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Home > Paper Promises: Money, Debt and the New World Order

Paper Promises: Money, Debt and the New

World Order
[1]

The paper money system is a matter of

faith.
by John Gray [2] Published 12 December, 2011 - 00:00
Paper Promises: Money, Debt and the New World Order
Philip Coggan
Allen Lane, 304pp, 20
"I wasn't worth a cent two years ago, and now I owe two millions of
dollars." Attributed by Mark Twain to "a speculator in lands and mines"
in The Gilded Age (1873), his satirical novel of post-civil-war America
co-written with Charles Dudley Warner, it is an observation that applies
in much of the western world. The incomes of most Americans have
been stagnant, in real terms, for roughly 30 years and yet, in the run-up
to the 2008 crash, millions were able to buy homes by loading up on
debt that they had no prospect of repaying. Ireland and Spain enjoyed
wild booms as a result of cheap credit extended to the construction and
property industries, while in Britain, the political economy of New
Labour was based on high house prices and not much else. Predicted
by Nassim Nicholas Taleb, Nouriel Roubini and a handful of others, a
bust was inevitable. But it seems that little has been learned since the
crash and, as a consequence, a crisis that our leaders have never
properly understood is now entering an even more dangerous phase.
One source of this intellectual deficit is denial of the past. Full of false
starts and dawns that never came, history is a solvent of illusions and
is for that reason hardly considered or else actively rejected by much of
the political class. Yet we can only understand where we are if we

know how we arrived here, a fact made perfectly clear in Philip

Coggan's Paper Promises, the most illuminating account of the
financial crisis to appear to date. Coggan begins his story where it
should begin, with an exploration of the nature and origins of money - a
more problematic subject than is commonly acknowledged. It has
become a commonplace that many things can serve a monetary role:
cowrie shells in ancient China and cigarettes in prisoner-of-war camps.
The rise of paper money is less well understood, though it has a clear
bearing on the present crisis.
First introduced by the 9th-century emperor Hien Tsung to deal with a
shortage of copper, paper money was developed by the Mongols.
Coggan describes the surprise of Marco Polo when he discovered that
the grand khan of the Mongols paid his soldiers with paper currency,
which for them had "the same value as if it were gold or silver".
Answering the Venetian merchant's puzzlement, Coggan writes, "Paper
clearly has no intrinsic value so why accept it as payment? The answer
was that traders had little choice. The Mongol regime had decreed
paper's use and theirs was not a government one defied. In a sense,
then, the value of the paper was equivalent to the citizen's belief in the
stability of the governing regime."
It is a highly pertinent observation, because, as Coggan goes on to
show, the world monetary system has had much the same basis ever
since Richard Nixon ended the dollar's convertibility to gold in 1971.
Since then, the global monetary order has been based entirely on fiat
currency - money that is created and managed by governments. Just
as much as the paper issued by the grand khan, the dollar and the euro
rest on faith in the regimes that underwrite them.
Contrary to the clamour for a return to a gold standard that can be
heard on the Tea Party fringes of the American right, fiat currencies
have been trusted for long periods even though their purchasing power
tends to decline over time. However, fiat money runs into difficulty
when - as with the euro and the US dollar, despite the relative strength
the dollar is gaining from the eurozone crisis - the ruling regime comes
to be seen as weak. In the last analysis, it is power that sustains any
monetary system, including those that have been based on gold.
As Coggan notes, "The First World War destroyed the cosy
arrangements that kept the gold standard in place." More than any
mistakes in monetary policy, it was the geopolitical upheaval that
followed the Great War that produced the Great Depression. Writing

with a lucidity that enables him to convey deep insights without a trace
of jargon, the author recounts the process through which Europe's old
elites destroyed their own power, while the politicians who inherited the
mess that ensued found themselves in "a world without ideas".
Democracy is more firmly rooted today, but with Europe's elites having
once again lost the plot, it is not unreasonable to fear that some of the
disasters of the 1930s will be repeated. Unfortunately, the debate about
how to deal with the financial crisis has degenerated into a dispute
between rival schools of economists, each convinced that it has the
solution. Rightly, the latter-day Keynesians highlight the absurdity of
imposing austerity when the economy is already burdened by high
levels of debt - economic activity shrinks and the level of debt rises. But
policies of the kind that John Maynard Keynes suggested in the 1930s,
which worked well after the Second World War, are unlikely to be so
effective in the current conditions. The role of the New Deal in ending
the Depression is disputed, some historians maintaining - plausibly, I
think - that it was the mass mobilisation of the United States during the
Second World War, rather than any of Franklin D Roosevelt's economic
initiatives, that was decisive. Even if it was the New Deal that began
the recovery, the trick cannot be repeated today, when the US is no
longer the world's industrial powerhouse.
The gargantuan levels of increased debt that the US has taken on
since the start of the crisis have been sustainable only because so
much of China's foreign reserves is locked in to the dollar. Economists
will tell you that rational self-interest will prevent China from disrupting
this relationship of mutual dependency. Chinese policy up to the
present supports this view, but it would be foolhardy to count on Beijing
financing America's borrowing indefinitely. A president who tilted the
US further in the direction of protectionism could alter the situation
sharply. Who knows what US policy will be like if the country ends up
being led by a religiose ignoramus such as Mitt Romney or a witless
buffoon such as Rick Perry?
However, we face problems that are far more serious than the inanities
of US politics. As Coggan intimates towards the end of his thoughtstirring book, the largest obstacles to "Keynesian" solutions are posed
by demographics and resource limits. Borrowing your way out of debt
works only if the present generation can dump its borrowings on the
next one, restarting growth in the process. With the ageing of the
developed world, the next generation will be smaller than the last, while
the cost of energy will rise as emerging countries continue to

industrialise.
Peak oil doesn't mean that there is no oil left, rather that the cost of
what remains - in terms of the capital and energy expended in
extracting it - is trending inexorably higher. Any pick-up in the global
economy is likely to hit this energy constraint pretty quickly, but
politicians and economists still seem to believe that we can somehow
return to pre-crisis conditions. With awkward facts submerged in the
loose talk about green growth, few are asking how the world is going to
adapt to low growth as a permanent condition in the developed
countries. Yet that is what is on the horizon.
John Gray is the New Statesman's lead book reviewer. His latest book
is "The Immortalization Commission: Science and the Strange Quest to
Cheat Death" (Allen Lane, 18.99)

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Source URL: http://www.newstatesman.com/books/2011/12/money-debt-paperworld-coggan
Links:
[1] http://www.newstatesman.com/books/2011/12/money-debt-paper-worldcoggan
[2] http://www.newstatesman.com/writers/john_gray