Greece and Gold

I know, I know. Why write about international finance when Ahnold’s divorce settlement hits the news? Or there’s a perfectly good fish-slapping dance competition begging for commentary? Well, it’s my job–kind of. Greece beats out those two because it could affect us.

What would happen if Greece were to default? Directly, perhaps not much. US banks are not as heavily invested in Greece’s economy as European banks. Indirectly, though, it could affect the US substantially. Remember 2008? Who cared what happened to Goldman Sachs or Merrill Lynch? You and I did after we learned that the entire global financial system was teetering on the brink of a complete meltdown.

So you are no doubt asking, “How did we get here?” The linked article provides an easily digestible explanation of at least part of the problem. Ever since the Vikings first sailed to Madagascar with Marco Polo (this was before they allied themselves with Germany to plunder Pearl Harbor)* trade has been international. When people trade, they need a standard of value.

Now, here’s the important part. When people trade using a standard of value, they need to have one that is stable. In other words, if Country A’s inhabitants are going to make neat stuff for Country B’s inhabitants, they need to know two things: 1) how much they can expect to get for each unit of that product, and 2) how much it will cost them to make it. Products cannot be produced instantly, so the manufacturer must be able to plan for the future. An unstable currency makes such calculations risky, if not impossible.

In a free market, certain things have traditionally emerged as standards for exchange, gold being the most consistently popular. Its value is not set by any authority when it is used as money in its raw form. Its value is reflected in what it will buy. Because of certain other characteristics of gold, its value tends to remain stable, an advantage for everyone.

OK, now we’re over the DUH part. The unDUH part is this: Political leaders do not tend to like gold as a standard of exchange because they cannot manipulate its value. In order to manipulate the value of currency, they have to force or trick people into using a substitute, like paper money.

When politicians can manipulate a currency, they will. Every time. Count on it. If you don’t believe me, research the history of fiat currencies sometime. Fascinating how we humans never seem to learn. There are too many ways for me to list here, but the gist of it is this: Politicians can, in the short run, make it look like an economy is prospering.

If, for example, the Fed were to give all of us $10,000 in fresh, crisp new one-dollar bills, we would all feel richer for a time. The guy/gal who makes fish-slapping sportswear would soon start receiving more orders for fish-slapping shirts, pants, and shoes because people would have more money to spend on things like that. In turn, he/she could raise prices as we customers bid against each other for the limited supply. No one is any richer in reality, but for a brief time, we feel richer.

When a whole country does this, the illusion is harder to see. For example, when Nixon unilaterally decided that the US would no longer honor its commitment to redeem US dollars in gold, there was little reason to limit the printing of US dollars. (You and I could not redeem dollars this way, but other countries could.) Here is the kicker. The entire world works this way now.

In short, the entire global financial system is based on fiat money; currencies are money because some government says they are. When countries like Greece spend like inebriated seamen, things can sail merrily along until something gums up the works. In our case, the solid waste is about to hit the breeze-generator. Guess who is standing downwind.

That’d be us.

Imagine a giant inverted pyramid made out of very stiff one dollar bills. Paper is piled on paper, which is piled on more paper. Each level up represents more dollars piled on fewer dollars one level below. When things are perfectly balanced, it stands. The least tremor and it starts teetering back and forth until it collapses. Because the supply of money worldwide is not fixed to any real standard of value such as gold, political leaders can and do “fix” things by printing money. Each printing appears to give us more wealth, or avert a crisis, but in reality it only makes the pyramid less stable.

When the global pyramid falls, it will start somewhere. Let’s say Greece, though it could be most anywhere. Greece cannot pay its bills and the private lenders who in part finance its government are not paid back. These people in turn owe other people money, who owe others, and so on. Under our current system, it is like a raging fire. With each successive default, there is increasing pressure for paper money to be shifted here and there (or printed) to staunch the bleeding. In 2008, problems in the US nearly brought the whole thing down. Some say we were within hours of a global bleed-out.

That, friends, is why we should care about Greece. The protesters may want to continue with life at is has been, but they cannot. Neither can we. Whether the collapse starts there, here, or somewhere else, the Day of Reckoning is nigh. Who will survive? Those who have built a shelter of some kind. Learn why some people are able to ride out the storm while others are crushed underneath the rubble. There may still be enough time, but don’t wait. Learn now.


*Historical information courtesy of Michele Bachmann.

About Terry Noel

I am an Associate Professor of Management and Quantitative Methods at Illinois State University. My specialty is entrepreneurship.
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2 Responses to Greece and Gold

  1. Cole says:

    Wouldn’t the impact of Greece’s default be lesss than the total impact if the entire state of Texas were to default on its debt? It would seem if Greece were to fail the fall out would be minimalized by the rise of the U.S. dollar against the Euro if not the failure of the Euro? This seems like it would be to the benfit of the U.S. Oil would fall in price and given China’s problems this would only increase our leverage in the world as investors would seek safe havens in the U.S. econonomy or maybe not?


    • Terry Noel says:

      Well, it is hazardous to make specific predictions with any economic disruption, but it seems to me that Texas defaulting would be similar to what I describe. In that case, the US would probably step in to pay its bills. That money has to come from somewhere, and printing money is the easiest solution (hello, inflation). If they did not, the shock waves emanating from the default could damage the national economy as creditors to TX are unable to pay their bills and so on down the line. In a future blog, I will explain how fractional reserve banking makes the whole system so unstable. For the moment, just know that no place in the world is immune from shocks in another place. In a real sense, we are all in this together. Thanks for the thoughtful comment.


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