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The Mysteries of Money - Exposed at Last
By Stephen J. Butler |
 Archives |
Baron Von Rothschild
once observed, "I only know three people who understand money,
and two of them have very little of it." During a recent
trip to New Zealand, I was struck by the phenomenon of currency
exchange fluctuations and how little I knew about them. Since
they can dramatically impact the cost for retirees who travel
or live overseas, I turned for enlightenment to Peter Bernstein's
best-selling book "The
Power of Gold" which reads like a novel.
For the record, New Zealand's dollars currently cost just 42 American
cents. Or, to put it another way, one American dollar buys $2.38
in New Zealand money. Domestic goods and services in these countries
cost what the market will bear IN THEIR DOLLARS, so a $12 dinner
in a restaurant costs us about half when we pay for it with our
valuable American dollars. Japan's yen, in just twelve months,
has lost 13% of its value in dollars. In theory, this means that
last year's $10,000 Japanese motorcycle will cost us just $8,700
today. In the same vein, Argentina's currency has collapsed, so
this could be an opportune time to visit Buenos Aires!
The best route to understanding it is to review the origins of
money. We can start with the invention of currency in the form
of metal coins back in 500 BC. Paper money was invented by the
Chinese in 800, and bills of exchange (today's checking accounts)
developed during the 1500's. Today, money is made up largely of
bookkeeping entries and computerized ones and zeros.
Coins and paper money have always been created only by governments
and can be categorized as "public money." By comparison,
"private money" consisted of bills of exchange invented
during the European trade fairs of the 1500's. This money was
essentially made up of IOU's between merchants in exchange for
goods that they were trading. These IOU's were denominated in
the currencies of the different countries represented by the merchants,
but they were "as good as gold," so to speak. If someone
had an IOU in Italian lira from a known wine merchant in Italy,
they could use it to buy wool up in Belgium. If they actually
needed French francs for some reason, they could take their Italian
IOU to a central bank where they would trade their IOU in lira
for one denominated in francs. Private money was effectively created
out of thin air when, for example, someone sheared his sheep and
sold the wool. This explains why the supply of money had to stay
in line with productivity, or inflation would result.
The fly in the ointment was the possibility of some prince or
king deciding to increase the supply of his country's public money
to pay off his government debt. He thereby created inflation by
reducing the unit of value of all money---both public and private.
(Does this sound familiar?) The central banks, in considering
the relative values of currencies they were exchanging, had to
be on the watch and adjust accordingly. They accomplished all
this in the 1500's with no computers, no adding machines and no
phones, which says something about the fundamental strength of
the concept.
Today, currencies are impacted in much the same way. If a bank
in France is cashing a lot of American travelers checks, it will
wind up with too many dollars and fewer French francs. If this
example reflects what is happening throughout France, then dollars
will drop in franc value and francs will increase in dollar value
based upon this supply and demand. Overnight, this will be reflected
in currency markets. There is a market for currencies based upon
supply and demand that works just like the market for stocks.
Underlying these daily reasons for fluctuating values will be
the power of the country as a strategic element in sustaining
a currency's value. Today's politicians are tempted to act like
the princes of the 1500's by increasing the public money supply
and using inflation to pay off debts. When this happens, the country's
currency drops in value relative to that of the rest of the world.
Currency traders try to be one step ahead by anticipating what
they think politicians will do, and prices change accordingly.
At one time, we were on the so-called "gold standard."
For about forty years, from 1933 until 1971, our money was backed
by gold bullion which meant that an ounce of gold bullion could
be purchased by a central bank or foreign government for $35.
We went off the gold standard because the amount of money in circulation
was overwhelming. There was no way we could honor that commitment.
Today, the dollar is essentially the gold standard. As the strongest
currency, all other currencies are measured against it. This used
to drive the French crazy, and Charles DeGaulle once tried unsuccessfully
to get everyone back on the gold standard.
Even counterfeit dollars play a role in Russia's economy. A heavily-guarded
company in Santa Rosa, CA makes the thin film that our currency
now uses so that numbers change color as you view the bill from
different angles. When I visited a few years ago, I was told that
their technology was designed to thwart the manufacture of counterfeit
dollars. The problem began when we provided Iran, during the Shaw's
era, with all of our currency-making machinery. Somehow, that
machinery has found its way to making dollars that work great
today in Russia. In Russia, they don't need to care. Across that
vast nine-time-zone country, people are just as happy with counterfeit.
They have no plans to try to spend the money here at, say, the
GAP where it could present problems. As I write this, however,
newspapers are reporting that Russian gymnast Olga Korbut's family
home in Atlanta is full of counterfeit American money. Where could
it possibly have come from? I rest my case. Meanwhile, both real
and fake American dollars are less subject to inflation than rubles.
The role of our fake dollars in Russia illustrates how the value
of a currency hangs on the emotional perception of its value.
There is no magic formula that pegs a currency value with any
finality. This is why the Pacific Rim countries saw the bubble
burst in the value of their currencies. When those countries borrowed
too much money, it became clear to currency traders that governments,
sooner or later, would use devaluation or inflation as the fastest
way to reduce the cost of paying those loans back. Traders are
paid to anticipate the inevitable, so currency values drop before
inflation actually hits.
For the immediate
future, then, our currency should remain strong relative to those
of other countries. Whether in New Zealand, or some other paradise,
the next few years will be the time to seriously consider trips
or investments overseas.
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