WHAT IS MONEY BACKED BY?
Money in modern economies is not backed by anything of perceived value such as Gold or Silver. It is called Fiat Money. Some find this disturbing. BOOM does not. Why? Because BOOM sees money as a social contract with its true value embodied in general acceptance. General acceptance is the value inherent in any money system.
Without general acceptance in the community, any form of money will rapidly become non-money.
The word “fiat” is defined by the Merriam Webster dictionary as
— an authoritative or arbitrary order
— an authoritative determination
— a command or act of will that creates something without or as if without further effort
In other words, the essence of commonly accepted modern money is found in the phrase — “it is because it is”. Or, more accurately, it is money because it is generally accepted to be money as payment and settlement in transactions by the society that recognizes its existence as such.
It is currency when it flows. And it can become wealth when it is captured in assets. The purchaser of assets ends up with the asset. The seller ends up with the money and that money may then begin to flow as currency if the seller spends it into the real economy. Or it may be used to buy a replacement asset or assets, which inevitably leads to increasing wealth and less currency.
Fiat money (from Latin “let it be done”) is a type of money that is not backed by any commodity such as gold or silver. It is typically declared by decree from government to be legal tender. Fiat money does not have intrinsic value. It has value only because the people who use it as a medium of exchange agree on its value and agree to accept it. They trust that it will be accepted by merchants and other people.
Fiat money is an alternative to Commodity money, which is a currency that is perceived to have intrinsic value because it contains a precious metal such as gold or silver which is embedded in the coins or is backed by gold or silver bullion stored in the government’s vaults.
Fiat money can be in the form of Credit Money (created as a bank loan when there is a willing borrower) or Cash (created by the Sovereign Nation State). Credit money is interest bearing. Cash is not. Currently, in most advanced economies, the balance is strongly in favor of credit money with 98% of the money supply being created as credit and 2 % as cash. This is a serious imbalance and must be corrected over time.
THE US DOLLAR — BACKED BY VOLUME — THE RESERVE CURRENCY
The US Dollar is not backed by any gold stored in Fort Knox. The link was separated by President Richard Nixon on August 15th, 1971. Nixon announced that the US Dollar could no longer be converted into Gold. This was an historic event and marked the end of gold backing for the US Dollar. The Bretton Woods Agreement on this matter from 1944 was, in effect, terminated by the US unilaterally.
By the way, the UK had abandoned its gold backing for the Pound Sterling in 1931. And the US Government had confiscated gold held by its citizens in 1933 under Executive Order 6102, signed by US President Franklin D. Roosevelt “forbidding the hoarding of gold coin, gold bullion, and gold certificates within the continental United States.” The limitation on gold ownership in the United States was finally repealed by President Gerald Ford who signed an act of Congress, again legalizing the private ownership of gold coins, bars, and certificates, which went into effect on December 31, 1974.
Since 1971 and the severing of the gold connection, US Dollars have been mostly created by banks when they make loans and by the US Government when it issues cash and coins. It is no longer “backed” by anything.
Some say it is backed by the (presumably) overwhelming power of the US military. Others say it is backed by the US Government. Yet others say it is backed by the institutions of the US Government and its Justice system. While others say it is backed by the deep and most sophisticated financial markets in the world that exist in the US — in other words by the assets represented therein.
BOOM does not agree with any of those explanations.
BOOM is of the opinion that the US Dollar is backed by VOLUME. In other words, it is the only currency that will be accepted as settlement of trade inside the US which is the largest economy on Earth — no other currency is allowed to circulate there. And it is also the currency of greatest volume outside the US. It is the most convenient, readily available global currency held by offshore banks and offshore central banks, external to the US and outside any controls from the US government.
Those offshore US Dollars are called “Eurodollars” — even if they are held in banks outside Europe. And they are (mostly) created by tax haven banks who issue US Dollar denominated loans to willing offshore borrowers (usually large corporations).
Eurodollars are therefore deposited (denominated in U.S. dollars) at banks outside the United States, and thus are not under the jurisdiction of the US Central Bank, the Federal Reserve.
Consequently, such deposits are subject to much less regulation than similar deposits within the U.S. The term was originally coined for U.S. dollars in European banks, but it expanded over the years to its present definition. A U.S. dollar-denominated deposit in Tokyo or Beijing is likewise deemed a Eurodollar deposit. There is no connection with the euro currency or the eurozone. The offshore locations of Eurodollars mean that they are exposed to potential country risk and economic risk but they can be rapidly moved between jurisdictions if any such uncertainty arises.
As long as the US Dollar is maintained in large enough volumes offshore (in comparison to other currencies), then it will remain the most readily accepted currency of convenience with which to settle trade transactions. That means it will remain as “The Reserve Currency” — the currency most held in reserves by the offshore banking system.
The US Dollar is often called a Safe Haven, especially in times of global unrest and uncertainty. In such situations, investors naturally seek refuge in the US Dollar. And this demand for dollars inevitably increases the price of assets inside the United States — purely because of increased demand from investors. Some cynical observers say that US foreign policy aims to increase global unrest and uncertainty to drive demand for US Dollars, while pretending otherwise.
US CENTRAL BANK RAISES INTEREST RATE
The US Federal Reserve raised its target interest rate last week by 0.25 %. BOOM had predicted a rise of 0.15 % some months ago but the war in the Ukraine has caused increased supply chain disruption with higher oil prices and therefore increased CPI inflation expectations inside the US. The Fed had little option other than to announce a 0.25 % increase. It is a token effort to fight CPI inflation.
This will increase investor interest in the US Dollar and in US Dollar denominated assets, especially US bonds and stocks. The US Dow stock market index rose by 5.5 % during the week. The S & P 500 index rose by 6.16% and the Nasdaq index rose by 8.18%. This was the strongest week in share performance since November 2020.
All US Bond prices rose throughout the week after an initial fall. Junk Bond prices especially rose strongly. This could well be the end of recently declining prices in US bonds which began in December 2021. Investor demand for the ultimate safe haven should soon drive US bond prices higher. This will not cause any great concern in the US Sovereign Bond Yield Curve which is still currently positive with yields below 6 months comfortably less than 1 % and the 30 year yield at 2.4%. However, the curve is tending to flatten from 3 years out to 30 years and this is certainly a potential worry. If it inverts over time as demand for US long bonds rise, then that could be ominous, especially if the short end rises above 2%. But there is a long way to go for that to happen. BOOM does not expect any rapid, large readjustment at the short end. Curve inversion is a rare phenomenon. BOOM cannot see the Fed constructing such a curve unless it is forced to by continued rapidly surging CPI inflation levels above 10 %. The current annual CPI inflation rate in the US is at 7.9 %.
UKRAINE WAR
The war in the Ukraine is now at a stage where both Ukraine and Russia wish to reach agreement. Upon agreement, the Russians will leave. That agreement must entail Ukraine becoming a neutral nation which would allow it to (possibly) become the Switzerland of the North. It would be an excellent outcome for the nation. But are the political leaders of Ukraine clever enough to see this opportunity?
The answer is Yes if they are masters of their own destiny and No if they are simply puppets acting on orders from foreign powers. BOOM expects a fairly rapid resolution in the former instance but if foreign powers are influential and want the war to continue then the nation state of Ukraine will be badly damaged and Russia will have to reluctantly consider a longer occupation. Either way, the effects on financial markets globally should begin to settle this week — hopefully.
NATO is nowhere to be seen after stirring the hornet’s nest.
West Texas Crude oil prices fell sharply during last week from around US$ 130 to below US$ 100. If a resolution is achieved quickly, BOOM expects crude prices to fall back quickly towards US $ 70. The world will breath a sigh of relief if that happens.
In economics, things work until they don’t. Until next week, make your own conclusions, do your own research. BOOM does not offer investment advice.
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