Walter Kita, Register Staff
New Haven Register
January 06, 2002
Money,
so the saying goes, makes the world go 'round, but the pace of life often
becomes most dizzying when it stops working the way it's supposed to.
For
the citizens of Argentina, now is one of those times. So many Argentines have
lost faith in their country's peso, the government recently announced plans for
a last ditch effort to pull the country out of its economic tailspin.
Argentina
will soon introduce a new and presumably more reliable -cash exchange system.
In contrast, another new currency, the Euro, is rapidly gaining acceptance in
Europe. That acceptance is tangible evidence, some experts say, of the unifying
power of globalization.
Taken
together, the stories of the incredibly shrinking Argentine peso and the
expanding Euro illustrate how monetary systems work in an economically united
world.
"Money
is very simply a form of institutionalized trust people have in their
government," said Martin Shubik, a professor of economics at Yale
University's School of Management. "When people trust the government not
to fiddle too much with the monetary system, the value of a dollar increases or
remains steady. When they lose trust, all sorts of things can happen and none
is good."
Money
101: The currency used in every developed nation today is called
"fiat" money. The authority to print and issue it is usually vested
in the government of each country.
In
the United States, the Federal Reserve Bank and the U.S. Treasury Dept. work
together to decide how much money is placed into circulation. The reserve also
sets the prime interest rate, the amount of interest banks pay to borrow money
from other financial institutions.
Prior
to thirty years ago, the question of how many dollars to print was less of an
issue, because the United States then subscribed to the "gold standard."
That meant that for every paper dollar printed there was, theoretically at
least, a corresponding value of gold locked away in the Federal Reserve's
vaults.
Gradually,
however, the U.S. began moving away from the gold standard, printing more
dollars than it could back in gold said Sam
Andoh, professor of economics at Southern Connecticut State University
in New Haven. The growing nation needed more money to fund itself and meet
rising public demand for goods and services.
President
Richard M. Nixon formally authorized the end of the gold standard in 1971. The
move away from gold standard did much to establish the kind of
"faith-based" monetary system the U.S. and other nations have today.
Unlike
"fixed" monetary systems, in which the value of a dollar changes
little, if at all, fluid monetary systems function precisely because currency
changes value daily. The changes are based on standard economic rules of supply
and demand.
In
a well-functioning system the shifts while not always predictable are never
too great in either direction, Andoh said.
While
such an economic model may seem to lead to chaos, it actually has benefits the
gold standard lacked, Shubik said. Speculators investors who bought, sold or
traded in gold -were no longer as free to hoard it or its paper equivalent,
waiting for just the right moment to sell or loan it out when demand was at its
peak.
The
current system ensures there is always plenty of money in circulation to buy
the things people need and want most. Inflation is good: Beyond that, fluid
monetary systems have another feature that make them particularly attractive to
governments: A hidden tax called inflation.
Inflation
is the result of pumping more currency into the money supply, which lowers the
value of currency, reduces the demand for goods and services and causes prices
to rise accordingly.
In
practical terms, Shubik said, inflation explains why a tenured Yale professor
who earned $20,000 in 1961 would have to be paid about $190,000 today to have
the same purchasing power. While inflation is generally regarded as something
bad, people are willing to accept it so long as it is within reasonable limits,
said Shubik.
Moreover,
because inflation helps fund the operation of the government in lieu of direct
taxation, it is not the evil it is portrayed in popular news accounts, he said.
When
too many dollars are placed in circulation, people tend to lose faith in the
value of their country's currency and spend furiously on the items they need,
fearing their money will be worth even less tomorrow, said Shubik. The problem
gets worse as prices rise correspondingly and new currency floods the money
supply to keep the whole system going.
That's
what happened during the U.S. Civil War, when southern states began printing
their own money, said Shubik.
Confederate
money was essentially worthless paper. The Southern economy actually improved a
bit after invading northern armies began destroying the presses on which
confederate cash was printed.
A
perfectly tweaked money supply has enough currency in circulation to meet the
public demand for goods and services, as well as fund the government through
taxation.
That
money can be in a direct form, such as the federal income tax, which comes
right out of your paycheck, or in a less direct way. By gradually increasing
the amount of money in circulation, say by two percent annually, the government
is encouraging prices to rise accordingly.
But
the cost of printing the additional currency is not nearly as much as its face
value, and therein lies its hidden power, said Shubik.
As
money is spent, taxes are meted out against the nominal value of the currency.
That adds up to a net "profit" for the government that is roughly
equivalent to the taxes on the currency's face value minus the cost of
producing it.
"The
trick to making it work is achieving the right balance," said Andoh. "If you go too far and print too much, the value gets too
low and the cost of goods and services becomes too high. Then everything is a
big mess."
Cash
equals confidence: The bottom line, Shubik maintains, is that in modern
financial and monetary systems politics and the economy are inextricably
linked.
Historically,
the systems that work best are the ones in which the central bank has few ties
to the elected government. That's the big reason the chairman of the U.S.
Federal Reserve is appointed to a 14-year term.
""The
president can come to the chairman and say, 'I want this,' and the chairman can
tell him to jump," said Shubik. "There's no political reason for him
(the chairman) to comply, because he'll be there after the president is out of
office."
Argentina's
economic problems have less to do with the amount of pesos in circulation than
with an earlier decision the Argentine government made to link it to the U.S.
dollar, the most trusted currency in the world.
For
a time, the plan seemed to be working brilliantly. Argentina's long ailing
economy looked to be on the rebound.
Recently,
though, Argentina's economy ran smack into one of the unpleasant realities of
the global economy.
Because
of the peso's ties to the dollar, Argentina's trading partners were forced to
pay U.S. dollars for goods and services purchased from Argentina. The cost of
converting their own less-valuable currencies into dollars proved too expensive
for some and they decided to shop elsewhere.
That
has left Argentina with the problem of how to cope with tens of millions of
dollars in lost trade revenue. Argentina's answer, Shubik says, was to take the
largely symbolic act of trading in its old currency for a new one.
That's
not unlike what the consortium of European countries had to do when it
introduced the Euro to a skeptical world 10 years ago.
Initially,
it was touted as a supplement to the individual European currencies. But it has
gradually become more of the standard, worth about 88 cents compared to the
dollar.
Shubik
maintains the emergence of the Euro is another step on the path of Europe's
emergence as a global economic power.
As
for Argentina, it must first address the short-term problems of fixing its own
broken economy before it can begin thinking about increasing its global
economic influence.
"The
Argentine government has to convince the people that this time around things
will be different," said Shubik.
©New
Haven Register 2002