What is money? If you take a £5 note out of your wallet, are you holding money? By many definitions, you are; you can take that £5, walk into a shop, and trade it for a sandwich, so it’s money, right? Well, only to a limited extent.
If you strip everything away from your £5 note, it’s not really money at all. Sterling only has value because we believe that it does, and we all accept it as such. Today, we spend notes (or move figures in an app), but on the Solomon Islands, shells are traditionally used as money and are a perfectly acceptable payment for dowries, land, and compensation.
Historically, gold has been our shared currency of choice. Gold coins were first struck in around 550BC, and the world never looked back. Available, portable, and long lasting, it’s been traded internationally and very keenly sought after (just think of the Gold Rush of the mid-1800s) ever since.
Gold – or even shells, for that matter – can be defined as ‘Outside Money’. This is money that exists outside the system: an asset that you hold, which doesn’t appear as a liability on someone else’s balance sheet.
The solid, tangible, hold-it-in-your-hand perks of gold and coins became more problematic, however, as trade and industry boomed from around 400 years ago. Then, with so much money being made, it became inconvenient to cart around a veritable treasure trove every time you wanted to do business. Instead, you might deposit your bullion in a bank for safekeeping, in exchange for a bank note testifying to the fact that they had it. A weight of gold could be swapped for a paper note, which was obviously much lighter – and far less tempting to your common or garden variety highwayman, waiting in the shadows to relieve you of your burden.
This tying of currency (specifically the dollar) to gold was formalised under the Bretton Woods system in 1944. But fast-forward to 1971, and it was all change again. At this time, America’s President Nixon decided that keeping large reserves of gold in places such as Fort Knox was inconvenient and unnecessary. Everyone was perfectly happy operating as if the dollar was money so, if people believed that this was money, why not let it be money, and take gold out of the equation? The advantages, of course, were that if notes were money, it was much easier to make more of it. And so, the link between gold and money was severed. Enter Bretton Woods II.
The second iteration of Bretton Woods essentially represents the time period in which money isn’t tied to the gold standard. Countries can now print their own money, and this happens all across the world, not just in the US. If you look at the Bank of England £5 note we mentioned earlier, you’ll see that it says ‘I promise to pay the bearer on demand the sum of five pounds’. In theory, this should mean that you could walk into a bank and ask for your note to be changed back into gold to the value of £5. However, in Bretton Woods II, this is a fiction – it can’t be done.
This kind of money can be described as ‘Inside Money’, meaning that what we think of as wealth is held inside the system. Your assets are someone else’s liability, property is exchanged on trust, and it can all be confiscated without warning. Of course, money is held within banks, which are regulated and protected for you under various acronyms and therefore considered secure, but if the Government chooses to take all or some of your funds (as happened in Cyprus), it can. You cannot defend Inside Money.
This can also be seen in the case of Roman Abramovich. Outside of anyone’s personal views about Russia, and the moral arguments around sanctions, the cold facts are these: he bought assets, and the Government confiscated these assets. Property ownership is considered to be one of the core tenets of civilization, but there are perfectly legal ways for countries to cross over into what would otherwise be branded property theft. Perhaps we might argue that this is fair if prompted by an event such as a major war, but it begs the question: where will it end? Is a smaller war a good reason to confiscate money? How about a minor transgression?
Inside Money is fundamentally based on trust, which makes it a heavily flawed system when stressed, such as when a war begins to take hold. As we’re seeing, that trust is no longer in place; Russia is now refusing to trade in US dollars (the global reserve currency) and accepting only rubles for its oil. The US and EU have confiscated currency reserves from the Russian Central Bank. China, too, has been quietly accumulating gold for some time, with a reluctance to ‘play’ in this particularly messy sandpit. Sanctions that are designed to punish the aggressor are nevertheless creating a shot that will be heard around the world.
So, when a trust-based system is destabilised, what comes next? According to Zoltan Pozsar of Credit Suisse Economics, we’re now witnessing the birth of Bretton Woods III. This means the emergence of a new, de-risked system that reverts to good old-fashioned Outside Money. Pozsar writes that, to get back to a system they can better control, major players will prefer commodities such as gold, or even Bitcoin. As he says, ‘After this war is over, money will never be the same again.’
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