A Response to an anonymous comment regarding currencies.

Dear Anonymous,

What great questions. I will attempt to answer while giving additional detail and background for those who may not be following these issues.

Fiat Currencies - Physical cash is of course merely paper in today's society. At best it is metal coins; but, who likes to carry around coins anymore. We created paper currency because it is easier than carrying around $100 in pennies or carrying around physical items to barter. Could you imagine bartering cows for a car or a house? The currencies merely represent a promise to redeem with labor and goods. So far, so good. Unfortunately, governments and banks determined that they could charge interest and game the system. Financial people discovered that they could make a profit by manipulating the value of the currencies without actually contributing labor or materials to anything of value.

The creation of physical paper currencies without them being pegged to anything meant that governments and banks could just print more money. The best example of this was probably Germany's hyperinflation prior to the Nazi's coming to power. Stories were told of people bringing wheel barrels of cash into stores just to buy a loaf of bread. The hyperinflation was done in order to pay off foreign debts cheaply. Today we call these things currency wars. The effect within a country of inflation is that it works as a form of taxation, reducing the value of what you have saved and increasing the cash a country can spend.

Prior to there being lots of international trade, it was not as important. With the rise in globalism, currency manipulation becomes more of a problem. For a while there were seven "hard currencies", these were currencies that were accepted worldwide because of faith in their underlying stability and because the countries with the hard currencies were selling products that others wanted. The English pound was backed by sterling silver and the American dollar was backed by gold and silver for a time.

Gold and silver were in limited supply and it was difficult to match the amount of gold to the true value of currencies which is in the underlying promise of labor and materials. A good example is food. The United States was able to produce lots of food and the food was exported; but, a currency backed by gold could not match the amount of food that was being produced. I recently watched a video where it was claimed that to produce a bushel of wheat requires a gallon of oil (transportation of the food required the use of the oil). There is however no direct connection between gold reserves and how much food can be produced. Since the 1900s, the real value of money became based on oil and oil was and is still traded in dollars; but, that is coming to an end.

Now here is the question I was asked. "The BRICS are looking to exit the USD as a reserve currency, how do you think it will play out with regard to the fed/imf/ecb etcdebt backed paper VS BRICS asset backed alternative reserve currency?" I don't see the BRICs as having an asset backed currency. The IMF and the BRICs have moved towards using "Special Drawing Rights", which is nothing more than a collection of currencies used as a reserve.

There are others who have accurately predicted our current situation; however, most of them are selling gold or silver. They call for a return to gold backed currencies; but, the BRICs real value is in their cheap labor and abundant minerals and goods for sale. Brazil does not need a gold backed currency and neither does Russia or India or even China. We want their products, not their gold.

By inflating their currency, Japan is making it's products more expensive to foreign nations except to nations which purchase using the dollar. Japan needs foreign oil. It has been claimed that the reasons Japan attacked Pearl Harbor was because we had restricted it's ability to buy oil prior to World War II in response to their military actions in Asia. People will go to war over real assets, things that they need to survive such as food, water, oil and now technology. There is much evidence and it had been predicted that the Soviet Union would collapse because of their inability to keep up with the wests technology. The USSR had a closed society and was unwilling to share information within it's own borders. This made taking advantage of computers and high tech difficult for them. Nobody goes to war over gold because you can live quite well without it.

The current value of gold did not go up because it is harder to find, it is actually being mined more now then two decades ago. As the value of gold went up, it made sense to mine it in areas where it was more costly. The true underlying value of gold has nothing to do with it's trading value. It does not cost $1,800 to mine one ounce of gold and the trading value of gold rises and drops totally unrelated to the cost to produce, refine and transport it. People have sold themselves into slavery in the past; but, not for gold. They sold themselves into slavery for food and shelter.

Lets say that America sold all of it's gold to China and paid off all our foreign debt, would it matter? The dollar is not backed by gold now and hasn't been for a long time. Yet, the dollar was the most important currency in the world and has truly been the only world currency in the history of the world. The dollar's real value has been that it was backed up by oil. That is why other countries saw the dollar itself as a commodity.

I promise I will answer the question. In a world of global trading, the total value of a nations assets is what should and will back up the underlying currencies. The IMF has called for all currencies to be pegged to the nations GDP (Gross Domestic Product). The GDP is the value of all final goods and services produced by a country in a single year. Now, it is true that the G20 and others have called for a single world currency; but, the value of it would still be the worlds GDP. It does not matter what the coin looks like, the question is what is it's trading value based on.

There are two scenarios where the BRICs (Brazil, Russia, India and China)might create an asset backed currency; but, neither is necessarily good for them. Lets say the BRICs backed their currency with gold. There is not enough gold in the world to back their currencies. A gram of gold would be equivalent to a years wages for some people in China. Now if the trading value of gold dropped to $30 it might work; but, then why back your currency by gold in the first place.

Germany is asking for roughly 500 tons of their gold to be put back in their nation (Germany like many other countries keeps much of it's gold in the United States of England, this was done in case the Soviet Union invaded them and for ease in international trade transactions). It is estimated that it will take 7 years to physically return the gold to Germany. The cost and hassle of nations trading in gold is unrealistic and not very effective in a world where international trade is done in seconds.

In my opinion, a gold backed currency makes no sense in the world anymore. Gold deposits can be part of what a nations currency is pegged to; but, there is really little need or any direct connection between gold and the value of what a nation produces. Trading gold therefore is just a much a fiat currency as is paper currencies. My biggest problem with gold is that it doesn't make sense on an individual level. During the depression gold could and was confiscated in the United States by the government and it still retains the right to do it again. All transactions over $500 to purchase gold must be reported to the government; but, the people selling gold don't really explain this. To get around this people began trading in gold options, stock in gold without the actual physical gold. That is a totally fiat currency.

Lets say that gold went to $100,000 an ounce, so what. It just means that the currency is valueless. What do you do after you sell the gold because you cannot trade in it directly. You cannot buy a new car with a chunk of gold. Gold dust will not pay rent or buy food or anything else. The current bubble in gold will burst; but, if it just keeps going up, it makes it less and less likely that it could be used in a barter system.

Here is what I think is behind all of this. Putin would not have promoted a single world currency if he thought that the BRICs were going to have their own asset backed currency and become the reserve currency of the world. The threat of a BRIC currency replacing the dollar is merely an attempt to convince the rest of the world to accept a single world currency and that is what the IMF is promoting.

We sold a lot of our debt to China, if the dollar is to completely collapse they get little in return. By pegging all currencies to a nations GDP, the Chinese are guaranteed to get real assets from us. It would prevent us from hyper-inflating our currency which is what Japan and the United States are doing in different ways.

While Wall Street is the leading place for stock transactions, the City of London is the financial capital for currency and debt valuations. That is why the LIBOR scandal is so important. LIBOR is a rate set by London banks for overnight trades, it is an interest rate. Turns out the system was rigged because it was not based on anything tangible, it was set by the banks themselves. Since then it has been hypothesized that most of the markets have rigged the setting of rates and this includes the rates for gold. The most successful investor in history is Warren Buffet and he has never been a big proponent of gold.

So, there is my long winded answer. I don't see the BRICs going to a true asset backed currency and if they did, it would quickly prove unsuccessful. One last thing, England sold off quite a lot of their gold not long ago and did so fairly cheaply. We have to wonder why. The City of London is the financial capital, they set many of the rates; but, the English got out of the gold standard.

In the end there is no single commodity that directly has it's value associated to a nations value. Why not back our currencies with diamonds? It makes just as much sense. What if we backed up our currency with the amount of food we produced and exported, that would make more sense. I trade food to Saudi Arabia in exchange for oil, that is a truly asset backed currency.

I want to thank the commenter for their question. I hope I provided enough background so all of the readers could understand my answer.

UPDATE: The following article is about why the EURO is going to be destroyed. The Atlantic - The Euro Is Still Doomed, in 2 Charts. What it says that is very interesting is that the EURO is fixed in value regardless of the country using it. If one country starts producing less it does not bring down the value of the underlying currency. This is why Germany had to bail out Greece, to protect it's Euro. It is a short article; but, a good one and I think it adds to the conversation.