback is the unit of account for settlement of most international transactions – be they gold, oil, wheat, lumber or any base metal that is traded globally. A dollar is a standard unit of measurement, not value. A dollar is a unit of weight. A dollar was originally defined as 371.25 grains of silver. This definition was established in the Coinage Act of 1792. Dollar coins were to contain a total of 416 grains, with 371.25 grains being silver and the remainder being copper alloy. Since then, however, Congress has further defined the dollar in terms of gold, despite the original definition in terms of silver remaining on the books. Although these various definitions exist, the word “dollar” no longer resembles the original definitions. Therefore, when people speak about the value of a dollar dropping, this is an absurd statement. To say the dollar has dropped in value would be the equivalent of saying a gallon dropped in value. What people should be saying when they speak of the declining value of the dollar is the “purchasing power or exchange value of a dollar is declining.” The reason for that decline is currency inflation. Of course, true dollars are no longer in circulation, but the previous example is still valid because the word dollar today is used to describe exchange value. We certainly understand the technical hair-splitting, but we also accept the modern day use of the word. What Makes A Currency Eligible For Reserve Status? First, it must be fully convertible and it should be widely accepted; second, its financial markets, for both domestic assets and foreign exchange, should be broad and liquid; third, its value should be reasonably stable; lastly, large amounts of trade and financial business should be transacted in it. If we begin by examining the first condition – convertibility – some would argue that U.S. Dollars are fully convertible. This is, of course, unless you happen to be CNOOC wanting to buy UNOCAL or Dubai Ports wishing to purchase the operations of six major U.S. port facilities. In these cases, regardless of price, your dollars are not convertible. Understanding how these two failed deals dissatisfies the precondition for Reserve Currency Status – one realizes why former Fed Chairman Greenspan and present Treasury Secretary Snow so ardently argue[d] for the United States Congress to avoid protectionism. U.S. financial markets are generally viewed to be the broadest and most liquid in the world. This explains why precipitous declines in stock exchanges such as the DOW are such unwelcome events. This also explains why the Working Group on Financial Markets, or the Plunge Protection Team [PPT] was formed in the wake of the 1987 stock market crash. To resolve the stability issue, let’s just say that it never hurts to have friends in powerful places – like the Bank of Japan – with an export led economy who are always ready to support your currency for their own mercantilist interests. When considering official interventions on the part of Central Banks – one should remember that Central Banks generally try to do so sparingly since their credibility can be jeopardized if such actions are viewed to be too heavy handed, Basic
Currency Principles So, utilizing currency interventions to lend stability to markets can be viewed much like expending political capital – using too much of it can leave one in a weakened and vulnerable position. For the world as a whole, this last condition tends to be closely related to the country's importance in the global economy, but the relationship is not simple. Once a currency is established as dominant it tends to be the currency in which business is transacted. As to whether or not large amounts of trade are currently conducted in U.S. Dollars – right now, as of today – U.S. Dollar denominated trade, without a doubt, dwarfs or renders trade in anything else moot. This is evidenced by the fact that, The advent of the euro at last gives portfolio-holders a viable alternative to the dollar. But the euro has only been in existence since 1999. It is under-represented in asset portfolios, including those of central banks, and the dollar is over-represented. So there is a sense in which the euro still has not grown into its true strength and it will only do so over time. That is why there is potential for the euro to be strong even while the euro-zone economy does not do very well. However, it would be wise to remember, a fully functional bourse which trades oil for Euros would represent an alternative that currently does not exist. Furthermore, any suggestions that the ECB [European Central Bank] would not print the requisite amount of fiat currency to facilitate the required [demanded] petro-trade is beyond ludicrous – so we won’t waste any time discussing it here. Today’s Market Overseas equity markets began the week on a positive note with Japan’s Nikkei Index adding 285 points to close at 16,624. Meanwhile, North American markets began the week mixed with the DOW down 5.12 to 11,274.53, the NASDAQ up 7.60 to 2,314.10 and the S & P down 2.15 at 1,305.10. NYMEX crude oil futures fell 2.35 to close at 60.42 per barrel. Interest rates remain mixed-to-inverted with the benchmark 2-year bond yielding 4.65%, the 5-year at 4.61% and the 10-year at 4.66%. The U.S. Dollar Index gained .23 – closing at 88.76. Precious metals had a volatile session and ended the day mixed with COMEX gold futures ending up 1.30 at 556.20 while COMEX silver futures were flat – closing at 10.36. The XAU lost 1.08 to close at 130.66 while the HUI lost 1.96 to 300.47. On tap for tomorrow, at 8:30 a.m. the Bureau of Labor Statistics [BLS] is due to release Feb. Producer Price Index Data – expected -.3% vs. prior +.3%. Core expected +.1% vs. prior +.4%. Wishing you all a pleasant evening and a most happy vernal equinox! Rob Kirby |
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