Let's talk about Economics

OK, it's tomorrow.

I have a couple of minor points to add in to your (excellent) explanation. I'm not going to touch the fixed-currency issue, because BeefNoMeat seems to have that well under control.

First, an economy developed because of both wants and needs, but mostly because of wants. Humans are able to survive on their own; if not, they would never have developed into a civilization. An argument can be made that we have evolved socially to the point where what once was a want has now become a need, but my definition of need vs. want is based on the circumstances of the time.

Today, our wants have become needs and we have come to expect that certain wants will be fulfilled as needs. As an example, I need food... but food is actually available all around us in most areas. We are omnivores and can eat several different types of plants and animals, even insects, and our bodies can adapt to lower levels of food than we presently consume. But society has developed so that even with that knowledge, I feel an actual need to go to the store once a week and exchange money for food I am more familiar with. Since my home is far from this store, I have a need to travel, which means I need a car and gasoline to fuel it. In reality, this could be seen as a want, because I could conceivably just exist closer to a store.

Some wants are more obvious. No one needs a cell phone. A cell phone may be necessary to fulfill another want, such as a job which requires one, but it still stems from a want.

Some may read the above and interpret that I am against fulfillment of wants.... that is a false interpretation. The want to conform to societal expectations and have an easier life is not a bad thing... and considering we have developed as a species to rely on such to a high degree, it is completely understandable and can be seen as a modern need... all I am saying is that these things, these modern needs, developed from wants. It is a delicate point to be made, but in the end an important one.

TheRedneck

Second point:

While our currency is typically seen as fiat, it actually is not completely fiat. By fiat, I am referring to the fact that a dollar can no longer be exchanged on demand for a pre-specified amount of gold or silver. That is no longer possible, but for some time the concept of a backed currency has still been present in our currency.

It is true that backing currency with physical commodities can have the effect of limiting growth capacity on an economy. The only way this can be overcome is by leveraging, which is similar to the multiplier effect so thoroughly debated above. That has one massive issue, however: if too many people decide to cash in their backed currency at the same time, it becomes quite possible that there will too little of the backing commodity to cover the demands and the backed currency becomes fiat overnight.

The concept of backed vs. fiat, however, goes back to the issue of confidence in a currency. For a currency to be valid, there must be confidence that the currency will be worth tomorrow what it is worth today (or at least close to it). Otherwise, who would accept currency as payment if there is no confidence that it will have value tomorrow when needed? Obviously no one. Thus, the real backing of the dollar among the population is based on the fact that the United States has a stable economy that will operate on the dollar tomorrow, next week, a year from now, ten years from now, and so on.

But... that is how the population sees it. Most people do not care about the intricacies of international currencies. They are too busy getting to work and back and trying to enjoy what little free time they have. As long as they know that their paycheck will cover the utility bills at the end of the month and they can purchase a meal or a movie ticket with their dollars, all is well with the world.

From a higher viewpoint, that of nations and the uber-wealthy, things get a little more complex. While a US citizen can have complete faith in the currency their government backs, another nation may not. China wants value for its products. China is interested in making sure that its currency is stable so its population can live without revolt or retreat from its borders. After all, that is the goal of any government: to exist and rule. Revolt and a decreasing population is antithetical to this goal.

So the Chinese government will artificially adjust its currency to try and compete with other currencies like the American dollar. If it has no faith that the dollar will have value tomorrow, the value of Chinese currency will rise compared to the dollar. That will trickle down to the general population and cause US goods to be cheaper than Chinese goods, because it will be cheaper from the Chinese standpoint to purchase dollars. this is how the economy naturally adjusts to currency values.

Unless the dollar becomes worthless. At that point, things change.

Consider this simplified example: let us say the dollar is worth the same as the yuan (the Chinese equivalent of our dollar). If an item in China costs 10 yuan, it also costs ten dollars. Somewhere, someone is trading in currencies, so this person will happily trade 10 yuan for ten dollars, as long as they get an extra dime for their trouble (I am assuming 1% trading fee). So the person living in China can buy a Chinese product for 10 yuan, or an American product for 10.1 yuan. They don't care about the dollars; they get paid in yuan.

Now if the traders decide they don't have as much faith in the dollar, they will consider the yuan more valuable, let's say 1 yuan is now worth $1.10. So the $10 from America now costs them 9.091 yuan, plus their 1% profit. The American product now sells for 9 yuan as compared to 10 yuan for the Chinese product. Obviously, more Chinese will buy the American product, which means the American economy strengthens, and the value of American currency rises again compared to the yuan.

If the American currency appears to be in danger of collapsing, however, the traders are not going to pay anything for the dollar! They want something they can trade tomorrow and next week and next year and whenever they need to. At that point, it becomes hard to find American products in China, because no one is willing to trade currencies. That's why the Confederate dollar is worthless today; no one will trade for it, because it's not backed by anything, not even a country.

With backed currency, this never happens, because the currency can always be converted to something that has value. But with fiat currency, it becomes a real danger, especially for those who live in the country where the currency is dropping. They lose access to products made abroad. In the previous example, that Chinese good that originally cost $1.10 in America now costs $1.20. As the currency depreciates, that cost rises and can become astronomical, meaning no one in America can buy Chinese products. The Chinese have the lion's share of the world's rare earth metals, required for high technology. So not being able to access those materials means the American economy cannot produce high-tech products. That further depresses the American economy, and makes the matter worse.

But, as I will explain further, we do not have a fiat dollar in international relations.

TheRedneck

a reply to: TheRedneck

Hi, is there a part 3 coming?

Genuine question not being snarky

a reply to: ScepticScot

There is now. I thought the thread had been abandoned...

TheRedneck

originally posted by: TheRedneck
a reply to: ScepticScot

There is now. I thought the thread had been abandoned...

TheRedneck

I thinks it's just the economics geeks that remain.

Now to leave the realm of examples and enter the realm of actual history. The last two posts were necessary to understand this one.

The global economy operates on a system which is based on the International Reserve Currency (IRC). The IRC is essentially the currency or currencies that are agreed by nations to be the most stable. Earlier in the modern era, this IRC was considered to be the British Pound Sterling. The UK had emerged as the largest nation, having conquered and trading with many areas across the planet. Since they used gold and silver regularly in their trading, there was a kind of gold reserve that accompanied the Pound, even though I know of no official declaration that the Pound was ever backed by gold. The UK simply had so much gold that it could cover it's printed money.

But the US was the nation that emerged in the best financial shape after WWI and WWII. The US dollar had been gaining favor internationally, and with the counterfeiting attempts during WWII by the Germans to destroy the Pound Sterling, the US dollar was in high demand. Then came the Bretton Woods Conference. Bretton Woods was a 1944 international agreement on establishing foreign commerce. While it did not establish an IRC, it did set up some ground rules which proved favorable to the US dollar. And it played into US plans established some time earlier.

Oil.

Middle Eastern oil has been exploited since the turn of the 20th century by Western influences. In the early days of oil exploration, the US was not involved; France, India, and the UK were the major players in exploring Arabia for oil reserves, while the US was busy trying to find oil at home. With all the areas where geology of the time expected to find oil tied up in agreements with other countries, US companies really had gotten left out in the cold. But so had Saudi Arabia. Geologists simply did not believe they held oil reserves, and this left the tiny Saud kingdom sitting watching their neighbors grow wealthy beyond their wildest dreams, and militarily powerful as a result.

Then one US company agreed to drill in Saudi Arabia and hit oil in 1932: SoCal. It turned out the geologists had been wrong about the country's geology... Saudi Arabia sits atop massive oil reserves. Suddenly the Sauds became fabulously wealthy and powerful thanks to the US, and the US got the oil reserves they needed to fuel the Industrial Revolution. Ever since, there has been a tight relationship between the US and Saudi Arabia.

In 1960, when OPEC was formed, Saudi Arabia was the most powerful oil-producing country and became the most important member of OPEC. They have controlled OPEC ever since, due to still having the 2nd largest estimated oil reserves, behind Venezuela. That began the most important financial agreement the US had ever entered into: an agreement with OPEC, via Saudi Arabia, to tie the export of oil to the US dollar. It was not the price of oil that was fixed, but the fact that OPEC would not sell oil to any country for any currency other than US dollars. In the meantime, US interests had gradually been buying up oil interests from other countries using money made in Saudi Arabia.

Bretton Woods made this feasible. Any country could exchange their currency for dollars under Bretton Woods, so this agreement did not restrict free trade of oil. However, it did mandate that all countries use the US dollar for their energy needs, forcing the US dollar to become the IRC. All of the troubles in the Middle East since have been a direct result of maintaining this agreement through OPEC. All of the troubles with Iran have been the direct result of US interference in seating and maintaining the family of Mohammed Shah as rulers prior to the Iranian Hostage Crisis of the late 1970s; that crisis was the direct result of Mohammed Reza Shah's brutal reign and the subsequent overthrow of his (our proxy) rule.

All of the Arab Springs have occurred within a few weeks, sometimes days, of the rulers stating their intent to depeg from the US dollar.

Russia regained its 'evil' status shortly after oil reserves were discovered there... Russia has no interest in a US financial arrangement because we took such advantage of them after the fall of the USSR.

Syria was a failed Arab Spring, which failed because of the alliance between Syria and Iran (and between Iran and Russia). Our hatred of Assad is because he has ceased selling oil for US dollars.

Saddam Hussein was an American-backed ruler, placed in power by the Carter administration in response to the Iranian dollar peg threat, who was backed by the US until he decided to depeg from the dollar. When he attacked Kuwait, we defended Kuwait but did not pursue Saddam. When he depegged, selling oil to Russia for Rubles... that's when we invaded Iraq and took out Saddam at all costs. It was not a war for oil, as many have speculated... it was a war for the oil-dollar peg. George W. Bush almost made the true intent public when he announced "mission accomplished" after Saddam had fallen... prior to the bulk of the warring itself. The mission was not to defeat Iraq; it was to remove Saddam. Bush was correct in his statement.

Having the oil-dollar peg and thus the IRC gave the US quite the advantage internationally. We could essentially print money wholesale, without any backing, and maintain our status. Other countries had to have our dollars to buy oil. Anyone else's currency would have long collapsed by now with the massive national debt we have accumulated over time. Now, with the Russia-Iran-Syria alliance, our IRC status is under threat. The dollar has become well-known and trusted, but only trust is now supporting it. We are in danger of losing the IRC, and that, my friends, will create an economic spiral into oblivion for the United States. All of our present financial moves are geared to preserving our economic status... and hiding the truth from the public of course.

So to recap: the US dollar was not truly fiat after we dropped the gold standard... but it is rapidly becoming such today. It was backed by OIL.

TheRedneck

a reply to: ScepticScot

That's a shame. The global economics control everything happening today.

TheRedneck

a reply to: TheRedneck

No, I am very much reading the responses! (now)

I just didn't have the time or energy to get into a insults match over some of earlier the responses.

You are headed right exactly where I was also going to head, but you've done a better job than I probably would have.

a reply to: Flyingclaydisk

Well, I had a head start. I've been following this line of thought since the first Gulf War. The refusal to go after Saddam is what caused me to question the official story.

I just gave a rough overview... there's so much more in the details. But that should be enough to get a conversation started.

TheRedneck

a reply to: TheRedneck

The use of the dollar as the main IRC, particularly in relation to oil, undoubtedly has an effect on the ability strength of the US dollar, however I think this is often overstated. Its important to remember that the dollar is used as an reeve currency because of the strength and size of the US economy, not that the economy is strong because of its status as reserve currency.

More important in my view in maintaining the position of the dollar is the desire of other nations to export to the US and hold dollar reserves. Some Asian economies have built their economic model and growth round running a continual surplus with the US and we are only gradually seeing a transition away from this. In the long run this will impact the relative value of the dollar, however it will be a very gradual process.

In terms of the debt position many other countries run similar or larger debt to GDP ratios without having the same status as the US so I don't believe the US is a special case and US certainly not doomed to some economic collapse if its status as main IRC was weakened or lost.

In summary I would say that the pricing of oil in dollars undoubtedly has an effect, possibly even a large effect, on the US economy. However loss of this would not be game changer feared by some. Oil certainly increases somewhat the demand for dollars but it does not back the dollar.

As a final point as you mention Bretton Woods. People often get hung up on currency being convertible or not and believe fiat currency had no real value Its worth remembering that, as Nixon demonstrated, they are still only convertible at the discretion of the issuing country.

a reply to: ScepticScot

The debt-to-GDP ratio is not the only consideration when looking at a currency, just as the debt-to-assets ratio is not the only thing a bank looks at when determining whether to grant a mortgage. There is the ability to repay which is based not only on the present assets, but also on the reasonable expectation of future ability... growth in the case of a nation. Growth in the US has been sluggish of late (pre-2017), which seems to have intensified the calls for a basket of currencies rather than a single one like the US dollar.

The decline of confidence in the Euro due to member nations having extreme fiscal issues has translated into pressure away from the Euro, which was at one time a primary candidate to be included in such a basket. It was a major competitor at one point against the US dollar, and that itself has given us some 'breathing room' so to speak.

Still, I'm not sure how much overstating has actually taken place. After all, we managed (through trickery and manipulation of other countries) to get a peg for the US dollar. Suppose Russia were to manage to get the peg shifted to the ruble? Or perhaps the Chinese yuan? Both countries are in a position where it is not unimaginable that they could do so; Russia because of its newly discovered reserves, and China because of its massively developing economy. If that were to happen, the effect would be two-fold for the US. Not only would we lose the advantage having the IRC has given us, but another country would gain that advantage.

Economics is a science of relativism rather than one of absolutes. There is no monetary value that signifies a country is economically preferable... it is the value of the economy in relation to other economies that determines position.

(sorry for the delay in responding... been busy and dropped the ball on this thread.)

TheRedneck

a reply to: TheRedneck

No problem. I appreciate you taking the time to reply.

I totally agree that debt/GDP isn't the only, or even the best, way if looking at level of debt. However I also think there is a danger of falling into a big number fallacy with regard the US debt. 20t sounds a lot therefore most be bad.

People and country's hold US debt and other dollar demoninated assets is because they gave confidence in the long term US economy. I think the switch a wider range of reserve currencies will happen, but it will take place over a number of years probably decade's. I think the likelihood of a sudden collapse in international demand for dollars is extremely unlikely.

The Euro is a whole different disaster waiting to happen. Unless there is major reform I don't see it surviving (certainty not in its current form) another major financial downturn.

I think the US dollar will continue to remain the most attractive place to park reserves for a good while yet. Not just because the fundamentals of the economy are strong but because it has strong democratic and legal norms.

I think there is much more danger to the US economy from politicians who believe that the debt is a problem, and who push for crazy ideas like balanced budget amendments, than there ever is from debt itself.

a reply to: ScepticScot

I think the switch a wider range of reserve currencies will happen, but it will take place over a number of years probably decade's. I think the likelihood of a sudden collapse in international demand for dollars is extremely unlikely.

I hope you are right. A switch to an economic basket would be preferable in the long run and inherently more stable, if that change can be done slowly enough to not upset the economic stability already in place. Economics despises sudden change.

The Euro is a whole different disaster waiting to happen. Unless there is major reform I don't see it surviving (certainty not in its current form) another major financial downturn.

Eh, I'm slipping off into prophesy here, but I do believe the Euro (or at least the EU) will survive in some form for a while yet. My reading of prophesy indicates it will be the victor in a coming World War.

Sorry if that's off-topic, but it seems appropriate with the mention of the EU.

I think there is much more danger to the US economy from politicians who believe that the debt is a problem, and who push for crazy ideas like balanced budget amendments, than there ever is from debt itself.

I agree that balanced budget amendments are dangerous, but so is a total lack of responsible spending. We seem to be faced with the conundrum to trying to rein in excessive spending without going too far. Some debt is actually a good thing as it allows for more growth capability, but too much debt endangers future prospects at the expense of immediate gratification. Debt is not the true issue; economic long-term stability is.

Unfortunately, governmental policy seems to act as a pendulum. Like any pendulum, the swings get larger as the pushes get stronger.

TheRedneck