The Clash Between Governments and Markets
Tuesday, 2 November 2010
As the use of currency spread, governments began taking steps to exert their control over it. This should hardly be surprising. Whoever controls currency holds power, and governments almost always seek power.
For thousands of years, Chinese emperors relied on a bureaucracy and a powerful army to control the use of money in their kingdom. As far back as 500 BC, tokens made from copper or brass were issued and circulated as cash. These tokens, which were strung together on strings, were backed up by gold and silver held by the government. Private citizens were forbidden to possess these metals on their own. No one could refuse the tokens, and the state maintained absolute control over the monetary supply and its value. This system is quite different from the metal coins issued by the Lydians, which had intrinsic value and were difficult for any state to keep track of once they had entered circulation.
The tokens were eventually replaced by two products of Chinese ingenuity—paper and printing. Sometime in the first millennium, paper made from mulberry tree bark was stamped with the Chinese emperor’s seal and backed up with gold. These bills, often the size of a modern sheet of notebook paper, were far easier to transport and use than the strings of bulky tokens. They are some of the first examples of paper money in history.
In the 1200s, most of China fell under the control of Mongolian emperors, whose vast horse armies would conquer much of Asia and terrorize populations as far away as Poland and the Middle East. The Mongolian emperors understood instinctively that loose money was a threat to their power. Like the previous emperors, the Mongols issued paper money and forbade private citizens from holding any gold and silver on their own. Anyone who did not accept these bills was severely punished.
Another threat were foreign traders, who could theoretically bring money into the empire and thus upset the state’s monopoly. Elaborate precautions were taken to ensure that this did not happen. Merchants entering China had to surrender all their money to a government official, who then paid the merchants’ expenses with the emperor’s paper money. Foreigners were kept under strict watch while in the empire. Sketches were made of them at the border for quick identification. Merchants had to report to the police whenever they stopped for the night and had to submit to searches each evening and morning.
The Chinese system of paper money held together as long as the emperor’s power was absolute. But no government system survives forever. In the late 1300s, the Chinese Emperor Ming decided to pay the 100,000 artisans who lived in the Forbidden City and its 60,000 guards in paper money. Whenever more money was needed, more money was printed. Marco Polo was stunned to observe the emperor’s bureaucrats stamping these slips of paper, which the Chinese used faithfully to exchange for real goods. But the faith was soon lost as the market was flooded with paper. By 1420, the emperor’s paper money brought only 1/40 of its original value.
This story illustrates another trait of currency—its value fluctuates.
Much of this depends on the laws of supply and demand. If a currency is too scarce—say, diamonds—there will not be enough of it to use in everyday transactions, and the economy will be strangled. But if a currency is too common, its value will plunge. If gold existed in great quantities in any streambed, for example, it would have no value.
Great influxes of gold have wrought great change to prices. When Spaniards in the 1500s brought back shiploads of gold from the Americas, the surge in gold ignited inflation and launched a price revolution.
This was unintentional. Most Spaniards were unaware of the economic relationship between an increase in the money supply and an increase in prices. But other leaders soon learned something that modern governments seem to understand intuitively—if you need more money, simply make more of it.
In the fifteenth and sixteenth centuries, both French and English kings found themselves heavily in debt. One, the dauphin in France, used his control over mints to melt down silver and reissue it as coins—mixed with a base alloy. Far more coins were dumped into the local economy, and the dauphin was able to pay his debts. Inevitably, however, inflation soon set in, and in Paris the coins were no longer trusted as a form of currency.
In England, Henry VIII tried a similar tactic. He hoarded silver and then announced that new silver coins would be revalued higher, even as he added an alloy to make more of them. In the short run, the tactic worked, and Henry eventually took so much silver out of coins that they had to be coated to display a metallic sheen. Henry VIII is rightly remembered in history for many things. To economic historians, he is the author of “the Great Debasement.”
Both Henry and the dauphin profited enormously from their debasement schemes, but the effect on common people—especially the poor—was destructive. The debased coins ignited inflation, raising the prices of everything from bread to livestock. The poor fell further and further into debt and were dispossessed of goods and homes. In England, the peasants revolted. Unrest, hardship, and war were the products of abusive monarchs.
These abuses generated a backlash, especially against the power monarchies had to manipulate the currency for their short term goals. The English philosopher John Locke, champion of reason and the Enlightenment, made a novel proposal. He suggested that money was of a set value and that the value should be honored—regardless of what the country’s rulers thought or desired.
This was a radical idea, and one that the royalty did not appreciate. The king held the power of the purse, but this reform would effectively sew the purse shut. The market, not the king, would determine a currency’s value, and the market had to be respected and its rules obeyed, or the people would suffer.
Understanding the long struggle between government and the market is critical to understanding the Forex market today.
Although kings and queens no longer rule over their subjects and the treasury as they once did, governments still spend money voraciously. When deficits balloon and credit is ruined, they often resort to tricks rather than making the painful and necessary decision to rein
This is where the market comes in. Because money today holds no intrinsic value—it’s simply an article of faith (our word credit comes from the Latin credere, to believe or put faith in)— someone must ensure that it is worth as much as a nation says it is. Forex investors, from the smallest to the largest, exercise the will of the market. It can be ruthless and sometimes scary, but it is also vitally necessary. Money is far too important to be controlled by government.
Of course, governments don’t like to be told how to run their affairs, and they’ll do virtually anything to retain control. In each case, however, the market is never wholly defeated. Black markets and underground trading schemes always grow up outside government control, no matter how earnest or effective police surveillance is. The market is always seeking true value, a spot where it can reach equilibrium.
This battle between markets and government is never-ending. A currency is often regarded with patriotism and pride, not to mention as a symbol of legitimacy for the government. If a currency appears wobbly or devalues, so do a nation’s leaders. This is why governments often openly detest currency speculators as ruthless parasites who cause and then profit from disorder. It will never be safe to say that the market, or the governments, have truly won. The influence of Forex has caused a backlash.
In 1978, Nobel Prize-winning economist Jame Tobin proposed that major economies levy a uniform tax on all foreign exchange transactions. The idea was called the “Tobin tax.” Tobin said a small tax would allow currencies to be traded but would discourage currency speculators from shifting currency around the world simply to take advantage of tiny differences in value.
Naturally, politicians, especially those who dislike the free market anyway, have taken up Tobin’s idea. They say that speculators have little respect or regard for nations or cultures. As we have already noted, currency fluctuations can devastate a society and ruin budgets. The Tobin tax, if it is enacted, could be fairly described as governments’ revenge.
In its defense, conservatives point out that the private market is a critically important check on government power. Market discipline keeps the government from dominating a society. In the most idealistic terms, Forex investors around the world are in a constant struggle to keep governments honest.
For thousands of years, Chinese emperors relied on a bureaucracy and a powerful army to control the use of money in their kingdom. As far back as 500 BC, tokens made from copper or brass were issued and circulated as cash. These tokens, which were strung together on strings, were backed up by gold and silver held by the government. Private citizens were forbidden to possess these metals on their own. No one could refuse the tokens, and the state maintained absolute control over the monetary supply and its value. This system is quite different from the metal coins issued by the Lydians, which had intrinsic value and were difficult for any state to keep track of once they had entered circulation.
The tokens were eventually replaced by two products of Chinese ingenuity—paper and printing. Sometime in the first millennium, paper made from mulberry tree bark was stamped with the Chinese emperor’s seal and backed up with gold. These bills, often the size of a modern sheet of notebook paper, were far easier to transport and use than the strings of bulky tokens. They are some of the first examples of paper money in history.
In the 1200s, most of China fell under the control of Mongolian emperors, whose vast horse armies would conquer much of Asia and terrorize populations as far away as Poland and the Middle East. The Mongolian emperors understood instinctively that loose money was a threat to their power. Like the previous emperors, the Mongols issued paper money and forbade private citizens from holding any gold and silver on their own. Anyone who did not accept these bills was severely punished.
Another threat were foreign traders, who could theoretically bring money into the empire and thus upset the state’s monopoly. Elaborate precautions were taken to ensure that this did not happen. Merchants entering China had to surrender all their money to a government official, who then paid the merchants’ expenses with the emperor’s paper money. Foreigners were kept under strict watch while in the empire. Sketches were made of them at the border for quick identification. Merchants had to report to the police whenever they stopped for the night and had to submit to searches each evening and morning.
The Chinese system of paper money held together as long as the emperor’s power was absolute. But no government system survives forever. In the late 1300s, the Chinese Emperor Ming decided to pay the 100,000 artisans who lived in the Forbidden City and its 60,000 guards in paper money. Whenever more money was needed, more money was printed. Marco Polo was stunned to observe the emperor’s bureaucrats stamping these slips of paper, which the Chinese used faithfully to exchange for real goods. But the faith was soon lost as the market was flooded with paper. By 1420, the emperor’s paper money brought only 1/40 of its original value.
This story illustrates another trait of currency—its value fluctuates.
Much of this depends on the laws of supply and demand. If a currency is too scarce—say, diamonds—there will not be enough of it to use in everyday transactions, and the economy will be strangled. But if a currency is too common, its value will plunge. If gold existed in great quantities in any streambed, for example, it would have no value.
Great influxes of gold have wrought great change to prices. When Spaniards in the 1500s brought back shiploads of gold from the Americas, the surge in gold ignited inflation and launched a price revolution.
This was unintentional. Most Spaniards were unaware of the economic relationship between an increase in the money supply and an increase in prices. But other leaders soon learned something that modern governments seem to understand intuitively—if you need more money, simply make more of it.
In the fifteenth and sixteenth centuries, both French and English kings found themselves heavily in debt. One, the dauphin in France, used his control over mints to melt down silver and reissue it as coins—mixed with a base alloy. Far more coins were dumped into the local economy, and the dauphin was able to pay his debts. Inevitably, however, inflation soon set in, and in Paris the coins were no longer trusted as a form of currency.
In England, Henry VIII tried a similar tactic. He hoarded silver and then announced that new silver coins would be revalued higher, even as he added an alloy to make more of them. In the short run, the tactic worked, and Henry eventually took so much silver out of coins that they had to be coated to display a metallic sheen. Henry VIII is rightly remembered in history for many things. To economic historians, he is the author of “the Great Debasement.”
Both Henry and the dauphin profited enormously from their debasement schemes, but the effect on common people—especially the poor—was destructive. The debased coins ignited inflation, raising the prices of everything from bread to livestock. The poor fell further and further into debt and were dispossessed of goods and homes. In England, the peasants revolted. Unrest, hardship, and war were the products of abusive monarchs.
These abuses generated a backlash, especially against the power monarchies had to manipulate the currency for their short term goals. The English philosopher John Locke, champion of reason and the Enlightenment, made a novel proposal. He suggested that money was of a set value and that the value should be honored—regardless of what the country’s rulers thought or desired.
This was a radical idea, and one that the royalty did not appreciate. The king held the power of the purse, but this reform would effectively sew the purse shut. The market, not the king, would determine a currency’s value, and the market had to be respected and its rules obeyed, or the people would suffer.
Understanding the long struggle between government and the market is critical to understanding the Forex market today.
Although kings and queens no longer rule over their subjects and the treasury as they once did, governments still spend money voraciously. When deficits balloon and credit is ruined, they often resort to tricks rather than making the painful and necessary decision to rein
This is where the market comes in. Because money today holds no intrinsic value—it’s simply an article of faith (our word credit comes from the Latin credere, to believe or put faith in)— someone must ensure that it is worth as much as a nation says it is. Forex investors, from the smallest to the largest, exercise the will of the market. It can be ruthless and sometimes scary, but it is also vitally necessary. Money is far too important to be controlled by government.
Of course, governments don’t like to be told how to run their affairs, and they’ll do virtually anything to retain control. In each case, however, the market is never wholly defeated. Black markets and underground trading schemes always grow up outside government control, no matter how earnest or effective police surveillance is. The market is always seeking true value, a spot where it can reach equilibrium.
This battle between markets and government is never-ending. A currency is often regarded with patriotism and pride, not to mention as a symbol of legitimacy for the government. If a currency appears wobbly or devalues, so do a nation’s leaders. This is why governments often openly detest currency speculators as ruthless parasites who cause and then profit from disorder. It will never be safe to say that the market, or the governments, have truly won. The influence of Forex has caused a backlash.
In 1978, Nobel Prize-winning economist Jame Tobin proposed that major economies levy a uniform tax on all foreign exchange transactions. The idea was called the “Tobin tax.” Tobin said a small tax would allow currencies to be traded but would discourage currency speculators from shifting currency around the world simply to take advantage of tiny differences in value.
Naturally, politicians, especially those who dislike the free market anyway, have taken up Tobin’s idea. They say that speculators have little respect or regard for nations or cultures. As we have already noted, currency fluctuations can devastate a society and ruin budgets. The Tobin tax, if it is enacted, could be fairly described as governments’ revenge.
In its defense, conservatives point out that the private market is a critically important check on government power. Market discipline keeps the government from dominating a society. In the most idealistic terms, Forex investors around the world are in a constant struggle to keep governments honest.
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History of Forex