Monetary Smoke and Mirrors

August 19, 1998

The deterioration of the ruble is generating a lot of solicited and unsolicited advice. Much of it concerns devaluation, which the Russians are, so far, resisting. After all, Thailand, Indonesia, and South Korea devaluated, and their financial situations are still miserable.

A Monetary Realist finds any discussion of devaluation of a modern currency interesting, because it is impossible. How could it be done?

I have a letter from the Treasury Department stating that no value is attached to the U.S. dollar. I am sure that the same is true of other currencies as well. How can you devalue what has no particular value?

What gives genuine money value is its weight and purity. If two coins have the same composition, the heavier one will be the more valuable. If their weights are identical, the 100% pure (gold, silver) one will be more valuable than the one of lesser purity.

Modern money, or what, literally, passes for it, makes such considerations irrelevant. For example, the twenty-five cent coin, and the dollar coin, have the same base-metal composition. But the dollar coin, or slug, weighs only fifty percent more than the two-bit coin. Does that makes the dollar worth thirty-seven and a half cents? Or does it make the quarter coin worth sixty-six cents? Since, by existing law, neither coin (being base metal) can settle more than twenty-five cents in debt, it's immaterial, in more ways than one. It's psychology, not reality, that counts toward "value" in modern coinage.

So how can you "devalue" modern money, like the ruble? You can't. What is meant is not devaluation, but an altered exchange rate.

You might deceive yourself by saying that devaluation of the ruble means reducing its value with respect to the dollar, which is a sort of international reserve currency, but that is sophistry, since the dollar itself has no value. That's like securing your balloon by tethering it to another, untethered, balloon.

I have some gold rubles bearing the likeness of the czar. When they circulated as money in Russia (known in those days as the breadbasket of Europe!) we used gold coins in this country, too. The exchange rate between dollar and ruble was a simple calculation based upon the amount of gold in the two coins. It was not politics, nor banking, but simple math.

In our brave new world, the dollar is no quantity of anything, and the ruble isn't any particular amount of any substance, either. The ratio between them, then, is determined by factors far more subtle and abstruse than simple comparisons of weight, of which neither has any. It is an agreement between bankers, probably in conjunction with politicians. It is based upon hunch, guess, and wishful thinking, with a bit of intimidation thrown in. It can be changed as needed, to satisfy the needs of the stronger party, in this case, almost any other party than Russia.

The Russians welcome American investment funds, but there is precious little in Russia to invest in. And the rubles earned in Russia won't buy enough, when converted into other currencies, to make doing business in Russia worth-while. So the economic situation in Russia goes from bad to worse, and it is suggested that devaluation (meaning a lowered exchange rate) might make the situation better. Better for whom? Certainly not for Russians, who will only see prices of foreign goods increase.

It has been suggested that only a political reform will solve Russia's problem. Well, it might make it better. But it still is based upon imagination and politics, with the loser's economy failing first.

The Russians have large gold stores. If they bartered gold for the goods and services they needed, they would have them. No one would question the wisdom of doing business with the Russians if they paid their bills, rather than settling them with the notes of a central bank which would never honor them. Devaluation would be too absurd to consider. An ounce of gold is an ounce of gold. True, if you call that a ruble, and then re-define ruble as half an ounce of gold, you will have devalued the ruble, but anyone could see that that was a joke: simply demand twice as many rubles. I don't think any nation has ever had the simple honesty to call its money what it actually was, and today that would be impossible, for few people would trade goods for nothing, if only because they didn't want to look foolish.

Well, the Russians are not going to pay their bills, but only "settle" them with paper. There's no profit in issuing "notes" or "obligations" which Gresham's law forces out of existence. If you're going to counterfeit successfully, you must have government regulations permitting it (in return for unlimited government financing) and you must have a gentlemen's (I give the benefit of the doubt) agreement with other national banks that they will counterfeit also. Then it is merely (!) a matter of arranging exchange rates, but the strong economies will dominate the weak in that determination. Arbitrage will accomplish what armaments could not do.

Our economy is strong because for many years we used actual money, and were able to develop thriving industries by having an honest medium of exchange with which to pay bills. Even after we were gradually weaned off the use of money and into the use of credit, the economy kept going from inertia. In Russia, there is no inertia left.

A two-tiered currency apparently isn't being considered for Russia, although it would seem to offer some temporary advantages. It would allow for the ever-popular inflation at home, and a stronger, more stable currency abroad. Perhaps it is hoped that the Russians can accumulate enough dollars to use them as an international currency. In that case, however, the dollars sent to Russia will have to accomplish something more than simply being siphoned into investments elsewhere. Since borrowed dollars cannot be repaid without more borrowing to pay the interest, the use of dollars by any nation insures its perpetual dependence upon, ultimately, the Federal Reserve. Should it appear to be succeeding in selling enough of its goods to obtain sufficient dollars to get the Fed off its back, rest assured that an adjustment of exchange rates would fix that!

A genuine economy is built upon genuine money. There is none of that; some economies are stronger than others, but, as I have indicated, it is inertia. Eventually, the productive people of the world will come to question why they should work to produce goods, when they are paid in promises never to be kept. The issuers of the promises get all the production for nothing; the workers sweat to get their promises. The inequity is so massive that it is invisible. Still, the truth, even when so stark as to excite disbelief, will out. Hopefully, there will still be some freedom remaining when it does.

The average human body contains 0.2 mg of gold with the bone containing .016 ppm and the liver .0004 ppm.

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