Money – the magical power it has over people is almost universal. But whether we earn it, spend it, or keep it, we almost never think about the following questions: what is money, why is it, and what will money look like in the future?
Why should we? Our money is working. Day after day, we use it without too much effort. So what is the problem?
Well let me explain. As August Friedrich von Hayek pointed out, we humans are constantly using things we don’t know anything about. It is precisely this fact that makes us such a successful species. It is no different with money. The fact that we don’t have to think about money but can still use it successfully is a great victory and a testament to the good functioning of our market and our knowledge society.
During the Great Recession of 2008 and this year’s corona crisis, questions about the role of money seem to arise again more frequently. Is money going through big changes? As the history of money shows, money has never been a dormant and immutable thing. Money and its nature have always evolved. Therefore, even with money, what we take for granted today may not be valid tomorrow. It’s just not a problem as long as it’s not a problem.
Money at a crossroads
The hypothesis that the essence of money has never been more mutating than ever could be due to the following facts: technological change, the Faustian hyperextension of our financial order, the old ideas of monetary theory, or how entrepreneurial discovery processes are shaking up current dogmas about money. Precisely because uncertainty about the future of money seems to be felt by an increasing number among the general public, it is worth taking an objective and sober look at current processes, trends and dynamics.
Today, we mainly associate currency with national currencies: dollar, euro or Swiss franc. These national currencies are issued by the state concerned, or more precisely by its constitutionally authorized national or central bank. These sums are also commonly referred to as fiat currencies. The term “fiat” is of Latin origin, meaning “it will be”, and is intended to denote the fact that national currencies were created from nothing (“ex nihilo”, also in Latin) and would have no support basic.
The extent to which this description is correct is the subject of heated debate. According to the chartalists, money derives its value from the state’s monopoly on money and taxes. According to them, the state is at the origin of money and determines what exists as money. Other economists stress the need for a functioning economy, whose diversified production structure necessitates a medium of exchange. This group sees the intrinsic value of money derived from the productivity of an economic area. Yet others see financial support as the determining factor. Historically, paper currencies were backed by gold. In August 1971, gold support for the dollar was abolished with the closing of the so-called gold window. Currencies no longer referred to commodity money. Ultimately, the origin of the value of silver is still debated, even after hundreds of years.
A battle of devaluation
With the abolition of the gold support, this last justification lost its argumentative brilliance. State currencies continue to exist without pecuniary ties; nevertheless, the modern monetary order did not collapse, but moved to a system of free exchange rates.
Closing the Golden Window in 1971 is often seen in libertarian circles as the sin of modern monetary history. ultimate. In fact, however, this certainly dramatic event also has great psychological significance. Because even the gold standard under Bretton Woods had little to do with a pure and real gold standard. What had started as a gold bullion standard in England after World War I continued with the start of the Bretton Woods system as a completely watered-down version of a gold standard. Gold coins had long ceased to circulate and could no longer be exchanged for notes by the inhabitants of a country. Only central banks were allowed to demand delivery of gold in exchange for US dollars.
For several decades in the late 19th century, and then throughout the 20th century, what was once inscribed in the history books as the classic gold standard gradually eroded. For the brief period arguably the purest gold standard of all time, the yellow precious metal served as an anchor of value and price. With its dilution of several decades, the stabilizing function that the gold in circulation could provide was increasingly weakened.
State paper currencies, which circulated more and more as a substitute for gold, became more and more important. Among them, a battle for national currencies gradually broke out. The longer this battle lasted, the more expensive it became. The different exchange rates of the individual currency pairs have led to an increase in currency risks. These have added transaction costs to international trade as a whole, which continue to weigh on it today. We could speak of our world as suffering from an international currency barter system.
Traders, businesses and politicians have reacted to this situation. In the political sphere, the US dollar has become the global unit of account for oil and other commodities due to US hegemony as the world’s strongest economic power. To this day, the US dollar continues to function as an international reserve currency. In this way, the greenback facilitates global trade, but due to its importance, it also allows the United States to exploit what is called the exorbitant privilege. The dominance of the dollar and the benefits to US markets are impressive.
The entrepreneurial response has been to create derivatives and more and more hedge funds. The first are financial products, the primary objective of which is contractual risk coverage in time and space. The latter, the hedge funds, are entities that trade these financial products. They are actively managed investment funds. It is therefore hardly surprising today that hedging transactions aimed at minimizing currency risks represent a considerable part of total financial transactions.
The importance of these instruments and entities is particularly evident in the case of companies active at the international level. Their income and costs often come from geographically diverse currency areas. Derivatives help reduce currency risk here. For example, the organizer of the Wimbledon tennis tournament receives dollar payments for broadcast rights in the United States. However, almost all tournament costs are incurred in pounds sterling. This makes the organizer dependent on the pound-dollar exchange rate. For a given price, this risk can be reduced with derivatives if the tournament organizer agrees to sell the dollars at a predetermined exchange rate for the pound at some point in the future.
The ever-increasing number of derivative products used today is ultimately a consequence of the costly effects of this diversity of national currencies. Anyone who wants to send money across national borders now pays high fees. The reason: the reality of the different currency areas requires the involvement of banking and financial institutions. Countless banks, partner banks and financial service providers from different countries are involved and want their “fair” share. So, at the end of the day, our current international monetary order looks like a global barter trade based on many fiat sums. Existing systems and regulatory requirements make it difficult to transfer these funds efficiently and quickly.
The various fintech companies today can therefore also be seen as an entrepreneurial reaction to this state of affairs. The most popular and successful are those who want to remove the artificial barriers in international payment transactions resulting from this global barter. What banks have barely managed to do is now made possible by upstart companies like TransferWise or Revolut.
Although sending and receiving national currencies is not only getting faster but also cheaper, one still wonders: Aren’t these fintechs fighting an uphill battle that they cannot win? Although they are trying to make our financial system work better for the masses, the devaluation of national currencies comes at the expense of all of us. If the foundation is rotten after all, any entrepreneurial effort ultimately comes down to putting lipstick on a pig.
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