Legal Tender

I remember the first time it happened:  I was at a conference in San Diego in the early 1970s, and my money was no good.  The conference hotel refused to accept cash, honoring only credit cards. Filled with righteous indignation – after all, the dollar bill reads “legal tender for all debts public and private” – I nevertheless paid with my card, sensing I had entered a new world. Paper no longer had value; all worth was electronic.  We’ve come a long way since then, far longer than most of us realize.  At a meeting I attended this week, one person commented idly that he never carried cash any more, preferring simply to swipe his credit card.

On a given day, the total transactions volume of world currency markets is about 4 trillion dollars.  However, David Rothkopf, in Power, Inc., estimates that of that 4 trillion, only about 1.25 trillion involves actual currencies. The remaining 2.75, over twice the physical currency amount, involves one or another forms of derivatives.  While not counted as officially money (M1) or near-money (M2) by any nation, derivatives are rapidly becoming, or have already become, the multi-national electronic currency of the world.  They constitute a medium of exchange between financial institutions independent of any one country’s economy or economic policies, and are not regulated in any meaningful way.  Their visibility in the official data is practically zero.  Yet, as the debacle in the Euro zone shows, they can wreck havoc to any nation’s economy (the role of credit default swap and cross currency swap derivatives in the Greek debt crisis is one of the more lurid tales in financial history:  http://www.bloomberg.com/news/2012-03-06/goldman-secret-greece-loan-shows-two-sinners-as-client-unravels.html  presents its murky outline.)

The total value today of the world’s physical currencies is estimated at 8 trillion dollars by Rothkopf, while the total value of the world’s derivatives is about $791 trillion.  That amounts to about 14 times the GDP of all nations of the world combined.  In macroeconomics 101, you learn that the ratio of money over GDP is a factor in creating inflation (how important a factor is a subject that economists love to argue about.)  When considering the role of “broad money”, the situation has all the earmarks of the world’s most giant bubble just waiting to burst.  Put another way, if all derivative contracts suddenly were sold for cash today, payable in physical currency, only about 1 on 100 dollars could be paid, and the global currency market would be demolished.  Of course, that couldn’t happen, but enormous risks exist. For example, since the repeal of the Glass-Steagall Act in the 1990s, banks have been permitted to mix their derivatives accounts with their commercial accounts, thus providing a measure of backup to their highly risky derivatives activity by the FDIC.  Failure of the bank from derivatives activity unlocks the taxpayer's wallet to cover the bank's losses.  And events like "too big to fail" bail-outs are precipitated.  Reenactment of Glass-Steagall provisions requiring separation of investment and commercial banking is a necessity.

The real story behind all the statistics is the rapidly waning financial power of governments versus corporations.  Major corporations prosper while governments cannot pay their bills.  And once again, governments are charged with responsibility for the general welfare of all their citizens, while corporations seek only the financial welfare of their investors.  A new, broader way of defining corporate goals and regulating corporate behavior must be found, while it still is possible.  If not, the future will more and more resemble that of the uncaring tyrannies of ancient times, not a step forward but, two steps back.