Are Financial Wars our Future?
The position of the dollar has been weakened the last few decades and the financial markets have increasingly become a battlefield for rich and frustrated organisations, including governments to attack particular established positions. Even terrorist organisations have found the financial markets as an effective instrument for their global war.
Over time we see an increasing share of fiduciary money in the total of money supply. In earlier times particular goods functioned as money, such as pigs and chicken. Later gold was very effective in its functioning as money. When storehouses began to lend money to people, thereby increasing the amount of money in circulation, part of the money become fiduciary, which means that money has no intrinsic value. The nominal value, as printed on coins and notes, was based on the confidence of the money-holders that the mass of the people would accept the nominal value of the money. In the Western world banks considered their gold stocks as the means to keep the confidence of the people intact. The higher the ratio of money in circulation relative to the stock of gold in the vaults of the bank, the more fragile the bank(s) and the monetary system. During the 20s and 30s of the previous century, an increasing number of Western countries dropped their gold standard: substitution of gold in exchange for money was not possible anymore.
- The International Monetary Order from 1944 Onwards
After WW II the international monetary order was formulated in Bretton woods (1944). It was based on the gold stocks of the central banks of the participating countries. The value of the dollar was linked to a particular amount of gold, which meant that the dollar could not devaluate or revaluate. Other members of the system could change their exchange rate if they considered that appropriate. This construction made the dollar to the most reliable curency in the international trade. For all members the dollar became the most important international currency, which functioned as a means of payment, as a unit of account and as a means to store value.
During the Bretton Woods meetings Keynes was one of the members of the British delegation. He disagreed with the plan that was adopted in the end. To him the world needed a global currency, which could be used for international payments. The meeting adopted a system, in which American hegemony was institutionalised. Now the USA was authorised to ‘print’ international money, needed for the financing of growing international trade. The history from 1944 until now shows that the structural deficits on the US balance of payments – necessary for a net outflow of dollars – simultaneously undermined the confidence in the dollar. This problem is called the intrinsic instability of the international monetary system. Unfortunately the mighty Western countries are not rational enough to see the danger. The Americans use a strictly economic argument in their defence of the current system and say that they deliver the money, necessary for the financing of the growing international trade. Their opponents use a strictly social argument, and state that they don’t want to live under American hegemony anymore.
- American Monetary Hegemony
- A growing economy needs a growing amount of money in circulation. If the money stock does not rise deflation results, which is generally considered as bad. In a completely decentralised world economy every country has its own currency, the value if it being determined by free currency markets. But the real world is different. Many economies are quite unstable, making their currencies volatile and unreliable. This makes it efficient to have a few stable currencies, which can function as international money. After WW II especially the dollar functioned as money on the global platform. At the moment the euro and the yen fulfil this function, although by far not as significant as the dollar.
From the end of the 60s of the previous century on, the US-economy appeared less stable than in the period 1944-1968. This undermined the trust in the stability of the dollar price. As described in the introductory section, it led to the decline of the international gold and dollar standard in 1973. Notwithstanding the disconnection between the dollar and gold, did the dollar remain its function as international money. The British Pound, devaluated in 1967, faced the same problem as the dollar. Only the IMF could offer an alternative: it created so-called SDR’s, the value of it was based on a basket of a series of relatively stable currencies. So far these SDR’s did not really challenge the dollar as the primary international reserve currency.
- Monetary Institutions Reflect Relative Power of Economies
Every action is a transaction and in every transaction costs and benefits are involved. As long as a battle increases benefits more than it increases costs, a rational actor continues the fight. Cost/benefit ratios reflect the relative power of the parties involved in the battle. Costs are not only influencd by so-called objective factors, such the availability of money or of a strong military army. But power is also affected by so-called subjective factors. If people perceive their case as just, they are able to organise more energy, and accept more costs. If people are more militant and have a long horizon, they accept higher costs now, in exchange for much higher benefits in the very future. Thus, power is also affected by culture and by personality; not just by the control of ‘objective’ resources.
When countries, such as China and Russia, become economically stronger, there might come a moment that they and other countries, such as a few South East economies, or India and Brazil, take the lead in a political AND financial attack on the position of the dollar. The economic advantage for the monetary leader is that it can print international money, and use it as if it had earned this money. The (big) difference between the nominal value of the newly issued money and the print costs is called seignorage. The social advantage of the near-monopoly position is the status a country derives from that position. Being the number one feels great – not only for the leaders, but for the population of the leading country as well. Mainstream economists are used to think in economic terms only. They wander what is the (economic) advantage for China if they use their exorbitant gold and dollar reserves to undermine the dollar and therewith the American economy. But if we approach the problem from a social perspective, we might better understand why the Chinese might do it some time in the future. More status leads to more economic prosperity in the future. It can aso function as a way to unite the Chinese people, so that they would increasingly accept their leadership. For Russia holds the same. Economically speaking the Russians are not doing well. A long and costly battle on the currency markets seems economically a bad option. Socially, however, it might be a very benefical policy. Russian people are very status-sensitive, and might accept their leadership, even in bad economic circumstances. In the next section we will discuss the idea that increasingly radical groups and organsiations might discover the economy, and especially the financial markets, as an effective battle field.
- The Radical Islam Might Enter the Financial World
Rickards (2014) tells the story of the Project Prophesy, in which the CIA tried to develop a financial model, which could predict the next terrorist attack. There is strong evidence that people, who had knowledge of the coming attack on the Twin Towers in New York, were trading on Wall Street. By trading shares, and especially options on shares in the aviation companies, which should be involved in the attack, they could profit from it. The model is established on the basis on long time series, to find out what can be interpreted as a ‘normal’ development. In this way they can calculate whether there is something special in the price development of particular companies. A list of potential targets has been made, and in case of a remarkable price deviation, the analysts try to explain the anomalies in a ‘normal’ way. If they can not find reasons, there might come an attack soon. Attacks that were planned after 9/11 could be predicted. In this way terrorist organisations also profited financially. Unfortunately, the CIA finished the project rather than etend it so as to prepare the financial world for a terrorist attack – not to kill people, but to attack the US economy. What if very rich terrorist organisations, supported by some very rich Arab countries suddenly sell large parts of their dollar reserves. Of course this is an expensive affair, which might not be economic-rational. But a growing group of people, including Westerners, do not believe in the Western ‘Model’ anymore and might become ready to participate in the financial attacks. These armies will not fight with military weapons, as is the case in the Arab world now. They will fight with computers, and execute orders from the terrorist elite.
As is the case with financial trading, minimal changes from the normal pattern can induce growing deviations as a result of herding behaviour. Political opponents of the Western world might strongly participate in this ‘herding’. It is not difficult to imagine that regular attacks can push the global economy into a severe depression, thereby hurting many developed and underdeveloped countries. In this chaos many countries would agree with changes in the monetary institutions. These changes are necessary until the institutions reflect the power relations again. As explained in a former section, people and countries, who are increasingly anti-Western and militant, become more powerful. The Western world must take this as a lesson: behave according to Western values rather than to Western power, and be prepared to fight for the own values.
In a last section we will discuss more thoroughly what could be seen as a constructive solution to the problems we will face within a decade or so.
- An Alternative Monetary Order
At the moment the IMF is a kind of global central bank. It is ruled by a Board of Governors, who represent the most powerful economies in the world. Some governors represent a whole group of smaller economies, so as to secure that all countries can participate in the decision-making process. If the IMF really represents the economies in the world, it can function as the global money-producer. Their SDR’s must increasingly take the role of international reserve currency. It goes without saying that every economic organisation, be it a firm or a government agency, is allowed to require payment in the ‘own’ currency. If this currency represents an unstable economy, it will make the goods of the organisation more expensive. Of course, every country is allowed to make agreements with a number of other countries to link their currencies to each other. If the most important economies would do this – dollar, euro, British pound, yen, renmimbi, for instance – that would contribute to a more stable global economy.
At the moment the global economy is not stable at all. The forecasts are not prospering. It means that every economic subject should protect itself against regular and large fluctuations, or even against a long turn depression. History shows that many people are inclined to become politically more radical, be it extremely right or extremely left. These reactions appear successful only in the short run. In the longer run radical solutions turn out to be desastrous. To prevent radicalisation, countries, firms, families and persons should build buffers. Not only financial buffers – they might be worthless in times of great uncertainty – but also buffers of an economic, a social and a psychic kind.
- A Multidimensional Buffer Stock
Most economists think of buffers of a financial type when talking about protection against uncertainty. Families and other organisations see their own capital as a buffer. The subjects, which have built up large debts are more vulnerable, compared to subjects, which possess many claims. But in times of chaos and depression claims cannot be realised, and do not help the owners to survive. So, economic buffers should also be held in another forms, such as a well-built house and a vegetable garden, for instance.
But economic buffers are not enough – we also need buffers of a social and of a psychic kind. Social buffers imply memberships of social networks of family, friends, neighbours and colleagues. The role of social media can be important, but at the moment many networks are not really ‘social’: offering the necessary solidarity in times of chaos and depression. Psychic buffers imply mental properties, which makes it possible for persons to maintain inner calm, also in times of uncertainty. Mental weakness leads to apathy or radicalisation.which are always accompanied by growing prejudice against people, who are different. These reactions makes the situation worse. Strong personalities, who have reliable knowledge of their self, are able to do ‘the right thing’. The more subjects are able to do the right thing, the more stable society as a whole, and the easier it is for subjects to deal with ‘their own business’. A multdisciplinary economic approach to our multidimensional buffer portfolio is needed to analyse the various complementarity and substitution effects (see Keizer, 2015 for an extensive exposition of a multidisciplinary economics.
Keizer, Piet (2015), Multidisciplinary Economics, A Methodological Account, Oxford: Oxford University Press.
Rickards, James (2014), The Death of Money, The Coming Collapse of the International Monetary System, London: Portfolio Penguin.
Dr. Piet Keizer
Associate Professor Economic Methodology
Utrecht University School of Economics