Currency

 

One

One is the loneliest number that you'll ever do
Two can be as bad as one
It's the loneliest number since the number one
No is the saddest experience you'll ever know
Yes, it's the saddest experience you'll ever know
Because one is the loneliest number that you'll ever do
One is the loneliest number that you'll ever know

Got it. How about Three? And how about neither “Yes” nor “No,” but “It depends”?

In game theory, a game of solitaire without rules is not a fair game. With rules, it becomes a game of two, eenif thee is only one player. But when there are two players, but one player decides not to play by the rules, then it also not a fair game. Only in a game of three players, where there might appear to be only two  contestants, but they are both playing by the rules, is there a fair game. One, no fair game. Two, not necessarily a fair game. Three (or more), always a fair game.

An economic transaction also requires three elements: a buyer; a seller, and goods being exchanged. The goods can be specific, in which case the transaction will only take place if the buyer and seller have different goods that they wish to exchange, i.e., the barter system. If both the buyer and the seller have the same good, or one party does not wish the specific goods that the other party has, no exchange will take place. But if the buyer has a general good,  e.g. currency which has a value equal to the good being offered by the seller, then an exchange can take place.

The buyer has to trust that the goods being offered are as represented, and the seller has to trust that the currency being offered has the value that is being represented. To satisfy the trust of the buyer is why sellers are subject to regulation of their goods. To satisfy the trust of the sellers is why currency is subject to regulation. Currency can be either commodity or fiat.

Historically in most cultures, precious metals, commodities, have been used as the currency. To guarantee the weight of the precious metal, and that this is indeed the precious metal represented, the sovereign of a nation may coin/mint currency. To make it possible that various exchanges are possible, it is also likely that the sovereign will coin many denominations which can be totaled for the value of the exchange, and enforce laws against counterfeiting that currency.

But precious metal as a currency has some issues. It has a physical weight that it is difficult to carry in large amounts. Instead notes may be issued, that represent the value of the precious metal backed by that note/bill. But the note/bill is still the value repeated by the issuer even if it no longer has the physical characteristics of the commodity.

The sovereign must then decide if its currency is to be backed by a commodity, e.g., precious metals, or backed by only its word, fiat. Both have their problems. A currency backed by a commodity has the danger of economic panics/bank runs when there is hoarding of the commodity that prevents the exchange. But the sovereign must also be trusted not to print/create currency only for their own needs, which is the danger of hyperinflation, e.g., the Weimar republic. It is the responsibility of the  sovereign/central banks to set the domestic currency to the value of economic transactions. E.g. the US Federal Reserve Bank sets the US Dollars in circulation/money supply to the amount of money in the domestic economy at a point in time in time which will  support the exchanges in that domestic economy.

The British Empire dominated the Global Economy for much of the period immediately prior to the 20^th century. Issac Newton, as Warden of the Mint, set the currency value of silver with respect to gold in 1717, despite the fact that silver was also used as a currency up until this point. This is arguably the origin of the gold standard for currency. This is despite the fact the British unit of currency is the Pound Sterling, which at one time was a pound of sterling silver. The US Dollar was based on a Spanish coin of silver, nicknamed pieces of eight. Two bits, two eighths of that coin, was a quarter of a US Dollar. Much of US paper currency was at one time silver certificates. But despite the historical context, the gold standard prevailed and the United States, for example, did not allow the free coinage of silver.

The United States domestic currency was backed by gold until 1933, at which point domestically it became a Fiat currency when domestic individual ownership of gold was prohibited. At this point, the international currency remained as gold. During WWII, international conditions resulted where most of the gold was being held by the United States. In order to prevent the stifling of international trade, the United States joined with other nations in the Bretton Woods agreement. There the international fiat currency was established as the US dollar fixed at an agreed upon value of gold. However there was no provision for raising this rate based on the growth in international trade. Consequently the accumulation of US dollars by foreign nations resulted. This was the basis for the “Nixon Shock of 1971”, when the Bretton Woods agreement was abandoned, and the US Dollar floated with respect to gold. This effectively returned international trade to  a commodity, gold, even though most international transactions primarily remained in US Dollars. This remained the international situation until the advent of the multinational Euro was introduced.

This resulted in some clearly identifiable periods of US domestic, multinational European, and international currency.

Time Period	US Domestic Currency	European Multinational Currency	International Currency	Notes
1793 -1933	Commodity/gold	None	Commodity/gold	Minimal International Trade
1933-1935	Fiat	None	Commodity/Gold: WWI disruptions	Much of the world’s gold in the US
1945-1971	Fiat	None	Bretton Woods: US $ as Fiat	Growing International Trade
1971-2002	Fiat	None	Nixon Shock: return to Commodity/gold	Accelerating International Trade, mostly in US $
2002-Now	Fiat	Euro	Commodity/gold	Robust int’l trade. The top 4 currencies, US $ (45%), Euro (15%); Japanese Yen (8%); and British Pound (7%), represent almost 75% of international trade. All other national currencies are individually each less than 4%, with most individually less than 1%.

 Perdiods: 

1.      US domestic currency Commodity: International currency Commodity

Domestic currency hoarding and bank runs; no domestic inflation: Minimal int’l trade

2.      US domestic currency Fiat: International currency Commodity

No domestic bank runs: no deity inflation: WWII distortion of int’l trade

3.      US domestic currency Fiat: International currency Fiat as US $

No domestic bank runs: modest domestic inflation; growing int’l trade

4.      US domestic currency Fiat: International currency Commodity, Transactions in US $

No domestic bank runs: significant domestic inflation; robust int’l trade

5.      US domestic currency Fiat: International currency Commodity, Transactions in mixed currency

No domestic bank runs: modest domestic inflation; robust int’l trade

Periods 1-2 provide background for US monetary policy and might serve as useful for additional analysis. Period 3 provides data for when the US Domestic currency and was a fiat currency and the International currency was also a Fiat currency but its value was fixed in 1945 and was not adjusted to reflect increases in international trading. In period 4, the US Domestic currency remained a fat currency, but the International currency was returned to a commodity/gold currency with little competition for the US $ as the international trading unit for this commodity currency. In Period 5 the US Domestic fiat and International commodity currency situation remained the same but the introduction of the Euro was a stronger competitor to the US Dollar for an international currency-based economy.

The Triffin dilemma, where the domestic fiat currency is also the international fiat currency was arguably in effect only during period 3. The return to international commodity/gold currency in period 4 is arguably why US domestic inflation soared during the early years of period 4. During this period the domestic fiat currency was a function of the domestic economy, but the international trading currency was unconstrained, but international dollars competed with domestic dollars for domestic goods. This dichotomy where the amount of US Dollars in circulation was constrained by the domestic economy but was unconstrained in the international economy is arguably the source of high infastion in Period 4 and the persistent inflation during Period 5.  The introduction of the multi-national Euro in Period 5, where some Euro members sovereign states grew at less than the total of all member states but the Euro could not adjust for those domestic economies is possibly the reason for the monetary crises in Greece, Italy and other domestic economies in the European Union.