The Global Collapse of Paper Money

This has been a very active week for the forex markets, with the FOMC and the Scottish vote, preceded by massive stimulus programs from China. There are signs regardless of comments from the OECD that the global economic situation is improving quickly. One of the biggest revolutions in the financial markets has been little noticed. Last week Apple introduced Apple Pay, which should rapidly become a major competitor to PayPal and Google Wallet. There is a quiet revolution underway as consumers, slowly move away from paper money. I know I rarely carry actual cash and if I need some I use my ATM card but the idea of not having to carry around a pocket full of coins jiggling when I walk would make me very happy. When I do not have to make sure I have cash on hand for the dog walker or the housekeeper, will make my life easier and I think most of us would love to move to a paperless world, if it was easy and safe. Recently in conversations with my colleague Scott Carter, of Lear Capital some interesting ideas were put forward. I asked Scot to collaborate on a bit of research with me and Scot has drafted an interesting article which you will find below. I have separated this article into two parts. The second of which will be published on Monday giving you time to digest and discuss the points raised.

 

“The Global Collapse of Paper Money.”

The world’s very first system of monetary exchange was physical barter in the form of livestock and sea shells with metal coins emerging around 1000 BC. This was followed by the first paper money originating in China during the Song Dynasty (960–1279). Ancient Chinese banknotes first came about from merchant receipts issued to depositors who exchanged heavy coinage that was held on account. Copper, silver, iron and gold were cumbersome. This new money was comparatively lightweight, foldable and easy to carry. But while it brought convenience, it also brought financial instability as paper production invariably grew, inflation skyrocketed, and the value of this new representative coinage ultimately plummeted. By 1455 paper currency had disappeared in China.

This was a fiat currency test case study and one of the earliest stories of fiscal mismanagement. Unbacked paper money and its early fate would foreshadow many of the hazards that awaited the rest of the world for centuries to come.

The list of subsequent collapsed currencies reads like a world history of war, strife, hyperinflation, and unchecked debt: the German Papiermark (1923), the Greek drachma (1943), the Hungarian pengo (1945), the Chinese CGU notes (1947), the Chilean peso (1975), the Argentinian pesos (1985), the Peruvian intis (1989), the Nicaraguan cordobas (1990), the Soviet rubles (1992), the Brazilian reais (1993), the Latvia dinar (1993), the Ukrainian karbovantsiv (1995), the Turkish lira (1997), the Romanian lei (2001), the Venezuelan bolivares (2002), etc.

By some counts more than 600 currencies have come and gone since the 15^th century … most casualties of over-printing, hyperinflation, revaluation, suppression, liberation, or abandonment. They now occupy the global ash heaps of history.

The Chinese used paper currency for hundreds of years before it migrated westward and was eventually adopted by Europe. When it was tested in Sweden in the 17th century, paper money had already failed miserably in both Asia and Persia. Similarly, the first Swedish bank to embrace bank notes printed itself into bankruptcy just a few years later. By 1694, the Bank of England began printing permanent bank notes which they would eventually back with gold. The United States followed suit 168 years later and ratified the Gold Standard Act in 1900 to create a gold-backed currency.

The success of the paper system would be tested shortly thereafter, however, as world financial markets crumbled under the threat of World War in 1914. A selling frenzy ensued, stocks crashed, credit dried up, central banks were under siege, and over a hundred world stock exchanges shut down. Bank runs were rampant. In London, throngs of investors gathered outside the Bank of England to exchange their bank notes for gold. The British government, however, swiftly severed the pound’s link to gold and within a matter of weeks 29 out of the 35 countries that were on the gold standard prior to the outbreak of hostilities … summarily suspended their currency’s convertibility to gold.

Much of the post WWI period was spent trying to restore the gold standard but there was little cooperation between nations, little in the way of a standard, and a great deal of inflation. The Brits had an overvalued pound, the French had an overvalued franc, and Germany was forced to print money in an attempt to pay its staggering war debt which pushed the Papiermark into massive hyperinflation.

All of this was followed by tariffs, trade disputes, a post-war gold shortage, rampant protectionism, widespread intervention by central banks, and The Great Depression. The latter brought gold confiscation, the suspension of the gold standard, and unchecked money printing.

The Bretton Woods agreement of 1944 attempted to restore the gold standard. It created the

International Monetary Fund and the International Bank for Reconstruction and Development and sought to stabilize exchange rates by requiring participating countries to “peg” their currency to gold in a new “gold exchange standard.” The United States rejected the floated notion of the Bancor, or a global currency concept, and promoted the US dollar as the world’s reserve currency. International monies were ultimately pegged to the dollar which was, in turn, pegged to gold.

The spirit of the agreement lasted until 1971 when inflation got the better of the buck and Nixon divorced it from the gold standard. After all, the US had only about one third of the gold needed to cover the amount of greenbacks being held by foreign investors. Upon President Nixon’s signing of the Smithsonian Agreement, the IMF became a pure, fiat entity.

End of Part 1… see our conclusion on Monday September 22, 2014