2 Types of Money

From the beginning, productivity improved with specialization. If one person can produce fruit more efficiently while the other was a better hunter, more wealth will be generated if the hunter hunts and the farmer farms. Forcing the farmer to hunt or the hunter to farm is just plain inefficient. But in order for the system to work there has to be a medium of exchange. Somehow the farmer has to be able to get the wild game in exchange for his crops. And what if the farmer wants meat but his crops aren’t ripe yet? Well, that is how credit developed. In today’s post Bill Bonner looks at mediums of exchange i.e. money and credit. He examines how they began and what they mean for us and our economy today. ~ Tim McMahon, editor.

Good As Gold

Credit and MoneyOver the last 10,000 years, humans have tried two different kinds of “money.” They began with exchanges based on credit – “You give me a chicken… I’ll pay you back later, maybe by helping you build a new wigwam.”

Then, when society became too large and extensive, they switched to gold and silver. The advantage of this was obvious: You didn’t have to remember who owed what to whom. You could settle up right away. “You give me a chicken. I give you a little piece of silver. Done deal.”

Periodically, governments were tempted to go back to credit systems. Essentially, they issued pieces of paper – IOUs – and declared them “money.” Usually, these hybrid systems began with some collateral backing up the paper. Issuers typically had gold in their vaults and agreed to exchange the paper for metal at a fixed rate. Holders of the paper money were told that it was “good as gold.”

In some cases, people believed [Read more...]

U.S. Foreign Exchange and The Chinese Currency Exchange Rate

U.S. Foreign Exchange

The number of international corporations and financial professionals that follow the ever-changing ratio of U.S. dollars to Chinese Yuan has increased and expanded beyond its borders. This is an indication of just how critical the trade relationship that binds the world’s two largest economies has become. Although the relationship between the United States, Canada and Mexico continues to be even more robust than the Sino-American arrangement, the consumer economy of the United States is heavily dependent upon smooth flows of goods from the workshops of China to the Pacific ports of California and Washington State. In many ways, the continued harmonious economic relationship is as important to the United States as modern technological innovations in the financial field (such as the latest trading and communications technologies, see OANDA for more information).

U.S. Foreign Exchange, the Yuan and the Flow of Goods

U.S. Foreign ExchangeThe value of the yuan has a tremendous influence on these flows of goods. Most of the export-ready products that Chinese factories produce for American consumption are low-margin consumer goods that require labor and raw materials to produce. Since these goods must be shipped thousands of miles across the ocean, global fuel prices add a significant and non-negotiable premium onto their final cost. As such, Chinese manufacturers have a keen interest in ensuring that the value of the yuan remains low enough to offset the added expense of bringing their products to market in the United States.

China’s Devaluation of the Yuan

The Chinese yuan used to be pegged the US Dollar to facilitate trade, this ended in 2005. Business deals were still denominated in dollars but [Read more...]

What Is Fiat Currency?

Fiat currency is a term that is used to describe a currency which is created by “fiat” or “arbitrary order or decree” of the government. It is not created by the free market or backed by anything like gold, silver or real estate. It is essentially an “IOU- nothing”. A lot of people do not realize that every currency in the world today is considered to be a fiat currency. (Although the Chinese may be working on creating a gold backed currency and several OPEC countries have considered it as well). The US dollar, the euro, the Great Britain pound, the Japanese Yen, and the Australian dollar are all fiat currencies, to name a few. Since everyone uses this type of currency, why is it such a big deal?

Why It’s Important

When you stop and think about the idea of fiat currency, you can see that there would be a few potential issues that could lead to problems. With a fiat currency [Read more...]

Using Forex to Hedge against Inflation

Forex Hedge

According to Wikipedia-A foreign exchange hedge (FOREX hedge) is typically used by companies to eliminate or hedge foreign exchange risk resulting from transactions in foreign currencies. In other words, if a company in based in one country most of its expenses are denominated in the currency of that country. So if a company is based in the U.S. most of its expenses are in dollars. But if it sells a significant portion of its products in another country like Mexico then a portion of its income will be in Pesos. If the Peso depreciates against the Dollar the value of their income could cause them to lose significantly even though they thought they were selling at a profit. This creates the need for a currency hedge.

Two common hedges are forwards and options. A Forward contract will lock in an exchange rate at which the transaction will occur in the future. An option sets a rate at which the company may choose to exchange currencies. If the current exchange rate is more favorable, then the company will not exercise this option.

Forex Inflation Hedge

Forex Money for International Curency

Forex Money for International Currency—epSos.de (Flickr.com)

How can investors use Forex to hedge against inflation? Inflation leads to a reduction of the purchasing power of the residents of the affected country. For an investment to be considered a hedge against inflation, it must be able to provide protection against the decreased value of a currency. How does this happen? This occurs by the investor putting money in an asset so as to maintain or increase its value over a specified period of time. Since inflation is just the value of a currency depreciating against commodities at the same time it may be depreciating against other currencies as well. So, just as we saw that companies used forex to hedge against currency depreciation vs. other currencies you can use Forex to remove yourself from the risk of your currency depreciating due to inflation.

One way to do this is by taking a higher position in assets which lose value less rapidly than the home currency value.

Poor Inflation Hedges

Money market instruments have never served as a good hedge against inflation. Their rates of return and dollar values are fixed, so there is no room for appreciation should the value of the dollar decline. For instance, if your bank pays a 5% interest, but inflation figures stand at 6%, you are not protected against inflation and your purchasing power is actually reduced. As at the end of the year the interest you earned did not even cover the loss of purchasing power. To make matters worse you actually owe taxes on the 5% “gain”.

[Read more...]

Why (and How) China is Boosting the Price of Gold

The History of Gold Prices (and How We Got Here)

To get the full picture of the current price of gold we have to look back nearly 100 years. In the 1800′s and early 1900′s gold played a key role in international monetary transactions. The gold standard was used to back currencies. Each country determined a fixed exchange rates for its currency, i.e. how many ounces of gold each unit of currency was worth.

Trade imbalances (importing more than they exported or vice versa) could rectified via the exchange of gold reserves. A country with a deficit would have to ship gold to the country with an excess. Any country experiencing inflation would lose gold and therefore would have a decrease in the amount of money available to spend.

Chinese gold coins

old Chinese gold coins—epSos.de (Flickr.com)

However, during WWI and WWII economic warfare was employed in an effort to combat poverty in ones own country by employing a policy called “Beggar Thy Neighbor”. This involved shifting demand away from imports onto domestically produced goods, either through government policy, rather than free markets. The primary vehicles were tariffs (or import taxes), import quotas, or by devaluation of the currency (i.e. changing it’s value in relation to gold). For example, During the 1930s, the British created their own economic bloc to shut out U.S. goods because they felt they couldn’t compete with cheap U.S. goods.

In July 1944, towards the end of the war 730 delegates from all 44 Allied nations gathered in Bretton Woods, New Hampshire. During this conference the U.S. held most of the cards because it was the least financially damaged by the War. The original plan presented by John Maynard Keynes was to establish a world-wide currency called the “Bancor”. Each nation’s individual currency would be pegged to the Bancor (rather than Gold) at a fixed rate. Governments would then be required to buy or sell Bancors in order to maintain the value of their currency at the pegged rate.

However, at Bretton Woods… [Read more...]

Is Gold Backwardation Now Permanent?

Its Weight in Gold: The Real Prices of Things

By Keith Weiner, Casey Research

Worldwide, an incredible tower of debt has been under construction since President Nixon’s 1971 default on the gold obligations of the US government. His decree severed the redeemability of the dollar for gold and thus eliminated the extinguisher of debt. Debt has been growing exponentially everywhere since then. Debt is backed with debt, based on debt, dependent on debt and leveraged with yet more debt. For example, today it is possible to buy a bond (i.e., lend money) on margin (i.e., with borrowed money).

The time is now fast approaching when all debt will be defaulted on. In our perverse monetary system, one party’s debt is another’s “money.” A debtor’s default will impact the creditor (who is usually also a debtor to yet other creditors), causing him to default, and so on. When this begins in earnest, it will wipe out the banking system and thus everyone’s “money.” The paper currencies will not survive this. We are seeing the early edges of it now in the euro, and it’s anyone’s guess when it will happen in Japan, though it seems long overdue already. Last of all, it will come to the USA.

The purpose of this article is to present the early-warning signal and explain the actual mechanism to these events. Contrary to popular belief, it will not happen because the central banks increase the quantity of money to infinity. The money supply may even be contracting (which is what I expect).

To understand the terminal stages of the monetary system’s fatal disease, we must understand gold. [Read more...]

How Does the Value of the U.S. Dollar Fit Into the Big Picture for the Economy?

Robert Prechter discusses his views on the credit crisis and the U.S. dollar

More credit is denominated in U.S. dollars than any other currency. What does this mean for the value of the dollar as the credit crisis continues its strangle-hold on the world economies?

Enjoy this video clip of Bob Prechter from an October interview with The Mind of Money host Douglass Lodmell, in which Bob discusses the debt implosion and the value of the U.S. dollar.

You can watch Prechter’s full 45-minute interview here — no sign up required!

Watch the full 45-minute interview FREEGet even more valuable insights as Mind of Money host Douglass Lodmell interviews Elliott Wave International’s President, Robert Prechter, about how to keep your money safe, the deflation versus inflation debate, and many more topics that are critical to your financial future.Start watching the free 45-minute interview now — no sign up required!

Rick Rule: “Bet against the dollar as a store of value”

In this excerpt from the Casey Summit When Money Dies, seasoned resource investor/broker Rick Rule discusses risk management and explains why the greatest risk you face as an investor is located to the left of your right ear and to the right of your left ear.

Listen to Rick’s complete summit speech – plus those of nearly 30 other renowned financial experts – from the comfort of your home. More than 20 hours of audio recordings on CD or MP3, including the experts’ top stock picks. Learn more.

Michael Maloney: “We pay tax for the privilege to have currency”

In this video excerpt from the Casey Summit When Money Dies, Rich Dad advisor Mike Maloney explains how currency is created, “fractional reserve banking,” and why our banking system is a pyramid scam of epic proportions.

Listen to Mike’s complete summit speech – plus those of nearly 30 other renowned financial experts – from the comfort of your home. More than 20 hours of audio recordings on CD or MP3, including the experts’ top stock picks. Learn more.

Is the US Monetary System on the Verge of Collapse?

By David Galland, Casey Research

Tune into CNBC or click onto any of the dozens of mainstream financial news sites, and you’ll find an endless array of opinions on the latest wiggle in equity, bond and commodities markets. As often as not, you’ll find those opinions nestled side by side with authoritative analysis on the outlook for the economy, complete with the author’s carefully studied judgment on the best way forward.

Lost in all the noise, however, is any recognition that the US monetary system – and by extension, that of much of the developed world – may very well be on the verge of collapse. Falling back on metaphor, while the world’s many financial experts and economists sit around arguing about the direction of the ship of state, most are missing the point that the ship has already hit an iceberg and is taking on water fast.

Yet if you were to raise your hand to ask 99% of the financial intelligentsia whether we might be on the verge of a failure of the dollar-based world monetary system, the response would be thinly veiled derision. Because, as we all know, such a thing is unimaginable!  [Read more...]