FROM JSMINESET.COM

How we got here The current financial crisis stems from the decision to divorce our currencies from a reliable standard of value Reuven Brenner , Financial Post Published: Wednesday, October 01, 2008 Gold is hovering again around $900, commodity prices are on the rise, and the U. S. dollar is back to its downward trend of the last few years. This isn't a surprise. The $700-billion bail-out plan is mum about the dollar -- a big mistake (reflected in the immediate currency/gold price movements), since the Fed's mismanagement of the dollar as a reserve currency contributed to the present mess. The signals were all there for the Fed to see. Yet academic fads blinded it. How did we get here? More important: how to get out? Take a deep breath. Abruptly, in 1971, the world moved from fixed to floating exchange rates without in-depth debate. Under a fixed exchange rate anchored in gold, 5% interest in London or 5% in NY reflects the same returns. Money, whether the dollar or the pound, anchors pricing. Coca Cola knows that in pricing its beverages and selling them around the world, or in issuing U. S. dollar denominated debt, it faces no exchange rate risk. The company is neither inadvertently drawn in the exchange rate business nor does it need to hedge and pay fees to avoid being in that business. This is not the case with floating exchange rates. Every global business -no matter what it sells or buys and how it finances itself -- is in the currency business. Unless companies buy complex derivatives to insure that they stay in their own lines of business, currency fluctuations cause volatility in their costs and revenues. Financing companies becomes more expensive, resulting in a contraction of the non-financial sector and a large expansion of the financial one compared to a world adhering to anchored fixed exchange rates. The fact that national aggregates count the financial sector's expansion as increased well-being just shows how meaningless such measures are. The expansion measures the cost of adapting to bad monetary policy, which could have been avoided. It has been a mistake to say that floating means "laissez-faire" for currencies. The main role of money is to be a trusted anchor for pricing. People's holding of cash as a "store of value" has always been insignificant. As to a medium of exchange: it fulfills this function properly only when people trust its stability. When the dollar plunges in terms of other currencies by 40% to 60% within few years, and when street vendors in emerging countries refuse dollar bills or accept it at deep discounts, as now happens, it becomes less of a medium of exchange. True, the dollar remains the reserve currency of choice because other countries mismanage their currency too. But relying on the mistakes of strangers is not a good policy. People want to understand that a promise to be paid 5% on U. S. Treasury represents 5% in their own currency too-- rather than, suddenly, minus 10%. When this happens, everyone speaks the same standard monetary language. When this is not the case, then it is gobbledygook to discuss what's "real" and what's not; what's floating and what not; and what clauses one must add to contracts to be reasonably protected. http://www.financialpost.com/related/links/story.html?id=851901