From: D Gulhati
About the World Bank and International Monetary Fund
To understand what has happened to the global financial system, we must begin with an understanding of the nature of money. Money is one of humanity’s most important inventions, created to meet an important need. The earliest market transactions were based on the direct exchange of things of equal value, which meant that a transaction could occur only when two individuals met who each possessed an item they were willing to trade for an item possessed by the other. The useful expansion of commerce was greatly constrained. This constraint was partially relieved when people began to use certain objects that had their own intrinsic value as a medium of exchange – decorative shells, blocks of salt, bits of precious metals, or precious stones. Eventually, metal coins provided standard units of exchange based on the amount of precious metal, generally silver or gold, they contained. Later the idea emerged that it was more convenient to keep the precious metal in a vault and issue paper money that could be exchanged for the metal on demand. In a sense, the paper bill was originally the equivalent of a receipt showing that the bearer owned an amount of precious metal, but the paper receipt was more convenient and transportable.
* Each of these innovations was, however, a step toward delinking money from things of real value. An additional step was taken at the historic 1944 Bretton Woods conference that created the World Bank and the International Monetary Fund [I.M.F.]. The countries represented at this meeting agreed to create a new global financial system in which each participating government guaranteed to exchange its own currency on demand for U.S. dollars at a fixed rate. The U.S. government, in turn, guaranteed to exchange dollars on demand for gold at a rate of $35 per ounce. This effectively placed all the world’s currencies on the gold standard, backed by the U.S. gold stored at Fort Knox. Many governments thus came to accept U.S. dollars as gold deposit certificates and chose to hold their international foreign exchange reserves in dollars rather than gold.
* This system worked reasonably well for more than twenty years, until it became widely evident that the United States was creating far more dollars to finance its massive military and commercial expansion around the world than it could back with its gold. If all the countries that were holding dollars decided to redeem them for gold, the available supply would be quickly exhausted, and those who had placed their faith in the integrity of the dollar would be left holding nothing but worthless pieces of paper.
To preclude this eventuality, on August 15,1971, President Richard Nixon declared that the United States would no longer redeem dollars on demand for gold. The dollar was no longer anything other than a piece of high grade paper with a number and some intricate artwork issued by the U.S. government [actually private Federal Reserve Notes – Ed]. The world’s currencies were no longer linked to anything of value except the shared expectation that others would accept them in exchange for real goods and services. Once computers came into widespread use, the next step was relatively obvious – eliminate the paper and simply store the numbers in computers.
Although coins and paper money continue to circulate, more and more of the world’s monetary transactions involve direct electronic transfers between computers. Money has become almost a pure abstraction delinked from anything of real value.
Four developments are basic to this transformation of the financial system:
(a) The United States financed its global expansion with dollars, many of which now show up on the balance sheets of foreign banks and foreign branches of U.S. banks. These dollars are not subject to the regulations and reserve requirements of the U.S. Federal Reserve system.
(b) Computerization and globalization melded the world’s financial markets into a single global system in which an individual at a computer terminal can maintain constant contact with price movements in all major markets and execute trades almost instantaneously in any or all of them. A computer can be programmed to do the same without human intervention, automatically executing transactions involving billions of dollars in fractions of a second.
(c) Investment decisions that were once made by many individuals are now concentrated in the hands of a relatively small number of professional investment managers.The pool of investment funds controlled by mutual funds doubled in three years to total $2,000,000,000,000 at the end of June 1994, as individual investors placed their savings in professionally managed investment pools rather than buying and holding individual stocks. Meanwhile, there has been a massive consolidation of the banking industry – more than 500 U.S. banks merged or closed between September 1992 and September 1993 alone concentrating control of huge pools of funds within the major international “money center” banks. Pension funds, now estimated to total $4,000,000,000,000 in assets, are managed mostly by trust departments of these giant banks, adding enormously to their financial power. The pension funds alone account for the holdings of about a third of all corporate equities and about 40 per cent of corporate bonds.
(d) Investment horizons have shortened dramatically. The managers of these investment pools compete for investors’ funds based on the returns they are able to generate. Mutual fund results are published daily in the world’s leading newspapers, and countless services compare fund performance monthly and yearly. Individual investors have the ability to switch money among mutual funds with the push of a button on a phone or their personal computer mouse, based on these results. For the mutual fund manager, the short term is a day or less and the long term is perhaps a month. Pension fund managers have a slightly longer evaluation cycle.
* Individual savings have become consolidated in vast investment pools managed by professionals under enormous competitive pressures to yield nearly instant financial gains. The time frames involved are far too short for a productive investment to mature, the amount of money to be “invested” far exceeds the number of productive investment opportunities available, and the returns the market has come to expect exceed what most productive investments are able to yield even over a period of years. Consequently, the financial markets have largely abandoned productive investment in favour of extractive investment and are operating on autopilot without regard to human consequences.
* The financial system increasingly functions as a world apart at a scale that dwarfs the productive sector of the global economy, which itself functions increasingly at the mercy of the massive waves of money that the money game players move around the world with split second abandon. Joel Kurtzman, formerly business editor of the New York Times and subsequently editor of the Harvard Business Review, estimated that for every $1 circulating in the productive world economy, $20 to $50 circulates in the economy of pure finance, although no one knows the ratios for sure. In the international currency markets alone, some $800,000,000,000 to $1,000,000,000,000 changes hands each day, far in excess of the $20-25,000,000,000 required to cover daily trade in goods and services.
According to Kurtzman: Most of the $800 billion in currency that is traded . . . goes for very short term speculative investments from a few hours to a few days to a maximum of a few weeks. . . . That money is mostly involved in nothing more than making money . . . It is money enough to purchase outright the nine biggest corporations in Japan overvalued though they are including Nippon Telegraph & Telephone, Japan’s seven largest banks, and Toyota Motors. . . . It goes for options trading, stock speculation, and trade in interest rates. It also goes for short term financial arbitrage transactions where an investor buys a product such as bonds or currencies on one exchange in the hopes of selling it at a profit on another exchange, sometimes simultaneously by using electronics.
* This money is not associated with any real value. Yet the money managers who carry out the millions of high speed, short term transactions stake their reputations and careers on making that money grow at a rate greater than the prevailing rate of interest. This growth depends on the system’s ability to endlessly increase the market value of the financial assets being traded, irrespective of what happens to the output of real goods and services. As this growth occurs, the financial or buying power of those who control the inflated assets expands, compared with the buying power of other members of society who are actually creating value but whose real and relative compensation is declining.