The daily fluctuations of financial markets and the fractious debates over economic policy are concealing something deeper and much more disturbing. The future of money itself is in question
A decade after world banking almost collapsed in the global financial crisis, the questions raised have not been answered. The only way to keep the system going—kick the can down the street, as it were—has been to reduce the base interest rate in the developed world to almost zero. It has been an admission that the cost of capital, the very cornerstone of capitalism, no longer applies.
This drama has several elements, some familiar and some new. One is soaring global debt, which is over $US200 trillion, or 325 per cent of global GDP. Although that aggregate is not necessarily as scary as it looks at first glance, it is too large to eliminate with inflation, which is how debt in the twentieth century was typically dealt with.
The problem persists because of an arithmetic truism. Compound interest on borrowings always grows faster than economic growth. The former increases geometrically, the latter is linear. Eventually, debt becomes too large and something has to be done.
As the economist Michael Hudson has pointed out, the pattern goes back thousands of years, to the Bronze Age. To solve the problem, civilisations had debt jubilees:
‘So central to Israelite moral values was this tradition that it framed the composition of both the Old and New Testaments. Radical as the idea of cancelling debts and restoring the population's means of subsistence seems to modern eyes, it had been a conservative tradition in Bronze Age Mesopotamia for some two millennia. It took thousands of years for the idea of progress to become inverted, to connote freedom for the wealthy to deprive the peasantry of their lands and personal liberty.’
Once, usury was considered a vice. Now, retiring debt, even with struggling developing economies, is considered an unimaginable economic heresy—demonised as an attack on democracy, free markets, progress, a return to communism and so on. We must protect the banks, after all.
Thus the global financial system has entered a kind of frozen condition, with interest rates negligible and ultimately unpayable levels of debt sloshing around the global markets. The financial disease that hit Japan in 1990—ridiculously high asset prices, especially land values and stratospheric levels of debt—has now spread across the developed world. Japan has still not recovered from those excesses, and the developed world (not including China) may similarly be in for decades of stagnation.
"The problem persists because of an arithmetic truism. Compound interest always grows faster than economic growth: the former increases geometrically, the latter is linear."
Meanwhile, an alternative form of money is emerging: cryptocurrency. This is really just a new form of trust, based on mathematics (called the blockchain) rather than government or private institutions.
It was originally conceived as a libertarian project to get away from governments' creation of debt (called ‘fiat money’). The founders of Bitcoin envisaged it as means of privacy and financial freedom—and fighting back against government intrusion.
However, Bitcoin and its successors, such as Ethereum, are now drawing the attention of the big private and public players. Banks like Goldman Sachs are looking at creating ways for investors to treat it as just another asset class, one of the reasons why the price of these ‘currencies’ is so volatile.
On face value, this is absurd. How can a currency’s ‘value’ fluctuate? A dollar is worth a dollar, and a bitcoin is worth a bitcoin, isn’t it? But because cryptocurrencies are evaluated using conventional currency there are really two kinds of ‘price’ being quoted, and this underlines the radical tensions being created.
Unnerved by the prospect of people making their own money, governments are closely examining how they can create their own cryptocurrency. The Bank of China is looking to develop its own blockchain, and the head of Ethereum is talking to Vladimir Putin about developing a partnership to develop a crypto currency. It is contributing to the world wide push towards electronic money, most notably in Europe and India.
As US policy analyst Pippa Malgrem observes, governments are scrambling to control the new forms of currency; there is a battle looming between private and public control of money. What governments fear is that transactions will go offline and be invisible to their oversight.
A trader reportedly made $US200 million on Ethereum recently. If so, that will essentially be untaxable. As Malgrem notes, that prospect ‘freaks government out, particularly given their debt situation.’
There is a further geopolitical dimension. The reason America can effectively control the world economy (and run the huge government deficits that fund its military expenditure) is the dominance of the US dollar. According to the Bank for International Settlements, average daily turnover in the foreign exchange markets last year was $US5.1 trillion, of which 88 per cent involved the US dollar. That means daily demand for US dollars is about $US4.5 trillion, a massive amount. Racking up a few trillion in Federal government debt seems paltry by contrast.
The total value of cryptocurrencies is currently only about $US100 billion, so it is still small. But the threat is nevertheless real. There is a very high chance that what we mean by money will become very different in the future and it will threaten current power structure.
David James is a financial journalst and the managing editor of businessadvantagepng.com.