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Perspectives on Money, Finance and Debt
Simon DaviesWe are in a war for economic recovery, but we haven’t worked out how to win it.
In a search for safety and security, with investment asset values bouncing around like a yo-yo, prospects unclear and economic growth uncertain, 'cash' has become an attractive asset, even if the returns on it are paltry due to almost zero interest rates available. But what is cash, and is it a valuable thing to hold?
People believe that cash is the number that shows in their bank account – which, to an extent, is true. However, I was more than a little perturbed to learn that, in a recent UK survey, 74 percent of people polled believed that, when they deposited money with their bank, the money remained legally theirs. Either people are not listening to proper disclosure of risks of depositing money in a bank account, or they are not being properly informed. I do not expect any of us have even started to look at the terms and conditions of our bank account. There’s just that inherent feeling that putting your money in a bank is sae – it’s your cash, they are just looking after it for you, right?.
Given the outcome of the survey, it is clear that the vast majority of us believe that when people put money in the bank, they own cash. The unfortunate reality – that they have a claim as an unsecured creditor against the bank to which they have just lent money, with the first loss amount of that claim of up to GBP 50,000 insured by the UK Government – is probably not quite what they expect, given the outcome of the survey.
However, all is not lost and, for so long as a person maintains a bank account with GBP 50,000 or less in it, then the Government will pay out if things go wrong and the bank can’t pay me cash. And the Government has plenty of cash, right?
As we have started to learn, the answer to that question is 'not necessarily'. Like any other person or company, if the Government wants to make a payment, then it must have the funds available to it – which it 'earns' through taxation and raises by borrowing from others.
The UK Government is not alone in being a Government which, on a net basis, currently needs to increase the amount of money it has borrowed in order to balance its books – it is spending more than it earns and is running a forecast budget 'deficit' for the medium-term.
It has raised taxes and is cutting costs, but the books are still not balanced unless it borrows more. For so long as the financial markets have confidence that the UK can, and will, pay it debts as they fall due, they will probably continue to lend the money it requires. However, as Greece has found, once confidence wanes, the deterioration is a steep and unpleasant one.
Therefore, as the rules are currently written (remember they were rewritten for Northern Rock for a time, but that was before the Government bailed out the whole banking sector), you’ll probably get your first GBP 50,000 back and a claim against the bank for the rest. Not quite the outcome that 74 percent of us are expecting.
Before you empty your bank account and start stuffing mattresses with cash, it’s worth considering what you are actually stuffing into the mattress. Once upon a time, currency was an asset-backed security – it was an actual 'claim to gold' and your notes and coins meant that, theoretically, there was a small lump of gold somewhere with your name on it. Its downfall came about as a result of the last global financial melt-down in the 1930s when the 'gold standard' was shown to be an inflexible mechanism for currency as a medium of exchange at a time when countries needed to devalue their currencies to make their economies relatively more competitive.
Today’s currencies are not linked to a fixed asset – there is no claim to gold and they are 'fiat' currencies. They exist as a medium of exchange to allow for business to be done and things bought and sold without requiring that we do everything by way of barter. Their relative value – the amount of any goods that they can buy and their traded value against other currencies – is a matter of confidence that the central bank will maintain a 'sensible' monetary policy, controlling the supply and cost of money so that it is maintained as a stable medium of exchange. As Zimbabwe showed, if all confidence in a currency’s role as that medium is gone, the currency is of no practical use and mattress stuffing becomes a value destructive hobby.
The Zimbabwe problem – which is one of the biggest risks to actually hoarding cash – illustrates most clearly the fact that cash is devalued over time in an inflationary environment. The rate of change of prices was so great that any cash retained was worthless within days.
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