The mystery of currency.

Every banknote in India carries a promise by the Governor of the Reserve Bank to pay as many rupees as printed on the note. For instance the Rs 1000, the highest denomination available, promises to pay Rs 1000. But what does it mean? Pay in what? In the past it meant that the bearer would get an equivalent amount of gold, in market value, in return for the note. But Richard Nixon ended the gold standard, which was fixed at $35 for one ounce of gold, in 1971 so now we have what is known as ' fiat money ', which is just a piece of paper with a number printed on it and whose value depends on what it can buy, which changes from day to day. So when the Governor of the RBI promises to pay Rs 1000 he is not promising anything tangible, he is really promising another Rs 1000 note in return. There are those who think that what Nixon did was a colossal error and ending the gold standard has caused enormous economic harm to the US. Not having any intrinsic value makes the rupee vulnerable to events outside the Governor's control. The rupee plunged to 68 to the dollar, labeled ' taper tantrum ' by the press, when Ben Bernanke mentioned a tapering of the Federal Reserve's bond buying program. The most spectacular loss of control of a nation's currency happened in 1992 when Britain lost 3.3 billion pounds trying to protect the sterling and the financier, George Soros made 1 billion pounds in just one week by short selling the currency. Last month the Swiss National Bank was forced to abandon its currency peg to the Euro and the Swiss Franc jumped by 30%, but later trimmed its gains. The reason was the announcement by the European Central Bank that it was going to buy bonds worth $70 billion per month. The SNB was buying Euros while selling Francs to prop up the exchange rate but the losses of accumulating huge quantities of Euros, which were going to drop in value anyway, became too much. Currencies can be bought and sold like any commodity, which makes them vulnerable to speculators. Why do governments allow such trades? After all, currencies are national assets, like our flag. We would take great offence if foreigners insulted our flag so why do we allow them to play with the rupee? Because we need foreign investment. Foreign funds with billions of dollars invest in our stocks and debt markets. This money has pushed our stock prices to record values, is propping up the value of the rupee and is pushing down yields on debt. They will not invest if they are not allowed to repatriate their money. Trouble is that rupee trading is not allowed in the country so rupee derivatives to the tune of Rs 2 trillion per year have developed in Dubai and Singapore. So now rupee trading will be allowed in India. A banknote is worth nothing and yet it can cause havoc. Scary, what?