From gold to dollar: How the modern financial system is undermining Pakistan

Published: December 26, 2011

As the reserve currency, the dollar attracts strong global demand as it is the means for millions of transactions taking place on a daily basis. DESIGN: JAMAL KHURSHID

When Pakistan gained independence, it entered a financial system in which the odds were stacked against it. As the financial system changes almost every 40 years, it is vital to analyse its history and mechanism in order to understand the dynamics that influence Pakistan.

During the classical gold standard (1817-1914) currencies were pegged to gold, and the elasticity of the currency was determined through it. A gold standard impels governments to be responsible: Investors that hold bonds can redeem gold if politicians run unsustainable deficits. It equally maintains open international trade equilibrium as gold is exchanged: When nations with comparative advantages experience an economic boom via exports they accumulate gold and are able to expand their currency supply to support it. With the economic boom the demands for imports accelerates, and gold begins to flow out leading to money supply contraction (deflation). Falling prices make the country attractive to foreign buyers and boosts exports again, the process restarts. In the long term, gold ensures a cyclical process.

Dollarisation

With the European and Japanese manufacturing base all but shattered after World War II, the United States emerged as an export leader accumulating 2/3 of the world’s gold. In 1944, 44 countries established the Bretton Woods System in which it was agreed to peg currencies to the US dollar, and make it redeemable for gold at $35 an ounce.

From 1959 to 1971, Gold reserves in US Vaults depleted by 50% due the costly Vietnam War and the Great Society Program. In addition, in1971, the US incurred its first ever current account deficit of $400 million. Nervousness spread across the globe and trading partners of the US scrambled to redeem dollars for gold. As the US did not have enough gold to pay all claims, on August 15 of 1971, President Nixon shocked the entire world by announcing unilaterally that the dollar would no longer be convertible to gold. With millions of dollars held as reserves all over the world, the international community had no choice but to accept the dollar as the world’s reserve currency. This is known as the FIAT monetary system in which money is established by government decree and is independent of gold.

As the reserve currency, the dollar attracts strong global demand as it is the means for exchange for the millions of international transactions taking place on a daily basis.

This demand artificially inflates the value of the dollar, and does not represent the real state of US economy. With $15.3 trillion in national debt and a $560 billion current account deficit, any other country would face a severe currency crises and experience rapid capital outflows. The dollar system influences Pakistan as follows:

1) The US has the ability to not only tax its own citizens but also foreign countries through inflation caused by deficit spending. When Pakistan exports, the dollars it receives enables it to import goods that are vital for its national interest: These include oil, raw materials, military equipment, etc. Currently Pakistan’s foreign reserves total to $16.69 billion. Since the 2008 crises, the Federal Reserve is continuing policies of printing money ($2.1trillion) known as Quantities Easing in attempt to spur growth. The value of Pakistan foreign reserves and its own currency that expands from its reserves are deteriorating (inflation) due to this.

2) “The flipside of currency with a value inflated by artificial demand is depreciation in the price of goods purchased with that currency. As a consequence of the dollar cartel, the United States has for over thirty years been able to purchase the exports of other countries at a discount”. This passage by Eric Janzen, a macro analyst at Itulip, exhibits how Pakistan is exporting at a discount, not realising the real value of its labour and its resources.

3) During an economic boom currency supply should expand relatively, and during a recession it should contract, a gold standard enforces this process. The central bank of Pakistan however is expanding currency in both, a boom and in a recession, leading to economic misallocations.

4) The FIAT system combined with fractional reserve banking creates currency by issuing more debt. Since 1971, economists report the aggregate global public debt to have risen exponentially to $40 trillion (GDP $63.04 trillion). Pakistan’s public debt stands at Rs11 trillion. In 2011, at Davos, Politicians, business and central bankers agreed to an expansion of credit to $100 trillion to support economic growth over the next decade.

The writer is a freelance journalist based in Germany.

Published in The Express Tribune, December 26th, 2011.

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Reader Comments (31)

  • You Said It
    Dec 26, 2011 - 5:35AM

    The article seems to be implying that the gold standard was an ideal monetary system. Pakistan’s economic problems have nothing to do with the Fiat Money system. Any commodity based monetary system would be undermined by changes in supply/demand of the commodity. Disadvantages of the gold standard are well documented, and the article would have been more credible if pros/cons of both the gold standard and the fiat money system had been presented.

    Economic strength requires fiscal discipline, strong economic policy framework and conditions conducive to investment and trade. It must be remembered that individual nations choose their own monetary system, their policies as well as the currency and amount of the reserves they want to hold.

    While the international financial system has many shortcomings, it is silly to think that Pakistan’s economic malaise can be blamed on them. Pakistan’s problems are entirely the making of its political and economic policies.

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  • Dec 26, 2011 - 8:33AM

    Never I have seen on Tribune article like this. Very good job Zain. There is a reason why our Finance Minister comes from US banks, to put more deeper into debt slavery. This article tacitly provides the working of the dollar shackles.

    Recommend

  • Saad
    Dec 26, 2011 - 1:57PM

    Very rare to see a good objective article from Express Tribune. Good job for a change. Recommend

  • Reader Shafi
    Dec 26, 2011 - 6:38PM

    This article is clearly showing how the current financial system is not just undermining Pakistan, but other resource rich nations as well. Gold cannot be printed like paper money, it is a universal currency (as its physical properties indicate) and unlike the dollar it has retained its value. On a gold standard resource rich nations such as Pakistan would have had a better chance on competing on the international stage. At the moment a lot of Pakistan’s revenues are going back to pay back the principal and the compounded interest all owed to foreign entities such as the IMF and the World Bank.

    Trusting a country, and giving it the right to issue the worlds reserve gives it the ability to run huge deficits and thus enjoy a living standard that would otherwise not be possible. The dollar is America’s greatest export, and it is the backbone of its military.

    It must said “It must be remembered that individual nations choose their own monetary system, their policies as well as the currency and amount of the reserves they want to hold.”

    This statement is definitely not true , countries are forced to operate in the dollar system as the financial system today is integrated like never before. Even through the EU crises it has become evident that the Central Bank of the United States, the IMF are bend on maintaining the current system. Even China Holds over $1.5 trillion in dollar based reserves is trying to accumulate gold in order to break away from the dollar system, China has increased its gold reserves from a mere 200 tons to 1100 tons in the last 15 years and has reduced its exposure to the U.S significantly.

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  • Optimist
    Dec 26, 2011 - 7:16PM

    Agree with the author. About time we changed our policy

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  • Meekal Ahmed
    Dec 26, 2011 - 7:21PM

    I’m afraid until a new reserve currency turns up, the dollar will remain king.

    It is true that over the past decade, the dollar has dropped some 40% in value. The other currencies have fared worse or, like the Swiss Franc, they are not traded widely.

    Maybe the Chinese yan will be the reserve currency of the future but China needs to make it fully convertible first. A Chinese official recently said that it would take about 10 years to achieve full convertibility.

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  • Ali Tanoli
    Dec 26, 2011 - 7:45PM

    Its eleven yaers ago i read the article of Baqir zaidi article in urdu express news paper this is
    a english version of same article in other world economy is just a blunder of the century like wise exchanges are just a empty paper sheets.
    we have islamic finance system but if our mullahs just stop fighting on firqas and frows and
    start doing research on system may be we get out of this artificial fabricated banking systems
    which is nothing but lies our prophet Muhammah (pbuh) said labour salary should be based on
    Equal to One TOLA of gold if we see the background of this then tola is right how much around 40000 rupees so there will be no stealing and crruption and poverty left in the country
    this is one small example and economy also runs on gold since world left the gold standerd
    of economy how we r now.Recommend

  • Yuri Kondratyuk
    Dec 26, 2011 - 7:54PM

    The gold standard was a legacy from the time when there wasn’t a well connected and high volume global economy.

    It’s ridiculous to evaluate US dollar by the gold reserves it had. Since it’s real value lies in the fact that it has the best army, is the leader in technology and research, political stability, huge high quality consumer base and its secure geographical location. These are more valuable today than some shiny chemically inert metal. Not that gold is not valuable, but, it shouldn’t be the only factor indicative of value, stability and prosperity.

    The elasticity of the currency will return as the global market matures and competing currencies emerge. The US dollar monopoly is just a passing phase when viewed in the historical perspective. Till them, bad economy or otherwise, US will be the sole economic, military and political super-power. And those who don’t like it will still have to live with that.

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  • Ali Tanoli
    Dec 26, 2011 - 7:56PM

    @Meekal Ahmed sahab
    why the currency only why not old gold system.

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  • Yuri Kondratyuk
    Dec 26, 2011 - 8:13PM

    @Ali Tanoli:

    we have islamic finance system

    How can an economy progress (or for that matter, even run) if interest is banned? What would be the impetus for growth?

    labour salary should be based on Equal
    to One TOLA of gold if we see the
    background of this then tola is right
    how much around 40000 rupees so there
    will be no stealing and crruption and
    poverty left in the country

    If labor were to be compensated in tolas of gold, gold would be worth many times more than it is now. Anyways, would you ever give 40000 rupees for any laborer?
    Also, your assumption that human beings would be peaceful once their coffers are filled is false in the context of human history. Humanity progresses on the desire for more. This dissatisfaction drives human-beings to excel and innovate. Even if everybody in the world is a millionaire with own cars, mansions and private islands they will still try to out do each other since all the so called luxuries will be the basic commodities in their view.

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  • Ali Tanoli,
    Dec 26, 2011 - 8:39PM

    @Yuri kondratyuk,
    The reason we are failling since we left the standerd of economy from gold to papers,
    1. Gap between wealth is so wide that is a reason of unjustice in distribution of wealth.
    2. i have seen in america in 2000 before all the wars and and bank crruptcy of economy
    the labour salary was around 400 to 500 $ a week and that was price of TOLA gold too
    that time and i have seen less poverty in america that time this is small example what i witniced and u r right human being is greedy creatue whose greed never ends but i will say
    this is some thing more easier than before now a days there are small countries which are much easier to control than past empires so system can run better but if wars stops and stealing of wealth end in the name of empire greed and intrest.
    3. and last thing why india being called golden bird in the past the reason was india had more gold and less peoples.

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  • Cautious
    Dec 26, 2011 - 8:56PM

    Your financial problems aren’t based on the dollar or gold standard — you simply don’ pay your bills (including taxes) and you don’t do anything to those that don’t pay there bills. It’s real basic stuff – it’s why your govt is broke and why your not considered credit worthy. You want to fix your economic woes — start with paying taxes — then start paying your utility bills — and don’t forget another basic — don’t spend more than you take in. It’s econ 101.

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  • Ali Tanoli
    Dec 26, 2011 - 11:10PM

    @Cautious,
    U got point too i agreed.sir/maam.Recommend

  • Tariq
    Dec 26, 2011 - 11:19PM

    What inflation, there is hardly any inflation in the US, if the author was correct, than Euro could have easily replaced the dollar. Pakistan’s problem is that it is living on borrowed funds, it does not export enough to cover its imports and its elite pay no taxes, so stop blaming everyone else for your own issues

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  • But
    Dec 26, 2011 - 11:59PM

    @You Said It
    The article does not imply the gravity of the points listed. Instead it gives a brief history of Dollars and Pakistani Rupees and how Dollars influence Pakistani Rupees. And the gold standard was a pretty stable system compared to that of now which has only been blown up to create more Dollars, which depreciate in value due to interest.
    Very nicely written and informative article.

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  • ALi Tanoli
    Dec 27, 2011 - 12:44AM

    Printing machines are running fast making paper money.

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  • A.K
    Dec 27, 2011 - 3:23AM

    We definitely need to tax more on our labor/trade, print less money and shift to gold,lithium and every other natural minerals in Baluchistan. That is if it isn’t annexed and made into its independent state – effectively depriving us of our most valuable resources.

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  • Hamid Khan
    Dec 27, 2011 - 10:23AM

    The article is a knowledge base one and the writer is trying hard to find out the way to tackle the depleting and fragile economy of Pakistan. The youth shall come forward as the writer is rightfully doing, as we know the issue, but we shall find the solution. Do think more and more and do continue writing and expressing yourself .Good work done Mr.Zain
    Hamid Khan

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  • Abdul-Razak Edhy
    Dec 27, 2011 - 8:24PM

    The history of gold based economy and its end is good and useful back ground. Dollar based foreign economies suffer (or share US losses) when dollar looses values because the real reserves value (purchasing power) deprecates for a given reserve figure. Wiser and potent economies counter the move by adjusting their exchange rates; Euro is one example.

    Our problem emanates from spending more than what economy produces. Our economics managers repeatedly blame low tax revenues but never check expenses though imbalance in the two is the real cause. Black economy is also a major cause, and it thrives on rampant corruption. Only a sincere government can control the situation.

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  • Khurram the Muhajir
    Dec 28, 2011 - 3:12AM

    @Zain Raza

    ///During an economic boom currency supply should expand relatively, and during a recession it should contract, a gold standard enforces this process.///

    It is not desirable for the currency supply to contract during a recession.

    Read up about the “Great Depression”. Not all countries can expand exports atthe same time. The world has done away with gold standard and for good!

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  • Dec 28, 2011 - 3:43AM

    Zain Raza

    I have never come across an article of this level in this news paper.It is a knowledge based article which is nicely written and informative at the same time. .

    Recommend

  • Harry Stone
    Dec 28, 2011 - 4:01AM

    Part of any soluction could include not selling exports to the USA thus not having to accept dollars. PAK could also accept only euro’s for its exports converting these into dollars only when it needed to purchase imports priced in dollars.

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  • Dec 28, 2011 - 11:08AM

    Excellent article, but it is not just Pakistan who has been disadvantaged by the use of the US$ as the world’s reserve currency. Gold is money, paper is not. We are now at the tail end of yet one more disastrous experiment with government printed ‘money’. Gold (and silver) are on the cusp of returning all over the world – whether governments want it or not.

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  • Ali Tanoli
    Dec 28, 2011 - 7:24PM

    Get the gold back or lost the economy dont forget gold is reallty and paper is just paper in the water resolve like asprin.

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  • Anthony
    Dec 30, 2011 - 12:15AM

    This is thought-provoking information not only toward Pakistan but any Nation’s economical structure. A Gold Standard did seem to carry a strong sense of control with it that would be nice to see in today’s global economy. Everyone talks about “uncertain” times in regards to economics but this definitely goes deeper and shows reasoning for the current economic situation. Well done Mr. Raza.

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  • Ali Tanoli
    Dec 30, 2011 - 7:23PM

    If Petro countries abandon $ and start prising black gold on golden gold then?????????

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  • You Said It
    Dec 31, 2011 - 7:03AM

    @But:
    I don’t know how you can claim the gold standard was a stable economic system.

    The gold standard provides no flexibility, since you can’t print gold. Studies have blamed the widespread misery of the Great Depression on the gold standard — the Federal Reserve was simply unable to expand credit and the government couldn’t spend its way out.

    Gold standard bring long-term price stability. But it also introduces high short-term volatility. The national economy would become vulnerable to any short-term fluctuation in gold price if for instance a large gold mine were to come online.

    There are a numerous problems such as the ability of a large gold producer like Australia, Russia, South Africa, Uzbekistan, etc to cause turbulence in every world economy by manipulating gold supply. The list of drawbacks are far too long.

    Fiat money has drawbacks too, but most are mitigated by sound, conservative fiscal policy — if you have discipline to apply them. Best of all, with the Fiat Money system if you really think the value of the dollar is inflated, you can put your money where your mouth is — take a bet against the dollar.

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  • Javed
    Dec 31, 2011 - 4:59PM

    @Tariq:
    It’s not just the elite; nobody pays taxes in our country. Out of a population of 180 million there are only 1.5 tax payers. By your definition 178.50 million elite reside in Pakistan. The problem lies from top to bottom but of course it’s fashionable to blame everything on the rich and absolve ourselves of any responsibility.

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  • Ali Tanoli
    Dec 31, 2011 - 6:21PM

    @You said it
    There are more paper money circulating in the world with less real asserts and money exchanges are just number sheets nothing reals. so what gonna happend now when this
    lies based system getting over with numbers??? what kind of new ISM we gonna need.Recommend

  • Reader Shafi
    Jan 6, 2012 - 8:18AM

    We must understand that gold is the only competitor that government bonds have. Savers, if not satisfied with the rate of interest offered by the government on its bonds, can hold on to the gold coin of the realm. Once gold is confiscated, the safest place to park one’s savings is the government bond. People are at the mercy of the government (and adventurers in government). Gold is the protector of the people against financial dictatorship.

    Recommend

  • faisal
    Jan 6, 2012 - 11:29AM

    informative article and very well versed

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