[The Editors' Verdict] The Survival History of the Credit-Based System

[Asia Economy Reporter Choi Il-gwon] The abolition of the gold standard in 1971 was a monumental event that changed the paradigm of the global economy. The gold standard maintained the value of currency equal to the value of gold, and it was the foundation of global monetary policy centered on the United States after World War II. Its advantage was that it allowed for stable monetary policy because currency could always be exchanged for "real" value in gold. However, it also had the limitation of being insufficient to meet the growing economic demand due to the limited amount of gold.

After the gold standard was abolished, credit took its place. This marked the entry into a credit-based society where credit replaced the "real" asset (gold). This was also the starting point that allowed the United States to print the dollar, the key currency, and supply liquidity worldwide.

Since the abolition of the gold standard, the economy expanded rapidly. According to economic data from the Federal Reserve Bank of St. Louis (FRED), the U.S. Gross Domestic Product (GDP) curve was almost flat until 1971, just before the gold standard was abolished. However, after that, the curve showed a steep upward trajectory. The U.S. GDP grew from $1.1648 trillion in 1971 to $21.4271 trillion last year, an increase of more than 20 times. Compared to the 11-fold increase in GDP from 1930 to 1970, the growth rate of the U.S. GDP after the abolition of the gold standard was significantly faster. It is no exaggeration to say this was the effect of massive dollar circulation.

However, along with economic growth, the side effects of the credit economy also grew. As money was printed whenever needed, economic agents became insensitive to debt. The more debt increased, the more unstable the economic system became. The operating principle of the credit economy is based on the belief that money circulates smoothly, but if even one link in this chain is broken, the entire system faces a fatal risk. A representative from the U.S. Institute of International Finance described the global economic situation as "sitting on a bomb that does not explode."

The global spread of the novel coronavirus disease (COVID-19) confirmed these anxieties. When concerns arose that "money might not circulate smoothly" due to the collapse of production and consumption, stock prices plummeted and a dollar rush phenomenon peaked. This was the result of fear spreading among economic agents.

The solution is cash distribution. The U.S. Federal Reserve (Fed) ultimately deployed the unlimited quantitative easing card, which had never been used before. Most countries in Europe and Asia have also joined in. Massive cash is being poured in to restore the credit economy.

We have long known that cash distribution, represented by "helicopter money," has been a symptomatic treatment over the past decade since the 2008 financial crisis. The effects of quantitative easing, which lasted at least five years after the financial crisis, have already shown their limits. Companies that borrowed massive funds under low interest rates have again faced situations where they cannot repay their debts. After warning signs lit up in corporate bonds following the COVID-19 outbreak, credit rating agencies have been busy downgrading corporate credit ratings. This is the cost of patching up crises with debt. Bloomberg recently reported that "the coronavirus crisis has begun to follow the contours of the 2008 credit crisis."

The high-intensity policies of countries worldwide in response to the COVID-19 crisis surpass the measures taken after the 2008 financial crisis. Once the epidemic subsides, the world economy may enter a stabilization phase with the injected funds. However, it cannot be assumed that there will be no more crises. The higher the level of countermeasures, the stronger the next crisis will inevitably be. Improvement of the credit-based system has become urgent after the COVID-19 crisis.