Fiat Money Magic

It's been a couple of weeks at least since I wrote my last KevBlog entry, and since then I have had the time and space, whilst on my hols, to ruminate on an endless slew of alarming news about financial markets - and Gordon Brown's proposed solution.

At times, it is the sheer number of noughts in the bailout figures which leave one gasping, but then after a little while a kind of numbness to digits sets in, and unless the next figure has at least one more zero at the end, one is left feeling perversely disappointed.  To be fair, our own Government appears to have set something of a lead in proposing a model to rescue les pauvre banks.  The initial nationalisation of Northern Rock now appears to be small beer in the wake of the public monies advanced towards the more fragile members of the banking system.

And yet, it appears as if the financial markets are far from appreciative of all this public magnanimity - those computer screens are still awash with red.  The banks are not passing on interest-rate cuts to consumers, and do not yet appear to be lending to each other.  To the average punter, perhaps this seems to be ungrateful in the extreme.

And yet...perhaps those banks are remembering something that politicians and the rest of us have forgotten.  This is far from being the first time that we've been here.  Since Alan Greenspan took over at the US Fed, he added a further $4.5 trillion dollars to the US money supply.  At the time, a great deal of this new money did little other than feed the tech bubble, purchasing junk bonds in markets where the assets were essentially valueless.  Handing these kinds of sums to an already over-leveraged market seems somewhat akin to helping an alcoholic out with a bottle of Bells.  Greenspan's actions were much lauded as they served to stave off a real recession, and we discovered later that he had been advising the UK Government - so don't for one minute think that we didn't also previously follow this path.

It is perhaps on this level that 'the markets' know the truth which politicians appear so reluctant to address.  So, Gordon Brown has introduced billions into the banking system.  Where has it come from?  What is it worth?  If it is borrowed, then all that has happened is that the Government has used one credit card to pay off another one which is maxed out.  If it is taxpayers money, then is this an indication that we've been paying far too much tax (this would hardly be a surprise), or does it put us in hock to support this particular policy spasm?  If the Government is recycling existing debt to introduce liquidity - where is the security underpinning that debt?  Following reports that the Government was considering selling off properties to the Saudi authorities, to lease back via some kind of Sharia Finance whimsy, one is beginning to wonder if we actually have any national assets left!

This is the crowning glory of 'Fiat Currency'.  It is, after all, nothing more solid than a series of fluorescent digits on a computer screen.  It has no value, other than political intention, backing it.  The markets know this.

Interestingly, Greenspan himself, in an article he wrote in 1966 argued that money not backed by gold was a sort of fraud perpetrated against the public.  Recently, he was asked if he would want to add a disclaimer.  No, he said.  He had re-read the article, and wouldn't change a single word.

P.S.  Just in case you think I am exaggerating this issue, just look at the following chart of new US money-supply up to 16/10/2008: