Saturday, July 10, 2010

Financial Cognitive Dissonance

One of the nice things about this blog is knowing that my readers (or my regular readers, anyway) are intelligent people who don't need me to explain that cognitive dissonance refers to the stating of a given belief but acting in a manner contrary to that stated belief. That's probably why my readership is so small.

The G-20's call for austerity, the burgeoning global debt and Greece's recent financial crisis have got me thinking about money, lately. I wonder how many of us recall that paper money has no intrinsic value in and of itself. Paper money is nothing more than a fancy I.O.U.

In medieval times, people would trade goods and services for other goods and services; "you give me that ox, and I'll give you twenty chickens" or "you give me a room and a bed for the night and I'll plow ten furrows for you tomorrow".

Trading literal goods in this way was somewhat cumbersome and arbitrary. Precious metals, such as gold and silver, were far easier to carry and exchange than oxen, and their value was more easily standardized; easier yet if those precious metals were stamped into light-weight, standardized coins.

One of the earliest examples of this originated in the Bohemian city of Joachimsthal in 1518, where a silver coin known as the "Joachimsthaler" or "Thaler" (pronounced "Tahler") for short was minted in large numbers thanks to the rich silver deposits to be found near that town. In fact, the "Thaler" is the origin of the North American "Dollar's" etymology.

Eventually, the world came up with something even lighter and easier to exchange than gold and silver coins; paper money. The idea, originally, was that each dollar (for those of us living in North America) was really nothing more than a government-issued voucher for an equal value in gold; in other words, each paper dollar represented one dollar's worth of gold stored in Fort Knox or some other such place of safekeeping. Rather than lugging around heavy gold coins or bars, people simply exchanged these paper vouchers instead.

In the early seventies, then President Richard Nixon stirred the financial porridge, so to speak, when he decided to kill the gold standard; in other words, he decreed that the U.S. dollar need no longer be directly convertible to gold. Why? Well, because the United States' ill-considered conflict in Vietnam plus increased domestic spending had created these pesky fiscal and trade deficits. Nixon's solution - no problem; we'll just start printing lots more paper money and do away with that inconvenient rule that it be backed up by something of real value.

You'd think that the rest of the global financial community would cry "foul" or something but, oddly enough, they did the opposite. Gradually, country after country began to follow the United States' lead and started printing currency willy-nilly, beginning with West Germany and followed by Switzerland and, eventually, the rest of Europe and, of course, Canada. Because of all this, today international currencies are valued based on their projected future value rather than the amount of gold that they can buy; in other words, currencies today have no real intrinsic value, other than that assigned by speculators.

In an earlier post, I wondered aloud whether the amount of money that is owed by Canada alone, to say nothing of the rest of the world, actually even exists. I suggest this answers that question.

I wonder what would happen if the majority of the world's financial institutions realized that simple fact tomorrow? More interestingly, if we assume that the world's financial institutions are governed and operated by basically intelligent people who already understand this fact, then we can only conclude that they conveniently choose to disregard that knowledge, and carry on as though money were still backed up by something of value. Now wouldn't that be a fascinating example of financial cognitive dissonance?

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