The great illusion

Courtesy a dear friend, the title needs to be clarified; this article is not about democracy, the undisputed greatest illusion of all time. Even those credited with its conception, much to the envy of Alchemists universally, cannot have imagined its magical powers of transforming humans. Just because of one vote, which does not matter at all, the "have nots" perceive empowered when in reality they continue to be fooled by the "haves". This forum, however, is not appropriate for a discussion on the antithesis of democracy.
Getting back to the great illusion is hardly simpler. Money, the embodiment of the seven deadly sins, craves intelligence beyond mortals for explanation. We may have created it, but today, are hardly in a position to explain it, let alone make predictions about it.
Imagine the glee the "haves" must have felt when they stumbled upon the idea for paper money; labour could be paid with pieces of paper, hence providing limitless opportunities to enhance wealth. Imagine the ecstasy when realisation dawned that even paper was frivolous; money could be created out of nowhere... Unfortunately it disappears as quickly.
The transition to paper was hardly a stroke of genius if you consider that the earlier means for storage of wealth was gold, a useless metal. Except that it shines, gold does nothing else. It boggles the mind as to why, at least in the known history, gold has been man's most sought after metal. The fact that it is scarce and indestructible might have been the reason it became the medium of exchange.
In the end its scarcity was probably the cause behind gold's dethroning as the universal currency. More money was needed to wage the King's war, to feed the greed of the bourgeois and to sustain the growing population of the proletariat migrating from the farms to the cities to fuel the industrial revolution. Having experimented with other metals for a while, bountiful paper became the ultimate solution... Until the final brainchild, nothing is money!
For a while sense prevailed, and legal tender was at least pegged to gold. Eventually even this was considered burdensome and henceforth gold was downgraded to female adornment only. While the intent is not to analyse the history of money, but there might be a possible link between world population growth and the continuing demand for more money. If each worker needs an annual increase in his remuneration and there are more workers to pay every year, where were governments going to get the funds. The easiest solution was printing, note that this breakthrough scientific discovery was before our independence; we did not invent the wheel!
Economic theory tells us that there are various parameters and factors which form the basis of and need to be considered by governments before printing money, in normal parlance money supply is a component of monetary policy as is interest rates. In the world of unmanageable national debt and fiscal deficits, monetary policy dictates are akin to advising a bull to be careful of the stairs while entering a China shop.
Armed with a printing press and sufficient paper and ink, all the government needs to do is print money. Again we are told that there is a method to this madness, you just can't print money indiscriminately. Excessive supply will result in inflation, devaluation and eventual loss of faith. Looking at what is happening globally today, one wonders whether the magicians, except for the Swiss probably, overlooked a critical component of the illusion.
Nonetheless, there was still not enough money; paper could not make the "cut". The world needed money out of nowhere. Enter the banking system. For every Rs 100 you deposit in the bank, a small portion is retained as a reserve and the balance lent out. This loan takes the form of a deposit in the ultimate recipients' bank, which then immediately proceeds to lend it out retaining a fraction, so on and so forth.
With unparalleled efficiency the banking systems ends up retaining the Rs 100 while having made loans of a multiple between 7 to 10, depending upon individual ingenuity. Factor in exotic options and bonds, this could double or treble. Money out of thin air!
The great wizards were, however, conscious of the insurmountable risk of creating money out of nowhere and armed the regulator with what is known as money market operations. Right about now the reader is sufficiently confused and clueless about how money is created and managed, a near perfect illusion which is impossible to explain in layman terms. If it helps, economists continue to debate the role of Alan Greenspan, Chairman of the Fed for 19 years before he retired in February 2006, in curbing or fostering the global financial crisis. Enjoy your grin and than sober up, we have yet to decide on a governor!
So if we can't understand money, why bother, at least we get to spend it! And someone, somewhere out there must know what needs to be done to keep the clock ticking. Unfortunately, illusions never achieve permanency and in the case of financial illusions end chaotically.
When the banking system collapsed in Afghanistan the cost of printing and paper was probably more than what their currency was worth. Imagine the predicament of the populace whose life savings were wiped out for no fault of their own. Consider the joy when the value of your home kept rising as banks lent money indiscriminately out of nowhere and then fathom the despair when facing foreclosure on the very same home you lived in all your lives since you are now unable to meet the enhanced obligations emanating out of refinancing.
For no fault of yours, you were sucked in by the illusion, spending more than you should have. Nothing changed, the same job, the same family except no wealth and no home! Conceptualise that after working all your life, looking forward to a comfortable retirement, you are informed that the money which should have existed for your pension savings have evaporated. You thank your stars that you were more prudent and having curtailed consumption have additional savings in your personal bank accounts. Unfortunately, your government in order to meet its obligations printed a hell of lot more money, and now your savings aren't enough.
Fantasise how big a vault is needed to store USD 14.3 trillion in cash and relish the thought of having the only keys to the vault. Now stop day dreaming and brainstorm how this kind of money was created? Whatever happened to simple trade, did speculation lead the drive for more money or was it vice versa? Is avarice the cause of this humongous debt or were Americans nudged towards consumption and housing finance to continue feeding the illusion?
Forget the US national debt, visualise what happens if Bill Gates withdraws all his money in cash and locks it in his vault. Simply the US government will print more and Gates will become another victim of the great illusion. Even if he continues to just bank them his wealth erodes consequent to the devaluation of the greenbacks.
Apparently, you just can't win against money. In less than 3 years the world is faced with another recession and the pundits are allergic towards predicting the magnitude of the forthcoming disaster. Even those on the positive side of the illusion, apparently flush with cash, are looking towards gold for an exit, back to the future. The eventual outcome is probably another illusion.
At the end of the day it is all about commodities and resources. When the dust settles those controlling resources and trained labour will dictate the future. Let us hope and pray that our government understand the illusions and is geared to visualise and meet the challenges ahead. In the meanwhile, lay back and enjoy the magical world of the great illusion.
(The writer is a chartered accountant based in Islamabad.)