/ 9 February 2009

Let them eat money

There was a time in the development of the present monetary system when you’d not accept a coin without biting it to check its authenticity. I hope we are not on our way back to such a system as I’d hate to bite the coins that find their way into my pocket.

There are voices out there, though, which see a return to the gold standard as the way out of the ­financial quagmire the world now finds itself. This means that money is backed by gold which the authorities hold somewhere in a vault.

That’s it. There are no exotic single-stock futures to cause Absa write-downs of R1,4-billion and no split-strike options associated with Bernie Madoff and his $50-billion Ponzi scheme. There are just notes backed by gold in the vaults.

A return to the gold standard is potentially great news for countries such as South Africa as we can mine all this gold to back the world’s currencies.

But Wikipedia tells me that when the world was last on a gold standard, between 1946 and 1971, the price of gold was fixed at $35 an ounce. That’s pretty paltry against the current $900.

We’ve long ago abandoned the gold standard and that’s where the trouble starts. An analysis by the Guardian, “Global recession — where did the money go?”, likens the modern monetary system to a global financial pyramid scheme. In other words, just the same as Madoff, but involving all of us.

Now that currencies are not pegged to gold, money is a nebulous idea, says the Guardian. It is a promise to pay. Central banks hold gold valued at just $84-billion.

Cash in circulation amounts to $3,9-trillion. Banks, which are allowed to lend considerably more than they hold in deposits, had combined loans last year of $39-trillion.

The shadow or unregulated banking system, which includes investment banks and hedge funds, kicks in with derivative instruments such as credit default swaps which stood at ­$62-trillion last year.

Note that this amount exceeds global GDP of $55-trillion. Meanwhile the notional value of all derivatives reached $863-trillion last year, the Guardian says.

Total asset values for developed economies peaked at $290-trillion.

It is hard not to see that the entire system had run amok and was due for a massive correction. Global stock markets lost $30-trillion since 2007, says FNB’s Cees Bruggemans.

Governments have since pumped in $1,9-trillion internationally to rescue the banking system. “Attempts to restore stability have had some effect but the sums of money are tiny relative to the problem.”

What to do? The despondency is more than palpable, Bill Gates, for instance, telling the globalisation overlords at Davos that he expects the recession to last a full four years.

FT writer Martin Wolf, who has an influential following, is calling for Barack Obama, deity-like, to come to the rescue by not focusing on his backyard, the Congress, but rather by doing what is right for the whole world.

Nobel prize economist Joseph Stiglitz said this week that UK banks should default on their international financial obligations rather than saddle the taxpayer with a bill which will take 20 years to repay.

These are desperate times. But while this is a big, monster-sized problem to deal with, we are not yet quite back to biting money to test its authenticity.

For one thing, the size of the derivative market is calculated on the face value of contracts, but the true underlying value is significantly lower. In the case of Lehman Brothers, for instance, RGE Monitor reports, it had $72-billion in credit default swaps, but at settlement the total cash exchanged by the parties was just R5.2-billion.

AIG, which is generally thought to have had a massive derivative exposure to Lehman, paid just $6,2-million on its Lehman exposure, says RGE Monitor.

Second, it is correct that the whole monetary system is underpinned by very little gold. But it is not as though there are not assets out there.

An analysis by Stanlib’s Kevin Lings shows that US household assets amounted to $71,1-trillion at the end of September, 2008, a massive $6,6-trillion below their record level of $77,7-trillion the previous year. Lings expects that there was a further loss of $5-trillion in the forth quarter, but this data is not yet available.

The decline in asset values over the past year has been both in terms of real estate ($2-trillion) and financial assets ($4.8-trillion). Pension values fell by $1.6-trillion, says Lings.

He says that despite the fact that US consumers have lost $6.6-trillion (R66-trillion to put it in local terms, 33 times our GDP), the net worth of the US consumer is a respectable 529% of disposable income, 5,29 times annual income after tax.

“That actually means that the average US consumer is still extremely wealthy. US consumers are still wealthier than during most of the past 50 years,” says Lings.