To trade is human, and trade over distance and time and debt needs to be accounted for, and so currencies were born.
As trade expanded beyond known society, so those currencies needed to be backed by something stronger than merely the transactions they account for, and thus came the idea of a backing by something of intrinsic value: a commodity, a precious metal such as gold. Then currency could perform another useful function: it could be a store of value.
And the currency itself became tradable, and trade could expand beyond borders. But eventually, there was too much trade for any one commodity, and the only way to have enough currency was to have it backed by full the faith and credit of its sovereignty, the economy’s depository of wealth. Thus, we have float.
And so, we can all too glibly sum up centuries of human endeavor to create and to trade and to find and exploit commodities, and to establish sovereignties that could establish currencies and protect trade. But it was only fifty years ago that currencies began to float in any real way, that is, free of any pretense of commodity backing.
At that point, world trade had been governed by an agreement, the Bretton Woods accords, drawn up in 1944. Among other things, the agreement fixed the value of the dollar to an amount of gold and fixed the amount of any other currency to the dollar. This ensured the primacy of the dollar as the world’s reserve currency and gave the U.S. a dominant role in trade.
But it meant that we had to maintain that currency value. That was manageable when economic growth was fast enough and our balance of trade was a surplus, but as our post-war prosperity slowed and our trading partners recovered and became competitive, it became a harder act to perform. It also meant that we had to maintain the gold reserves, and by then those stocks were running low as our trade deficit grew.
And so, in August 1971 President Nixon simply declared that that our currency would no longer be constrained by a commodity nor fixed to other currencies. And float began. Of course, it was nowhere near that simple. Much diplomacy ensued to mollify our major trading partners at the time, West Germany and Japan, who were enjoying the trade surpluses that fueled their own post-war recoveries.
And there was a fear of inflation, fear that a less-tethered dollar would be harder to control. But the more fundamental fear was that world trade could not withstand such a leap of faith, that is, the leap from a commodity-based currency regime to one of simply “full faith and credit.”
And we did have inflation, and since then we have tried to use monetary policy, control of the sovereign money supply, to manage it. Our trade deficit has grown, but it turns out that there is utility in consumption, not just in production. And currencies have themselves become a commodity, with the added attraction of becoming an object of speculation, another asset class for global traders.
Gold had been a basis and store of value for centuries. It was well-suited: difficult enough to find and mine to make it valuable, but not so obscure to make it impractical. It was divisible yet durable, and most importantly perhaps, it was comprehensible: it gave currency enough of a connection to real value to be trusted as both a medium of exchange and as a store of value.
A floating currency is only as valuable as it is useful, and only as trusted as that value is guaranteed by sovereign power. It is abstraction at its best. Now we have cryptocurrencies, with value derived not from faith in a sovereignty that guarantees value but by performance in the global “block chain,” in the accounting of the transactions of trade. That is, the currency of trade is created and backed by the act of trade itself, just as it was millenia ago.
Cryptocurrencies are defined only by utility, backed by neither asset nor sovereignty. They are certainly a commodity and an asset class, already having their own classic bubbles and crashes. In some instances, they are accepted as a medium of exchange. But their ability to function as a store of value is not clear, because it is not clear where, in what, we should place our full faith and credit: we seem to have gone from gold to government to gigabyte, but wherein lies the value?