Monday, March 14, 2011

Economist's Thought 1 - Key Currency

First of all, I wish that all who are affected from the Earthquake in Japan - whether directly or indirectly are safe. May our prayers reach those who are in pain and are in need.

I've been asked several times about my personal thoughts about China and their potency of being the next superpower, so I decided to write up an article about it on the blog. It is undoubtedly true that China presents the most-promising all round profile of a potential superpower, compared to other nations. Analysis behind this potency is highly convoluted and requires a great understanding about how the superpowers are formed. In this article, I plan to analyze one of the most dominating factors for superpower as a mean of making an intelligence guess behind if China will truly become the next supwerpower.

Some scholars, such as Aberkane argues that the notion of "superpower" is increasingly anachronistic in the 21st century as increased global integration and interdependence makes the projection of a superpower difficult, but I think this is total bullshit. No nation so far in the history of world have not projected their dominancy via their power and influence on others in someway, be it economically, militaristically or diplomatically. Our multipolaristic human nature inevitably results in some sort of hegemony as a fit to survival, and this is certainly true in a bigger scale.

That being said, for a nation to be considered a superpower, there are certain requirements that need to be met:
  • Economic
  • Military
  • Geographic
  • Political
  • Cultural
  • Demographic
Out of the 6 requirements, economic and military considerations have been, and will always be the dominating factors for becoming a superpower. Obviously, just considering those factors, there are MANY MANY different variables we must take into account in order to make a valid prediction on guessing who will become the next superpower. Today, I will look at the economic factor leaving the others for further discussion later on.

First, we must fully understand one of the most important aspects of economy in order to proceed with our discussion - Currency.

Over the centuries, many nations developed rapidly as the world population also witnessed an exponential growth. The demand for goods also increased at an unbelievable rate which inevitably led to need of a key currency - a medium which anybody on the planet can use to exchange goods with other people. In ancient times, many 'objects" were used as a substitute for the "exchanging medium", such as rice (Asia), salt, ivory (Roman) and even Slaves.

However, using the above mentioned mediums eventually led to collapse in trading system which pointed many different flaws. It was more than apparent that the introduction to a different form of "exchanging medium" was necessary.

Ancient people discovered that this "exchanging medium" must meet the following requirements in order for the trading system to work flawlessly:
  • The medium must be universally desirable.
  • The medium must be abundant.
  • The medium must retain its value for a reasonable amount of time.
  • The medium must be stable.
  • The medium must be "precise in terms of trading".
There's one thing that meets all the requirements written above that we all are aware of. Well, almost. It's gold. Everyone on the planet wants it, it doesn't lose its value for a long time (Gold that was buried under the sea by the pirates 1000 years ago still shines brilliantly if you were to dig it up now), gold doesn't corrode or break easily (Where as Salt and Rice requires special treatment to be kept until they become bad) and gold is a really precise medium for trading. (For instance, the quality of salt and rice might differ, resulting in disparities when trading). It used to be abundant enough for gold to be used as a coinage, but as the world population increase, the abundance could not keep up with the demand. In other words, there weren't enough gold for everyone to be used as the currency.

Eventually, the introduction of paper money became inevitable. It's definitely abundant (You can just print money when you need more), it reasonally retains its value for a long time (As long as inflation is controlled. If not, you can always reform the currency itself so this is hardly an issue), it's quite stable (Paper money won't corrode at least for decades), and there's no question about how precise paper money is when it comes to trading. Now the only question is, "is this paper money really universally desirable?", After all, paper currency IS just a piece of paper. Would anyone really desire this?

Alas, the topic that I really wanted to get into - the introduction of gold standard. Basically it's a monetary system in which the standard economic unit of account is a fixed weight of gold. In simple terms, under this system, you could turn your bank notes into gold at anytime. With this system, they made the paper currency "safe and desirable" because you could always change it into gold.

Now, for the discussion of a key currency - an internationally accreditted currency for medium of international exchange, it is more than apparent that whichever country has the most amount of gold, will be able to maintain the "most trustworthy currency". Two countries truly adopted the gold standard policy and maintained a monetary hegemony- Britain and the United States.


A caveat- both Britain and United States eventually had to close the gold-standard system as many other countries were taking advantage and have attempted to extract gold from the above countries. In case of US, it was closed in 1971 by Nixon when France reduced its dollar reserves, trading them for gold from the U.S. government, thereby reducing U.S. economic influence abroad. Still, this by no means that the paper money lost its place as a key currency. It is still the only medium that is available on the planet which is reliable enough to be used universally. Only difference now, was that gold became a lot more valuable and in fact, the private trading value increased by 900% within a decade after closing of the gold standard.

Back to the discussion regarding economic aspect of Superpower: In order for dominance, you must first achieve a high-economic standard.When anyone speaks of measuring the "economic power" of a nation they mostly refer to the following two things: GDP (Gross Domestic Product) and PPP (Purchasing Power Parity). To achieve a high scale on either of these measurements, you must be able to have a bucket load of currency that is reliable, which links to our discussion regarding improtance of gold reserve.

Now take a look at this chart

Country/Organization       Gold (Tonnes) Forex Reserves (%)

1United States United States   8,133.5                 73.9%
2Germany Germany3,401.870.3%
4Italy Italy2,451.868.6%
5France France2,435.467.2%
6People's Republic of China China1,054.11.7%
7Switzerland Switzerland1,040.116.4%
8Russia Russia775.26.7%
9Japan Japan765.23.0%
10Netherlands Netherlands612.557.5%
11India India557.78.1%
12European Union ECB501.427.9%
13Republic of China Taiwan423.64.6%
14Portugal Portugal382.581.1%
15Venezuela Venezuela363.952.4%
16Saudi Arabia Saudi Arabia322.93.0%
17United Kingdom United Kingdom310.316.8%
18Lebanon Lebanon286.827.6%
19Spain Spain281.638.6%
20Austria Austria280.056.2%

That chart alone should really end the discussion. And based on that, I will make the following claim:

China has no chance of becoming the next superpower at least as a mean of economic way for at least next 25-30 years.

Please remember that I am only considering ECONOMIC ASPECT, and only ONE PORTION OF economic aspect at the moment. There are far more things that needs to be discerned in order to complete the discussion, but what I mention above is one of the strongest reason of why I believe China will not become the next superpower at least for the next two to three decades. After that, it could be anyone's game.

China of course, realizing this fact, they have been increasing their gold reserve annually, but Earth's gold supply is severely limited. To come close to US's supply of gold, they'd have to buy in a lot of gold and many other nations (hopefully) aren't going to be idiotic enough to just give away their precious gold in masse.

I should also mention that the FOREX reserve of China is also direly low (1.7%). This means that the foreign currency depositis and bonds are actually held privately, not by central banks and monetary authorities. So, the liability is also at question in discussing the gold reserve by China.

Questions, comments, criticisms are always welcome.

1 comment:

  1. Thanks for the post. This was very interesting. :D Go USA!