A Question of Confidence
When it comes to the fall-out of the financial crisis much has been written about the need to stabilise the global financial system, regulation of the banking sector and the reform of banks to ensure none is “too big to fail”.
What we also hear is a word oft used in relation to these matters. Confidence. Confidence in the markets. Confidence in the financial system. Confidence that regulators are alert and proactive. The confidence of the markets that economies in distress are taking the necessary measures to address deficits and national debt levels.
There is also another reason why confidence is needed. Confidence in a currency. The money we carry in our pockets. Be it the Pound Sterling, the US Dollar or Euro, each is a currency precariously in existence uniquely through the power of confidence. How is that the case?
Currencies today are not the currencies of yesteryear that were backed by a commodity such as silver or gold. Bank notes used to represent deposits of gold so when we view the statement on our notes “I promise to pay the bearer on demand the sum of five [ten/twenty/fifty] pounds” we once upon a time could exchange, at the Bank of England, the paper bank note into the sum of the note into a quantity of gold. No longer. To present today a bank note for exchange into gold at the Bank of England would likely raise a few eyebrows by the official concerned with a quick explanation that these days notes can only be exchanged for notes.
So what does the Bank of England do if not hoard ingots of gold to back our currency? According to its remit, its key role is “Gaining and maintaining public confidence in the currency is a key role of the Bank of England and one that is essential to the proper functioning of the economy.”
Today’s currencies are called fiat currencies with the term deriving from Latin with fiat meaning “let it be done”. It has no intrinsic value other than that bestowed on it by government decree or law as being legal tender.
Should we be surprised that the price of gold has hit all-time highs? As central banks in the UK and US have turned on the printing presses (aka quantitative easing) are the financially savvy telling us that our paper currencies are worth less and less? Perhaps so.
If the consequence of maintaining a fiat currency is ever increasing amounts in circulation then history shows us that there is inevitably a decline in purchasing power (as now being experienced in the UK and USA) and ultimately the unleashing of hyperinflation. Whether it be the Roman Denarius, the French Assegnat or German Mark of the Weimar Republic, history has shown us the dangers of fiat currencies and their inevitable failure.
And so we return to the question of confidence. Confidence in our currency and confidence in our financial system. One of the Financial Services Authority’s (FSA) statutory objectives is “market confidence – maintaining confidence in the UK financial system.”
As a result of the financial crisis the FSA is to be dismantled (despite only coming into being in December 2001) and replaced by the Consumer Protection and Markets Authority (CPMA) and the Prudential Regulation Authority (PRA) from 2013. A move designed to instil confidence that the financial system in the UK will be subject to more incisive oversight and effective regulation.
Our political leaders and financial sector supremos exhort us to have confidence in their measures to solve the financial crisis. Can we have confidence in them when the evidence points us in the other direction?