Currency and the Barter System
To grasp how global currency works and before we discuss future of US dollar as global currency, we must first understand what exactly defines a currency. Currency is basically something that is generally acceptable as a medium of exchange. From the digital world of bitcoins to the ancient yet effective barter system, currency has unfolded itself in several different shapes which have constantly evolved throughout the passage of time. Nowadays, we regularly hear the terms “Forex” and “Fiat Currency”. They have become common names for everyone who is acquainted with modern economics and business. What do these terms stand for?
To understand that, we must first speculate upon the concept of barter system. The system originated when historical societies realized the need of services of their fellows for their personal objectives. For example, if a farmer needed a wooden plough, he could obtain it from a carpenter in exchange of wheat. Likewise, different people could exchange something of equal value for the service or object they desired. This eventually set the foundations for the barter system which became a standard medium of exchange for our ancestral societies. So, why was such an effective system replaced?
The problem began when people found themselves offering something that the other party did not desire. For example, a carpenter could not acquire timber from a woodcutter in exchange for a plough because he wanted to be paid in food. When such complications arose, the system became both unreliable and ineffective in the eyes of the common public. What came as the alternative was what the world knows as “The Gold Standard”. People began looking for a suitable enough metal which would be rare to be valuable but not as rare to make it seemingly impossible to find. The older generations found Gold to be the best option as most elements hadn’t been discovered and gold was declared to be the most suitable among the available options.
The Gold Standard
To understand the concept of “The Gold Standard”, we shall take the use of a very simple illustration. Imagine a village where every residing individual possesses a certain amount of gold. As with all societies which existed before the introduction of coins, people would be unable to divide the lumps of gold proportionally to suit their needs. Apparently, a few wise people sat together and had all of the gold collected in a single building in the village and gave out “money certificates” of equal value to the respective owners of the gold. This resulted in the modern phenomena of banking and paper currency. As the frontiers of the world further expanded and international relations began to take shape, the world found a safe medium of exchange in the form of the Gold Standard.
The Fall of the Gold Standard
Up until the early 20th century, the Gold Standard reigned in all European countries and the United States of America. There were various economic crises when gold mines were discovered in California (America) which resulted in the deflation of the value of gold. Due to its vast size, America soon dominated the entire world by possessing 3/4th of the total gold discovered around the world.
At such perilous times, the countries sat down together and signed the Breton Woods Agreement. The agreement pegged the various currencies of countries to the value of American dollar which, in turn, was pegged to the value of gold. This agreement also resulted in the creation of The World Bank and International Monetary Fund (IMF). The system continued to be in effect until the 1970s until the American President Richard Nixon declared that the US would no longer exchange its currencies for gold. Hence formally ending the undeniable dominance of the US dollar as a global currency. After this abrupt announcement dollar was effectively converted into a fiat currency which basically meant that dollar was not to be backed by any value of gold.
The Rise of a Modern System – Fiat Currency
Fiat currency is not a scarce or fixed resource like gold or silver. It soon gained prominence in the modern world because countries wanted to protect themselves from economic instability and monetary depressions. The is no value to a fiat currency. It has value only because the government issuing it says so. On a localized economic society, such a system can be effectively regulated to control inflation and ensure proper compensation for goods and services.
Now to summarize how it affects the global economy. What is the US Dollar worth to other countries? In one way, it’s worth the reputation of the US economy in front of the world. The US has one of the largest and most stable economy in the world. Despite having the greatest amount of foreign loans, investors are ready to invest more into the US economy because it has shown incredible potential to recover and reward its subjects.
Fiat Currency – A mere imagination?
In a world of fiat currency, how is it possible for countries to exchange their currencies with each other? Where and how is the store of wealth maintained?
Is there any actual worth to the paper notes in our wallets, the digits in our bank balance or are we just slaving our lives away for some imaginary figures?
These questions remain unanswered as critics of fiat currency argue that the limited supply of gold makes it a much more suitable form of currency than fiat currency that has a seemingly unlimited supply.
The Future of the Global Economy
With other nations such as China and Russia joining the economic game, the dominance of the US dollar or “Future of US Dollar as Global Currency” finds itself being challenged yet again. China has become the world’s fastest growing major economy and has the 2nd biggest GDP of all the world. In an unprecedented economic alliance, Russia and China have insisted for a new fiat currency to be introduced which is delocalized and not backed by a single country. Considering the examples of the establishment of Euro as a standard currency for the Eurozone nations, China is revolutionizing the modern economy with its economic endeavors. The world will experience a new frontier of global economic policies in the upcoming decades.
Author: Ali Anwar (Law Department, Islamia University of Bahawalpur)