emzee

The latest round of hand-wringing about the stability of the US dollar as a global reserve currency, this time by the Chinese, makes me wonder why they don’t get it yet. There can be no stable store of value, ever. Why? Because all forms of money are inherently debts that others take on. What is money? Tokens that you can offer to others at a later date in exchange for their goods or their services. Why would they give you their goods or services in exchange for mere tokens? Either because they need those tokens to repay debts, or because they in turn hope someone else will need them enough to accept them in exchange for stuff you want to get. So when you save money, you’re effectively making a loan to society by delivering value (e.g. working) in exchange for paper, a loan you can call in later by trading in your paper for stuff you want.

The most common alternative to this type of “loan” is to store your value in something physical - either commodities (gold is a favorite) or real estate. Instead of making a loan to society, you’re trading your labor for something physical that you can later barter for other valuables, and in the case of real estate you get to enjoy having it in the meantime. As a method of savings this has two problems - the value of your storage medium can fluctuate wildly due to supply and demand, and at a macro level it doesn’t scale well, which is why countries have been slowly ditching their gold reserves.

Back to cash then.. so what China has been doing for the past few decades is busily manufacturing goods for Americans in exchange for a big IOU in the form of US dollars. The only way those dollars will be worth anything to the Chinese is if someday they want something back from the Americans, for which they can offer them these dollars. Problem is, they’re starting to wonder whether there will ever be enough stuff they want from the Americans to make good on the massive IOU they’ve accumulated. Bigger problem is, if there isn’t, then that IOU isn’t worth much unless somebody else wants it, but nobody really does, so they’re stuck with it.

This entry was posted on Tuesday, March 24th, 2009 at 9:17 am and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.