Sunday, February 24, 2008

Falling Slowly

Historically, monies have been backed. Typically by Gold; occasionally by a basket of commodities; in more recent times to the value of another base currency. When asked what is the base currency backed by, since 1972, one could say "it's turtles all the way down".

i.e., Modern money is backed by only goodwill of the issuing government and the value that we, the holders, deem it to have. In the past, money was backed by commodities. Cowries, gold, oil, wood , slave girls etc., The Great British Empire was run on backed gold -- of varying quality -- backed by an asset, nevertheless. Since 1945-- the USD which has been the de facto currency of the world. On the extreme de jure currencies might exist but nevertheless be virtually ignored -- as in say, Afghanistan under the Taliban. Alongside, the key historical aspect is there has often only been a single de facto currency, on average, since the Enlightenment. Even the Nazi Germans during the forward stashed away their currencies in GBP.

What is peculiar about past four years is the following. We have two major currencies backed by nothing. And it seems increasingly clear there are two competing de facto currencies. The USD and the Euro. While the two currencies have had differing changes in value relative to other currencies over the past year (and more). See two cool graphs here: Euro & USD. The US is a behemoth with a cashflow problem; the Euro is essentially confederate money in a continent with a demographic problem. (See an interesting paper on confederate money.)

Now, the critical problem is globally: what is the optimal holding between USD and EUR. No ones the answer. In fact, one doesn't know if this is dichotomous choice itself is a false one. Increasingly, there are two other alternatives. Holding Gold itself. And as well, the basket of non-USD and non-EUR currencies. These are tough questions - but one thing is clear. The times have changed -- and we are, perhaps, entering for the first time since 1700s into an era of financial history that isn't very well known or even how to frame the questions correctly.

My own understanding of all this, on a weekend of Oscars, is more or less summarized by the preface to this song...

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