FX macroeconomics declines, the note loses value.
Te concept of a printed note representing the value of the issuer gives rise to the evolution of central banks. Modern central banks are specialized asset holding banks. Tey also have the advantage of a legal monopoly over currency5
. Te assets
Expansion of global trade demanded an increased use of paper notes
In medieval Europe merchants routinely carried written notes3 promising redemption in gold or silver. Gold and silver standards for written paper currency were common by the 19th
century.
Notes were usually issued by private banks in the form of banknotes. Governments were also beginning to issue gold or silver backed notes. The increased use of paper notes may have led to the first asset liquidity problems. Shortages of gold and silver created by war funding or trade deficits required improvisation. Governments issued base metal tokens or promises to pay. Te result was a chaotic system of many different circulating and competing banknotes. As chaotic as it was, this was a major evolution of currency. Paper money now had relative and variable value.
The basic premise, even under an imperfect precious metal standard regime remained essentially
44 FX TRADER MAGAZINE April - June 2016
unchanged. Governments and banks provided a service similar to a clearing house: executing the opening and closing transactions of an asset backed contract. Once done, the note, i.e., the memory of the opening transaction could now circulate. Te issuer had nothing more to do with it until a bearer showed up at the window demanding the redemption value. Tis was also a sea change in the evolution of currency. Te value of the paper note had migrated from the underlying asset to the issuer’s ability to redeem the stated value. Notes now circulated the value of the issuer and not the asset itself.
If word got around that a particular issuer was short, that issuer’s note lost
stated redemption value4
value no matter what the . Tis
is fundamentally the same as the farmer’s written promise to the laborer. If there is a drought, the farmer’s ability to make good becomes suspect, circulation
on deposit include, in large part, sovereign bonds issued by the bank’s government, other high quality bonds, currency reserves and short term notes.
It isn’t quite accurate to say that a modern currency has no redemption value. Ideally, sum total of issued paper notes is matched by the sum total of the assets the issuing central bank holds. Central bank issued notes have a value which cannot be accessed, only traded. Tis may sound paradoxical, but it would be no different than having a gold or silver based system using non-redeemable gold or silver backed notes: the sum total of gold or silver backed notes issued by the central bank is matched by the sum total of the gold or silver it holds. So does gold or silver make a paper currency any more or less valuable? Or is it simply the certainty of the existence of the stored asset?
In Voltaire’s Candide, the hero and his friend Cacambo stumble upon El Dorado where the ground is literally covered in precious stones of all kinds. Candide and Cacambo are dumbfounded to learn that the precious
stones are in such
overwhelming abundance that the inhabitants of El Dorado considered
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