Currency functions as a central nervous system: by its "flow" it sets the value of all other assets in a given community. Bonds are an attractive investment so long as the money in which they are denominated is stable and maintains its value: that is, when inflation is low or falling. Stocks fall when interest rates rise, and when an economy is in trouble, its interest rates can be expected to rise dramatically as the central bank tries (by offering high rates) to tempt investors (who notice the country's trouble) from taking their money out. The effect of currency value on real estate is more indirect. On the one hand, real estate is a well known "hedge against inflation", meaning that it keeps its relative value. Another way of saying "hedge against inflation" is that as the value of the currency falls, the price of real estate rises in a compensatory degree, so one is "hedged" or protected. Nevertheless, an individual in financial difficulties who can't pay his mortgage easily loses money if he can't wait for his price and has to sell right away. That is what is meant by real estate being a non-liquid asset....it can't immediately be turned into cash (liquid money!) After the 1929 crash, real estate values fell as much as stock value. At that time, the only assets that retained value were treasury bills...that is, the bonds of the US government, which could not declare bankruptcy, and could print more money if it needed. In his book "How Credit-Money shapes the Economy: the United States in a Global System", Professor Robert Guttmann says the only way we could see another real depression would be through collapse of the currency.
The interconnectedness of financial markets means that currency collapse is a contagious disease. Such befell the currency of Thailand in 1997, when it fell 42%. This was followed by falls in the currencies of 9 other countries: four fell less than 42%, but the Indonesian currency fell 80% and the Russian currency 86%
Banks have always been "special". The nature of their classical business was to take in (low risk) deposits for which they paid a small interest to depositors , and loan out this money at a higher interest rate to entrepreneurs, that is to say, people who were willing to risk entering or expanding some business. This has always called for bankers to assess those who take loans. If they make good calls, they keep the profits, but when they lose, depositors lose as well. These days the government insures depositors, so the tax-payers lose when the bankers succumb to the temptation of higher profits and make risky loans. The profits of the banks stay with the banks, but the problems of the banks become everybody's problems, as we have clearly seen in 2008.
No one has ever figured out how to keep the banks under control, but "central banks" have been one attempt at it. Central banks were so called because they were usually located in the capital of whatever country, and they had a monopoly on the emission of "legal tender" for that country. When some local bank got itself in trouble, the central bank could be called upon for a loan -"the lender of last resort". This arrangement could prevent "runs on the bank" (such as the one prevented by Jimmy Stewart as a banker in "It's a Wonderful Life" where the local community itself saved the day and does not need to call upon the central bank)
From time to time the central banks themselves gave way to temptation and the bank of one country might discretely bail out the bank of a neighboring country when it managed to get itself into trouble (The Bank of France bailed out the Bank of England in 1825, and in 1860 the Bank of England bailed out the Bank of France in return) Such episodes were infrequent, and hushed up. The Federal Reserve System in the US was created in 1913 on the model of these earlier central banks. It wasn't until the Bretton Woods in 1944 that modern central banks formally took specific responsibilities- a formal commitment to being a lender of last resort for smaller banks, and the control of inflation.They do this indirectly: they set the interest rates that other banks must pay, and they buy and sell treasury bills. In the past thirty years, more and more economic turmoil has spilled over from one country to another, so that the International Monetary Fund and the Bank for International Settlement have been increasingly involved in attempts to contain the contagions. This is far from the "world government" that so frightens to many people. More about them next time.
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