If you care about and plan for your future rather than let serendipity take it’s course, then understanding the use, distribution, debt and exchange of currency should be important to you. It’s a complex topic. This single post barely scratches the surface. I think it does bring into focus some of the history and how decisions in the past carry consequences of serious nature.
We’ve come a long way since the time when trading meant, bring some pelts, beads, corn or wheat with you to buy what you need. In short, beads won’t buy you a train ride to Manhattan.
The ideas behind the use of currency are simple, the value and trade of it are not. Furthermore, most educational structure, at least in the U.S. assumes somehow you’ll gain an understanding of economics through osmosis. That is unless you attend a post secondary school such as Harvard, Wharton, Yale, etc. Most often the prestigious schools mentioned are headed by former government / institutional policy wonks, which in the end do consume a lot of time to explain the fundamentals of how the system is supposed to work.
The basic idea behind the use of a substitute trading object rather than hard goods goes back to ancient Greek and Romans. They realized early on it was impractical to carry large quantities of items with you to buy everyday needs. Of course there weren’t any international trading agreements among neighboring nations and so trade still went on with goods trekked across vast distance. This went on for centuries even though individual countries created coinage and even currency for trade among themselves.
International monetary standards didn’t come into effect until the late 19th century. At that time, just as in times past, it was based on a specific quantity of a precious metal. This usually meant either Gold, Silver or a bimetal, as the basis in which to set your accepted standard of exchange. Wars, national identities and isolated economic upheaval created a challenge in how these agreements between nations function. In addition to the order of exchange, commonly referred to as the “rules of the game”, mechanisms have been developed through treaties and agreements on coping with the dynamics of nation states. What I mean by that is, an individual nation goes through times of prosperity and economic hardship. Each of these nations float their own currency and wish to make adjustments to the amount in circulation and the rate of exchange for commodities within. This also affects the willingness of a country to purchase commodities at the previous agreed price. When nations used a common commodity, such as gold to set the standard, it tied individual nations to policies they felt were not in their best interest.
A period known as the “First age of Globalization” existed in the 1870s to the outbreak of World War I (1914). World exchange was conducted through an amalgamation of money unions between specific countries and of those who simply used the gold standard. This meant you could either accept a currency you had faith in or gain the equivalent in gold bullion when conducting international trade.
The years between the World Wars (1919–1939) brought forth increased autonomy and de-globalization. During World War I most countries abandoned the gold standard except the United States. A brief period came about for some nations which returned to this standard. By the early 1930’s trade order became a fragmented system of floating exchange rates. Politics within countries often were the determining factor as to what were the appropriate economic mechanisms. In Great Britain, economist Nicholas Davenport argued that the wish to return Britain to the gold standard, “sprang from a sadistic desire by the Bankers to inflict pain on the British working class.” Nothing could have been further from the truth.
Countries were being pushed from within to isolate themselves from other nations because of the World War. When hardships at home developed, international cooperation became a low priority. The Great Depression in the United States and the failure of many banks exacerbated the problem of war debt in Britain, France and Germany. These turbulent years gave opportunity for despots in Germany, Italy and Japan to capsize stability and increase national fervor to the point of starting another war.
After death and economic catastrophe of World War II, new international agreement became a necessity. The reality of World War II changed the entire dynamics of individual economies. For England and Germany, as well as other smaller economies, the war was a financial disaster. Up to that time, the British Pound Sterling was the international float currency of exchange. Now, the United States became a much stronger economy and a new world reality emerged. The dollar became part of an exchange agreement at Bretton Woods conference in 1944. The agreement defined both the Dollar and the Pound as reserve currencies. Each country, including Britain, defined the value of its currency in dollars, and the U.S. would tie the value of the dollar to gold. This was seen as the only practical solution since the U.S. could tie its monetary standard to the vast gold reserves it held in Fort Knox. No other country held such reserves and therefore international trade agreed this would be the basis going forward.
Why History is So Important to Learn
motivational poster produced by the British government in 1939
The primary policy makers of the post war international monetary system beginning in the early 1940s, were Great Britain and the United States. Each saw the role of a flexible international system allowing freedom for governments to pursue domestic policies aimed at promoting full employment and social wellness. The principal architects of the new system were John Maynard Keynes and Harry Dexter White. They created a plan which was endorsed by all 42 countries attending the 1944 Bretton Woods conference, formally known as the United Nations Monetary and Financial Conference. These nations agreed to a system of fixed but adjustable exchange rates where the currencies were pegged against the dollar, with the dollar itself convertible into gold. Two international institutions, the International Monetary Fund (IMF) and the World Bank were created. These replaced private finance. They were viewed as a more reliable source of lending for investment projects in developing states. Private institutions were the catalyst for lending policy and arbiters of successful wars; private institutions such as Rothschild.
This period (1945-1971) has been known as the Bretton Woods era. Schools in economics studied and patterned their curriculum on Keynes. The principle opposition to these ideas came forward from political idealism using socialistic models of equality in outcome and state managed industries. It wasn’t until the Chicago School of Economics, primarily under the leadership of Milton Friedman, that serious education in free market economics re-emerged.
Meanwhile fortunes continued to change among nations and most importantly, trusts and allies were altered. This is the key to understanding any principle in free market exchange, trust must prevail. As trust erodes in an instrument of exchange, so to does that instrument. During a period of almost 30 years, nations turned to the U.S. and the dollar for their consumer necessities. The U.S. post WWII, became a major manufacturing center of products in demand around the world. This further weakened the British economy, and by 1949 Pound Sterling as a reserve currency was severely diminished. When this currency lost its status as a primary currency of exchange, the immediate result was a devaluation of the pound by 30%. Imagine the effect that has when everything you purchase goes up by at least 30%! Almost over night, everything you own and want to purchase adjusts to this new reality.
The post Bretton Woods era began just after the peak build-up in the Viet Nam War. In 1971 President Nixon devalued the dollar, in response to damage done by the cost of the War. This opened a new era of floating exchange. The stability of the postwar settlement was over.
Wars in the Middle East, high oil prices and an international recession, combined with the UK’s slow economic decline further decimated the British economy. By 1975, with rising inflation after a further pound devaluation in 1967, and a large-scale coal miners’ strike, the UK had to apply for a loan from the International Monetary Fund. Loans notwithstanding, the economic pressure on the UK government caused further devaluations of the pound on the exchange. In 1976, the pound fell below the $2 point for the first time on the exchange. This is where the citizens of the United States should learn and understand what history demonstrates.
The U.K. after World War II had large debts, in addition to that they had a manufacturing economy focused on war production. Civilian commercial products lagged the demand and therefore they often had to buy at unfavorable market rates through international trade. Trade deficits rose, the pound was devalued, making the trade deficit worse and goods at home more expensive. When commercial manufacturing re-tooled the economy was frequently impaired through labor strikes, shoddy goods, and a demand on the government to provide more social programs including health care.
The economy of the U.K. was on the brink of collapse and books like Orwell’s 1984 seemed to predict the tension between society and government. The last grasp of trying to convert into a free market economy arose with the election of Margaret Thatcher to Prime Minister. During her brief tenure, she divested vast holdings of government-owned and mis-managed communications, energy, air commerce, housing and to some extent gave more free rein to private / commercial banking. The results of this change to “monetarism” brought great wealth into the U.K. but the rest of Europe, including Germany, were nowhere near the growth rate now seen in the U.K. This growth brought new problems, primarily social, into the mix. Vast segments of the population had become accustomed to the economic assistance seen as benevolence or necessity. The coal industry had largely been supported by artificial government stimulant and when that went away, so did much of the expensive British coal production. People living in public housing and some school program subsidies were reduced or eliminated. Just like what occurred with Churchill shortly after WWII, new elections ended the days of Margaret Thatcher. She was seen as a polarizing figure and the social engineers wanted her out.
What goes up must come down and it did so in splendid fashion by the 1990s. Europe regained economic improvement while the U.K. was sinking. The reaction even during Thatcher’s period was to tie the Pound to the Deutschmark in attempt to control inflation. Nigel Lawson was Mrs Thatcher’s Chancellor of the Exchequer and he wanted to limit growth and control inflation.
The Exchange Rate Mechanism and Black Wednesday
John Major became Prime Minister after Margaret Thatcher. He had to reduce UK interest rates to discourage inflation while maintaining the revival of the British economy. He decided to join the Exchange Rate Mechanism (ERM).
Interest rates in Europe were lower than in Britain. Sterling joined at £1 to 2.95 Deutschmarks, much the same rate as Lawson’s cap, but Major was hoping for the inflation which Lawson had not wanted. ERM rules dictated that the pound was to vary by no more than six per cent from its entry rate, three per cent either side. The idea was to reduce UK interest rates by linking them to Germany’s 8 per cent, rather than the UK’s 15 per cent. The rising value of the Deutschmark and the lower growth of the Pound caused an uneasy alliance between Germany and the U.K. even though at the time, the U.K. was acting President of the E.U. The Germans were unwilling to shift policy, despite the pleas of the U.K. because they were suffering the inflationary consequences of incorporating East Germany.
Along comes the European born, American financier, George Soros. He saw the international monetary markets for what they were. He was devoid of societal interests and nation-state politics. What he saw was an opportunity in the making. He thought the U.K. was over leveraged in its investments to control the value of the Pound. Seeing this opportunity, he bought large quantities of Deutschmarks, effectively betting against the Pound. His currency speculation strategy was to sell Sterling for Deutschmarks and British securities. His combined war chest with other speculators was just under $10 billion. This was slightly less than Chancellor of the Exchequer Mr Lamont, had to throw into the currency, and the Bank of England was running out of reserves. On September 17th 1992, Mr Lamont announced that the Pound was to leave the ERM and devalue through exchange. The pound devalued and Mr Soros, was rumored to have made as much as $2 billion betting against the Sterling. He was christened “the man who broke the Bank of England” by the Daily Mail.
So what does all of this mean to you or me living in the U.S.?
National debt % GDP & actual number
To quote the Sage CQpress: “The shifts in the international political-economic system increase the likelihood of greater disparities between those who can play in the game of global finance and those who cannot. These changes also add to the uncertainty about how national political economies are connected. Both good and bad effects can be conveyed across linkages that are not completely understood and are consequently difficult to manage and mitigate, in the case of bad effects.“
Well a few of those effects are relatively well understood. Exchange rates are set by complex formulas but they revolve around the relative stability of the nation-state. All are based on trust. Diversity of economic specifics may alter the trajectory of an economy but the specifics which adversely affect an economy largely depend on the willingness of the government to manage the affairs of the nation. Frequent and expensive wars throughout history have always created a debilitating drag by maiming or killing those coming of age as well as a resultant indebtedness.
A nation must have energy policies which sustain it to produce goods and improve services. Any nation which doesn’t produce will eventually fade away. This has nothing to do with free market economics, it’s just the result of any country or any person without artificial support. Thus trade unions, industries, or individuals which fail to produce will also lose support once national income is insufficient to support paying its debt.
There will always be opportunists and speculators like George Soros or T. Boone Pickens. They merely take advantage of down turns as well as up swings. The rest of us rely on the willingness of a nation to choose sound economic policy, free of long-term strangling debt and frequent war.