Cash Is a State-Backed Utility – Part 1

The year 1971 was a seminal one for the world of finance: West Germany withdraws from the Bretton Woods system, the US cancels the direct convertibility of the dollar to gold, the US dollar floats against the Japanese yen for the first time and John Lennon’s second album, Imagine, is released.

As we can only speculate, or shall we say, ‘imagine’ the effect Lennon’s album had on the global monetary system, it is safe to say the other developments had an immediate socioeconomic impact and set in motion a series of events, the implications of which are being fiercely debated even today.

To help put it in perspective how far back 1971 was in time, the real inflation-adjusted price of crude oil was under $8 a barrel. The price of gold was under $41 per troy ounce. We will come back to the gold.

The US moved to effectively delink the value of the dollar, which by then was well established as the world’s reserve currency, and from its gold reserves, ushered in a new era of fiat money. Before the Nixon Shock of 1971 – as it is widely referred – the global monetary powers had agreed to a system of valuation and convertibility of their respective currencies to the US dollar, which in turn was pegged to its gold reserves. The year 1971 was when the world stopped using commodity money and started using fiat money.

Strictly by definition, fiat money derives its value from state fiat or government law. Commodity money derives its value from its composition or linkage to a commodity, which in most instances over the course of human history, has been gold and silver. In both instances, though, there is active participation of the state. This is a critical point of consideration. Purists who argue that the value of commodity money is not as easy to fudge as fiat money often overlook the fact that the commodity link is managed, monitored and manipulated by the state.

While history teaches us many invaluable lessons, it is the present that interests and influences us more. The year 1971 may seem a long time ago but in the eons of human endeavor, it is like the beginning of the trading session on Wall Street this morning. The Nixon Shock was the burst of caffeine that set this session off to a rocking start.

We are now living in an era of quantitative easing. Central banks around the world are printing money, the value of which is determined by the respective country’s intrinsic variables but has to yet operate in the extrinsic bands of global convertibility and commerce. There is much debate about the gold standard, or lack of it, and the eventual emergence of a new utopian standard that the whole world will adhere to when it comes to valuing money.

At the other end of the spectrum, there is a growing consensus and confusion around virtual currencies, supported by the strong contention – once again – amongst the utopians that its underlying blockchain technology will replace the global monetary system, or in their parlance, the Cartel of Central Bankers.

Check out Mehul Desai's August of Money.