Monetary system under threat after pound dives

Have it made: The UK’s pound sterling is the world’s oldest surviving currency, dating to 1694.

The pound has suffered a second dramatic fall in four months. Confidence in Britain’s currency is at a low ebb. But is this a sign that the way money is valued is fundamentally flawed?

Moments after midnight on Thursday, millions of Britons were fast asleep. But thousands of miles away, a sudden shock was about to make them much poorer, very quickly.

A ‘flash crash’ was taking place on stock markets in Asia. The value of the pound fell by more than 6% in just two minutes.

It soon stabilised. But the crash was the second time the currency has dropped sharply in recent months, after the surprise of the EU referendum result. And it was the latest of several recent signs of volatility in global currency markets.

The trend has cast doubt on the way money is valued. Currently, most governments use a fiat money system: they print money and guarantee its value. Money, author John Lanchester says, is ‘a collective act of the imagination’: banknotes are only worth the guarantees behind them.

So a currency’s value relies on investors’ confidence in those guarantees. But confidence has been hit several times in recent years, particularly since the 2008 financial crisis.

Fiat money has existed since it was briefly used in China in the early 11th century. But the average life expectancy of a fiat currency is 27 years. Economist David Galland says: ‘It is clear that the monetary system is irretrievably broken and will fail.’

Some now suggest adopting an alternative. Lewis Lehrman, a conservative economist, has called on the USA to return to the gold standard — a form of representative money which most countries abandoned during the great depression of the 1930s. An even more retrograde option would be to introduce commodity money.

Others have more novel ideas. In 1984, Richard Cooper of Harvard University proposed a single world currency. There have since been steps towards this. Nineteen European governments have joined the euro, giving up their right to set the value of money. And 55 states and territories around the world now operate a fixed-value system: their money’s value is fixed to that of the euro.

Making the world go round

Fiat money is doomed to fail, say some. All monetary systems become obsolete eventually. Just as the depression of the 1930s killed the gold standard, the aftermath of the 2008 crash is killing trust in governments’ guarantees. National governments cannot predict or deal with the fluctuations of the modern, globalised world. People need something more reliable than their vague promises.

Wrong, others respond. Current volatility is largely linked to short-term causes, such as Brexit. The alternatives to fiat money are either retrograde steps to past failures or unworkable new suggestions. The problems that have dogged the eurozone show what happens when national governments give up the right to decide monetary policy.

You Decide

  1. Would you prefer to use something other than money to pay for things?
  2. Is fiat money doomed to fail?

Activities

  1. Write a list of five questions which this article has prompted in your head. Discuss with a partner why you chose them and what the answers might be.
  2. Work in groups of three. Each choose one way in which money could be valued (for example, fiat money or commodity money). Research it in full and then write a short sketch illustrating how it works.

Some People Say...

“Money may buy things, but it has no true value.”

What do you think?

Q & A

I just use my money to pay for stuff. Does it matter where it comes from?
The way money is valued affects the wealth of people across the world — including you and people you care about. When you are older, the money you earn will increase or decrease in value depending on those changes. And if the monetary system failed or your country’s currency declined in value dramatically, your money could be worth much less than it used to be.
I do not have much money. Why does the work of governments or central banks concern me?
However much money you have now, the value of any goods you own or have to buy changes depending on the fluctuations on currency markets. Understanding economics can help you to know how to earn money when you are older, and to understand how best to use it.

Word Watch

Fell
Possibly the result of a computer error or nerves about Brexit.
Fiat money
So titled as it is created by government decree. ‘Fiat’ means ‘let it be done’ in Latin.
Print money
Central banks do so on behalf of governments which back the value of money with their ability to raise revenue by taxation and borrowing.
China
The Song dynasty’s system where notes could be redeemed for gold after three years was soon abandoned as almost nobody redeemed their notes.
27 years
According to a study by DollarDaze.org.
Gold standard
The value of money and gold were linked: banknotes could be redeemed for the equivalent in gold.
Representative money
Similar to fiat money, but the government guarantee is backed by a commodity of equivalent value.
Depression
The UK abandoned the gold standard in 1931, the US effectively did so in 1933 and cut the link entirely in 1971.
Commodity money
Money would physically consist of something valuable. For example, gold, salt or tea.
Euro
Born virtually on January 1st 1999, the euro became legal tender in 12 countries on January 1st 2002.

Subjects

PDF Download

Please click on "Print view" at the top of the page to see a print friendly version of the article.