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Small debts lead to a borrower, while large debts invite an adversary.#

A fundamental characteristic of debt is that the debtor acknowledges their obligation; if they fail to repay the debts owed, they cannot incur further debts. In short, debts must be repaid; failing to do so is essentially a violation of rules. In contrast, debt derivatives allow parties to pay interest without requiring immediate repayment, which is, in essence, true debt. This gives rise to a new form of debt, known as contingent liabilities, which are entirely subject to various factors that may or may not arise during the validity period of the derivative contract.

Debt derivative contracts cause people to overlook the interest on contracts, focusing solely on the net cash flow between the swap parties. The complex nature of swap contracts obscures the relationships between debtors, creditors, and the essence of debt itself. Nowadays, if interest rates change during the validity period of a swap contract, the payer can become the payee. In the next phase, this situation may reverse again, perhaps continuing to oscillate until the contract is terminated. The certainty and urgency of debt have now devolved into a matter of probability, which many risk managers confidently believe they can predict accurately.

The Modigliani-Miller theorem is an important theory in financial economics, proposed by Franco Modigliani and Merton Miller in 1958. This theorem primarily explores the impact of capital structure on company value.

Core points of the Modigliani-Miller theorem:

• Independence of firm value: Under assumptions of no taxes, bankruptcy costs, and imperfect market information, a firm's market value is independent of its capital structure. In other words, a company's value is not affected by its debt-to-equity ratio.
• Cost of capital: When a firm increases its debt, shareholders may demand higher returns to compensate for increased risk, but the overall weighted average cost of capital remains unchanged.
• Market efficiency: The Modigliani-Miller theorem assumes that markets are perfectly efficient, and all investors have the same information.

Applications and limitations:

• Application: The Modigliani-Miller theorem provides a theoretical foundation for understanding capital structure decisions and has influenced subsequent research in financial management and corporate governance.
• Limitation: In actual markets, factors such as taxes, transaction costs, and information asymmetry exist, making the conclusions of the Modigliani-Miller theorem not entirely applicable in reality.

In summary, the Modigliani-Miller theorem laid the groundwork for the subsequent development of financial theory and sparked widespread discussion about capital structure.

The Black-Scholes model is a very important option pricing model in financial engineering, proposed by Fischer Black, Myron Scholes, and Robert Merton in 1973. This model provides a theoretical basis for pricing European options.

Basic assumptions of the Black-Scholes model:

• Market efficiency: The market is efficient, and prices reflect all available information.
• Constant risk-free interest rate: The risk-free interest rate remains unchanged throughout the option's validity period.
• Stock prices follow geometric Brownian motion: Stock price changes are random and follow a log-normal distribution.
• No arbitrage opportunities: There are no opportunities to profit from buying and selling options and underlying assets.
• No transaction costs: Buying and selling assets incurs no costs.

Main formulas:
The core formula of the Black-Scholes model is used to calculate the theoretical prices of European call options and put options:

Call option price formula:
[
C = S_0 N(d_1) - Xe^{-rT} N(d_2)
]

Put option price formula:
[
P = Xe^{-rT} N(-d_2) - S_0 N(-d_1)
]

Where:

• (C) = Call option price
• (P) = Put option price
• (S_0) = Current stock price
• (X) = Strike price
• (r) = Risk-free interest rate
• (T) = Time to expiration (in years)
• (N(d)) = Normal distribution function
• (d_1) and (d_2) are calculated as:
  [
  d_1 = \frac{\ln(S_0/X) + (r + \sigma^2/2)T}{\sigma \sqrt{T}}
  ]
  [
  d_2 = d_1 - \sigma \sqrt{T}
  ]

Where (\sigma) = Volatility of the stock price.

Applications and impact:

• Wide application: The Black-Scholes model is not only applicable to option pricing but is also widely used in pricing other derivative financial instruments, risk management, and portfolio optimization.
• Nobel Prize: Myron Scholes and Robert Merton received the Nobel Prize in Economic Sciences in 1997 for this model.

Limitations:
Despite its significant position in financial markets, the Black-Scholes model has some limitations:

• Assumes constant risk-free interest rates and volatility, which may vary in actual markets.
• Not applicable to American options (which can be exercised before expiration).
• Does not consider market frictions, such as transaction costs and taxes.

In summary, the Black-Scholes model is one of the cornerstones of modern financial theory, greatly advancing the development of options and other derivatives markets.

The emergence of this model coincided with the collapse of the Bretton Woods system. Since then, the earliest stock option models have expanded to other financial instruments. Merton gained fame for his empirical research on the efficient market hypothesis, which is the dominant theory analyzing how stock markets operate in the context of information asymmetry.

Interest takes two forms—surplus interest and credit interest—both of which belong to sales transactions. The former refers to an increase in capital assets in a transaction, where the exchanged items are of the same kind; the latter refers to immediate payment, selling something in exchange for another or entirely different item, with the amount exceeding deferred payment.

The term "sale" implies some form of profit. However, in Islamic thought, the relationship between interest and profit, while not entirely opposed, stands on different sides. Why is profit encouraged while interest is prohibited? For centuries, banks have believed that interest is the profit from lending.

The construction of interest is not meant to allow both parties in a credit transaction to share the corresponding risks; there is no fixed amount, allowing one party to benefit at the expense of the other. Initially, the same prohibition extended to other financial products, such as futures contracts, which are seen as a form of risk. Any financial product involving zero-sum games is classified as gambling.

Debt capacity should be a straightforward financial concept: assets greater than liabilities indicate the ability to repay; conversely, liabilities exceeding assets indicate bankruptcy risk.
— Financial Crisis Inquiry Commission, 2011

The management of float reflects the traditional conflict between liabilities and repayment. Suppose a tenant's rent is due on the first day of the month, which happens to fall on a Saturday; even if he does not have sufficient funds in his account, he can arrange to pay that day because the check deposited in the landlord's bank will not clear until the following Monday, and settlement may take at least two days. This means that the funds do not need to be deposited in cash accounts before Wednesday; in other words, the payer has a five-day float period. From both parties' perspectives, the tenant wishes to extend the float period, while the landlord wishes to shorten it as much as possible.

The ability to control this process depends on the structure of the banking system. If the payer and landlord's accounts are in the same bank, the settlement time becomes zero; if they are in two banks, both members of the Federal Reserve, the process may take several days; if one is a Federal Reserve member and the other a state-chartered bank, it will take even longer. Float management has become an art, especially on Wall Street. Many retail clients of brokerage firms withdraw cash from their accounts, often finding checks from small banks located far away on the East Coast, typically from the Midwest or West (using "float"). Deliberately staggering settlements is intended to maximize the float period for the brokerage firm.

Corporate finance departments are well aware of float periods, but if individuals wish to use float periods to pay bills, it raises an old question—are debtors allowed to delay repayment, even for a very short time? There is an illegal practice known as "bad checks," where the issuer knowingly signs a check without sufficient funds, relying on some temporary transaction. Simply put, the check is supported only by air.

Among various measures, electronic banking and electronic payments have reduced the number of checks that the Federal Reserve must settle each year, having the most significant impact on unpaid float amounts. Direct deposits and online banking, once introduced, significantly reduced float, but one high-interest area of banking remains unchanged: payday loans still depend on the traditional check turnover. This again shows that financial services aimed at marginalized citizens still carry high-interest rates, often disguised as some form of fees.

Debt
Noun. 1. The total amount of money owed. 2. The state of owing money. 3. A feeling of gratitude for help or services provided by others.
— Oxford English Dictionary
If you owe the bank $100,000, then your property belongs to the bank. If you owe the bank $100 million, then the bank belongs to you. — America
"Owe money, pay money back."
The power of this statement lies in the fact that it does not belong to the realm of economics but rather to a moral discourse. After all, isn't the essence of morality built around the idea that people should repay their debts? Giving people what they deserve; accepting responsibility; fulfilling obligations to others, just as one expects others to fulfill their obligations to you. Is there a more straightforward example of evading responsibility than breaking a promise made or refusing to repay a debt?

Moral hazard is an economic term referring to the risk that one party to a contract may change their behavior in a way that is detrimental to the other party's interests. For example, when someone obtains insurance from an insurance company, the cost of that person's behavior is partially or fully borne by the insurance company, which then faces moral hazard. If that person defaults and causes a loss, they do not bear full responsibility, and the insurance company often has to bear most of the consequences. At this point, the individual lacks the incentive to avoid default, relying solely on their moral self-discipline. They can change their behavior at any time, causing losses to the insurance company, which must bear this risk.

Consumer debt is the lifeblood of the economy. All modern nations are built on the foundation of deficit spending. Debt has become a core issue in international politics.

Throughout human history, certain debts and certain debtors have always been treated differently.

A more elegant way to express the same idea is as follows: One day, I was walking down the street with a friend when suddenly a guy jumped out of an alley, pointed a gun at us, and said, "Robbery!"
As I pulled out my wallet, I thought, "I need to minimize my losses." So I took out some cash and turned to my friend and said, "Hey, Fred, this is the $50 I owe you."
The robber felt so humiliated that he pulled out $1,000 and forced Fred to lend it to me at gunpoint, then robbed me of that money.
In the final analysis, the armed man does not need to do anything he does not want to do. However, to successfully implement a mechanism based on violence requires establishing a set of rules. The rules can be made arbitrarily. Sometimes even the content of the rules is irrelevant. Or at least it was irrelevant at first. The key is that from the moment people reinterpret issues through the concept of debt, they inevitably begin to ask who owes what to whom.

The debate about debt has persisted for at least 5,000 years. For the vast majority of human history, at least in the context of states and empires, the overwhelming majority of people have been told they are debtors.
The struggle between people is most often presented in the form of conflict between debtors and creditors—debates about the morality of interest payments, debt repayment through labor, debt forgiveness, repossession, compensation, seizing sheep, confiscating vineyards, and selling the children of debtors into slavery.
Regularity begins in the same way: by destroying debt records—wooden tablets, papyrus, bills, etc., which creditors might use at any time and place (after which rebels usually seek to obtain land ownership and tax assessment records). As the great classical scholar Moses Finley often said, all revolutionary movements have the same step: "Cancel debts and redistribute land."

Moral and religious expressions contain a considerable amount of terminology derived from these conflicts. Therefore, our tendency to overlook this point seems even more strange. Terms like "calculation" or "redemption" are the most obvious examples, as they directly borrow from economic terminology. More broadly, terms like "guilt," "freedom," "forgiveness," and even "original sin" can be said to originate from economic activities. In establishing the foundational expressions of human morality, the debate over who owes what to whom plays a central role.

Most people naturally hold the following two views: (1) Repaying borrowed money is a moral issue; (2) Anyone who has a habit of lending money is a bad person.

For the vast majority of people in the world, the two largest expenses in their lives are marriage and burial. Both require a significant amount of money, which can only be raised through debt.
Religious traditions seem to address this dilemma in various forms. On the one hand, all human relationships involve debt, and they all make moral compromises. Both parties may become guilty simply because they have established some form of relationship. At least if repayment is delayed, they are likely to become guilty.

On the other hand, if we say that some people's behavior seems to indicate that they "owe nothing to anyone," this statement does not praise that person as a moral model. In the real world, morality largely means fulfilling responsibilities to others, and people stubbornly imagine this responsibility as debt. Perhaps monks can escape this dilemma because they are completely isolated from the secular world. The rest seem to be guilty, so they can only live in a world that is not very reasonable.

Deficit spending refers to relying on debt rather than taxes to meet expenditures.
If the obligation to pay taxes is viewed as a debt, then it becomes an absolute majority—and if there are no other factors, the two are closely linked. Because throughout history, the need to save money for taxes has often been the most common reason for falling into debt.
Who exactly owes what to whom?
This perfectly illustrates that once a person raises the question of "who owes what to whom," it indicates that they have begun to adopt the creditor's perspective. It is as if if we do not repay our debts, then "being reincarnated as an ox or a horse is our way of repaying." Therefore, if you are an excessively demanding creditor, you will also "repay again." In this way, even the justice of cause and effect can be simplified into a commercial transaction.

To be precise, what would it mean when our sense of morality and justice is simplified into a commercial expression? What does it mean when we reduce more responsibilities to debt? What changes occur when a person turns to another person to borrow money? When our expressions have been shaped by the market, how do we discuss them? In a sense, the distinction between responsibility and debt is simple and obvious.

Debt is the responsibility to repay a certain amount of money. Therefore, unlike other forms of responsibility, debt can be precisely measured. This makes debt simple, cold, and devoid of any personal feelings—correspondingly, it gives debt liquidity. If a person owes another person a favor, or even their life, then this indebted relationship is only valid for that specific person. However, if a person owes a $4,000 loan with a 12% interest rate, then who the creditor is does not matter; there is no need for the creditor and debtor to ruminate over what the other needs, wants, or can do—if what is owed is a favor, respect, or gratitude, then both parties must engage in such contemplation. If what is owed is money, then there is no need to consider human influence; one only needs to calculate the principal, balance, penalties, and interest. If the final calculation indicates that you need to leave your home and abandon your house, or your daughter has to go to the lumber camp to sell herself, it is certainly unfortunate, but it is necessary for the creditor. Money is just money, and transactions are just transactions.

The distinction between debt and moral responsibility does not lie in whether there is a person holding a weapon to confiscate the debtor's property or threatening to break the debtor's legs to ensure the fulfillment of responsibility. In fact, the distinction is very simple: it lies in whether the creditor can quantitatively and precisely state how much the debtor owes them.

However, if one looks deeper, one will find that these two factors (violence and quantification) are closely linked.

Violence, or the threat of violence, transforms relationships between people into mathematical equations of behavioral change.

Financial products are almost entirely carefully designed scams.
Their operation includes: selling loan products to poor families, which are designed to inevitably lead to defaults; betting on the time it takes for these products to default; bundling loan products and bets together and selling them to institutional investors (perhaps the retirement pension accounts of the loan product holders), claiming that they will make money no matter what happens, and allowing the aforementioned investors to transfer this bundled product as if it were currency; transferring the responsibility for paying off the bets to large insurance groups, which, when unable to repay the final debt amount (which is bound to happen), will have these debts borne by taxpayers (and those insurance groups indeed received emergency bailouts).

With the collapse of well-known capital financial institutions (Lehman Brothers, Citigroup, General Motors), advanced financial knowledge was proven ineffective. Everyone believed that, in terms of the essence of debt and credit institutions, at least a more extensive discussion needed to be restarted, rather than just a simple dialogue.

The collapse timeline of well-known capital financial institutions:

• Lehman Brothers: Filed for bankruptcy on September 15, 2008, marking a significant milestone in the financial crisis.
• Citigroup: Although Citigroup did not completely collapse, it experienced a significant financial crisis during the 2008 financial crisis and accepted government assistance in November 2008.
• General Motors: Filed for bankruptcy protection on June 1, 2009, becoming one of the largest bankruptcy cases in U.S. history.

(Here, "democracy" refers to "capitalism.") This is intriguing: those who feel responsible for the current global economic system's operation.

Currency. The distinction between debt and responsibility lies in the fact that debt can be precisely quantified, and the quantification process requires the use of currency.
The definition of currency functions typically includes three aspects: medium of exchange, unit of account, and store of value. All economics textbooks define the medium of exchange as the most important function of currency. The following quote is from the book "Economics" edited by Case, Fair, Gärtner, and Heather (1996):
In complex societies, the types of goods traded are numerous. If trading were conducted through barter, the workload would become enormous and unbearable. Imagine walking into a store and trying to find someone selling all the items you need, while those people also happen to need what you can offer in exchange—how difficult would that be!

Some believe that the emergence of a medium of exchange (or payment method) eliminates the problem of double coincidence of wants.

Thus, the minting of currency was born. Indeed, issuing minted currency means that the government must be involved, as mints are typically operated by the government. However, in accurate historical terms, the government's role is limited—ensuring currency supply, and it always messes this up. Throughout history, unscrupulous rulers often cheat on very simple economic principles: they lower the value of minted coins, leading to inflation and various other adverse effects.

What is a favor? How can a favor be quantified? On what basis can you say that so many potatoes or a pig is roughly equivalent to a pair of shoes? Because even a rough estimate must have some way to determine that X is approximately equivalent to Y, or that the value of X is slightly lower or higher than Y. Doesn't this indicate that at least in terms of comparing the value of different items, something like currency has already existed in this sense?

In most gift economies, there are indeed rough ways to solve this problem. You need to establish a series of graded categories for the types of items. Pigs and shoes can be considered roughly equivalent objects, and you can exchange one for the other; while coral necklaces are another thing, requiring another necklace or at least another piece of jewelry for exchange—anthropologists call this creating different "transaction hierarchies." This does simplify things to some extent. Once cross-cultural barter trading becomes common, it will operate under similar rules: specific items can only be exchanged (for example, exchanging fabric for spears), making it easier to calculate equivalences between items. However, this does not help us solve the question of the origin of currency; in fact, it makes the problem extremely tricky. If salt, gold, or fish can only be exchanged for specific items, then why do people still stockpile them?

People are born with debts—gods, saints, ancestors, and others are all creditors. If a person offers sacrifices, it is because they have owed a debt to the gods since birth... If a person recites a scripture, it is because they owe a debt to the saints... If a person hopes to have children, it is because they have owed a debt to their ancestors since birth... If a person generously hosts strangers, it is because they owe debts to others.
— "The Book of the Dead"

(Or using Smith's terminology—"divine will") the principle upon which things are arranged is that in a free market, people's pursuit of their own interests, as if "guided by an invisible hand," enhances the overall interests of society. According to Smith in "The Theory of Moral Sentiments," the famous "invisible hand" he proposed is the embodiment of divine will. It is, in fact, the hand of God.

Transactions between individuals, as well as between nations, can essentially be summarized in the form of barter. Others mention that "the veil of currency" obscures the essence of the "real economy" (where people produce actual existing products, provide actual existing services, and then repeatedly exchange them).

Debt. In fact, a coin is a promissory note. Although traditional views hold that paper money is a promise, or should be a promise, to guarantee the payment of a certain amount of "real currency" (gold, silver, etc.), credit theorists argue that paper money represents a promise to pay something equivalent to an ounce of gold. But that is the entirety of currency's meaning.

How is credit currency born?
For example, we can assume that Joshua is ready to give his shoes to Henry; and Henry's promise is not just to owe him a favor, but also to promise that he owes Joshua something of equal value. [He gives Joshua a promissory note. When Henry has something useful for Joshua, Joshua can take the promissory note to redeem Henry's promise. In this way, Henry tears up the promissory note, and the matter ends. But if Joshua transfers the promissory note to a third party—Hila, because he owes Hila something else (he can also use the promissory note to offset his debt to the fourth party, Laura), now Henry owes Hila something, the value of which is equivalent to Joshua's shoes. This is how currency is born. This process has no endpoint. Suppose Hila wants to buy a pair of shoes from Edith; she can give the promissory note to Edith and assure her that Henry will fulfill his promise. In principle, the promissory note has every reason to circulate in the town for years—as long as people have confidence in Henry. In fact, if the promissory note circulates long enough, people may completely forget its original owner. Such things do happen. Even if the coin Henry gave to Joshua is not a piece of paper but a gold coin, the situation does not fundamentally change. A gold coin is also a promise, a guarantee to pay something equivalent to the gold coin. After all, in reality, a gold coin itself has little utility. A person accepts a gold coin because they assume that others will do the same.

In this sense, the value of a unit of currency is not a measure of the value of an item, but a measure of a person's trust in others.

Of course, the element of trust makes everything more complicated. The process of early paper currency circulation is almost identical to what I described above. There is only one difference: like merchants, each recipient would sign their name on the paper currency to guarantee the legitimacy of the debt. However, in general, viewing this process from the perspective of chartalism (this is the later recognized term, derived from the Latin word "charta," meaning "token") is difficult because it raises the question of why people would continue to trust a piece of paper. After all, anyone can sign someone else's name on a promissory note, and there is no reason not to do so, right? Yes, this debt-token system might work in a small village where people know each other; or it could work in a more dispersed society, such as among merchants in 16th-century Italy or 20th-century China, at least they have ways to know each other's movements. However, such a system could not develop into a fully mature monetary system; there is no evidence that those societies established a monetary system. Even in a medium-sized city, providing enough promissory notes to ensure that everyone can use such currency and smoothly complete most of their daily transactions would require millions of notes. To provide guarantees for all promissory notes, the amount of wealth Henry would need to possess would be unimaginable.#

Monetary nationalism is an economic theory and policy concept that emphasizes the sovereignty and independence of nations in monetary policy. It advocates that countries should formulate monetary policies based on their own economic conditions and needs, rather than relying on the international monetary system or the monetary policies of other countries.

National sovereignty: Emphasizes the independence of nations in currency issuance and management, asserting that nations have the right to control their own money supply and exchange rate policies.

Economic self-sufficiency: Advocates promoting domestic economic growth and employment through currency control, reducing dependence on external economic fluctuations.

Protectionism: Often combined with protectionist policies, supports protecting the domestic economy by limiting imports and enhancing export competitiveness.

Opposition to the international gold standard: Criticizes traditional gold standard or fixed exchange rate systems, arguing that these systems limit the flexibility of national monetary policies.

Historical background:
Monetary nationalism gained more attention during the economic crises and the Great Depression of the 20th century, as governments adopted more independent monetary policies to address economic challenges. Particularly after the global financial crisis, this idea was reintroduced to emphasize national autonomy in responding to economic risks.

Impact:
Monetary nationalism may lead to currency competition and trade friction between nations, affecting international economic relations. At the same time, it may also encourage countries to adopt more flexible and targeted measures in monetary policy to address specific economic challenges.

Why do they tax the public?#

This is not a question we often ask, as its answer seems self-evident. Governments require citizens to pay taxes because they want to lay claim to the wealth of the people. But if Smith is correct, that the natural operation of the market, completely independent of the government, can turn gold and silver into currency, then for the government, the most important and urgent action is to control the gold and silver mines. In this way, the king would possess all the wealth he needs. In fact, among ancient kings, this practice was quite common. If there were gold and silver mines within their territory, they would typically control these resources. Therefore, refining gold, marking the gold bars with someone's portrait, facilitating the circulation of currency among the people under someone's rule, and then demanding that these subjects return the gold through taxation—what is the significance of doing all this?

This is indeed puzzling. However, if currency and markets do not arise spontaneously, then everything makes sense. Because among the many ways to create a market, this is the simplest and most effective one.

For example, suppose there is a king who wishes to support an army of 50,000 men. In ancient or medieval times, maintaining such a force would face severe challenges. Unless these armies were already deployed, hiring nearly an equal number of laborers and beasts of burden to find, acquire, and transport the necessary supplies would be required. [Additionally, if simply distributing coins to soldiers and announcing that every household in the country is obligated to return those coins to the king, you would instantly turn your entire kingdom into a massive machine for supporting soldiers, as every household must find some way to provide the items needed by the soldiers in exchange for the coins they hold. The market, then, emerges as a byproduct of this process.

This is somewhat like the plot of an animated film, but the rapid growth of the market around ancient armies is a clear and undeniable fact. One only needs to look through Kautilya's "Arthashastra," the "Circle of Sovereignty" from the Sassanian period, or China's "Salt and Iron Debate" to find that many ancient kings spent considerable time pondering the interrelationships between mineral resources, soldiers, taxes, and food.

The Iron Chancellor#

The Chancellor of Prussia (later the Minister). He immediately took action to achieve German unification without compromising the movements for freedom and constitutional reform. The war with Denmark in 1864 allowed Prussia to seize Schleswig-Holstein and Lauenburg. The war with Austria in 1866 ended in a great victory for Prussia, leading to the formation of the North German Confederation under Prussian leadership. The war with France in 1870 was swift, culminating in the establishment of the German Empire in 1871.

An ambitious plan for political expansion and empire-building was immediately implemented, and the domestic economy rapidly developed. The gold standard was implemented in 1871. After a financial crisis in 1873 and the subsequent recession, the Reichsbank was established in 1876. It replaced nine currencies with one, helping stabilize the economy and making Berlin a leading financial center. A large network of banks grew, pushing out many old private banks, although savings banks, mortgage banks, and cooperative credit societies survived.

German industry experienced significant growth. Germany quickly surpassed France and Britain in steel production. The length of railways tripled from 1870 to 1914, and Germany's commercial fleet increased fivefold. The scale of Germany's foreign trade developed to nearly match that of Britain. Urbanization, industrialization, and growth rates were perhaps unprecedentedly concentrated in the last 30 years of the century. Nevertheless, the prices of German goods remained very stable, and in fact, they were on a downward trend until 1896, while national debt remained relatively moderate, and interest rates fell.

The financial history of the 19th century highlights two key years—1815 and 1870. After Napoleon I's defeat in 1815, Germany was reconstituted in its ancient form, with multiple independent nations, each a separate political and financial entity. After the defeat of Napoleon III in 1870, these city-states united for the first time to form a great nation, the German Empire, and thus shared a common political and financial history.

The social turmoil leading to the July Revolution of 1830 in Paris had an impact across Germany but was strongly suppressed without significant political change. However, the widely recognized desire for greater economic and political unity led to the establishment of the Customs Union under Prussian leadership. This was a tariff union of several German states aimed at overcoming the burdensome restrictions imposed by multiple tariffs.

The Rise of Financial Capital#

Financial capital is powerful, but once a financial war breaks out, the attacked country (or region) will mobilize the entire nation's (or region's) strength to retaliate. Therefore, financial wars do not occur at any time or place. Financial capital often waits for a favorable opportunity; when a country (or region) faces significant economic problems, it strikes swiftly to reap huge profits. An ironclad rule is: the more severe the economic problems a country (or region) faces, the higher the probability that financial capital will successfully attack; conversely, the less severe the economic problems, the lower the probability of a successful attack.

The inducing factor of financial wars is the bubble economy. A bubble economy refers to a false economic prosperity caused by excessive speculation. When people stir up a speculative frenzy over a certain physical or financial asset, the price of that asset tends to rise. Thus, for a period, speculation on that physical or financial asset can yield substantial profits.

For example, during the tulip speculation in the Netherlands from 1634 to 1637, the price of tulip bulbs reached 5,500 Dutch guilders, only to crash afterward, with similar bulbs dropping to 10% of their peak price. However, in modern economies, speculation on ordinary goods leading to bubble economies is rare; the most speculative physical and financial assets are real estate and stocks, with modern bubble economies often arising from excessive speculation in the real estate or stock markets.

The typical example of a modern bubble economy may be Japan in the late 20th century. In January 1986, the Nikkei average was 13,000 points. By September 1987, it had risen to 26,000 points. On October 19, 1987, global stock prices plummeted, marking "Black Monday." This was the second most severe stock price drop since the inception of stock trading. The first occurred in 1929, leading to unprecedented economic depression in Western developed countries. However, the pace of Japan's stock price increase was not halted. By 1988, the total market value of stocks exceeded 477 trillion yen, while Japan's GDP that year was only 387 trillion yen. On December 29, 1989, the Nikkei average reached its historical peak of 38,915.87 points, nearly three times that of 1986, with a price-to-earnings ratio of 70.6.

The price of stocks continued to rise. On April 2, 1990, the Nikkei average plummeted to 28,002.07 points, a 28.05% drop from the peak at the end of 1989. By October 1, 1990, the Nikkei average had fallen to 20,221.86 points, erasing over 270 trillion yen in market value. The decline in stock prices prompted domestic investors to sell off bonds and stocks, transferring funds overseas, leading to a chaotic situation in Japan's financial market, with simultaneous depreciation of stocks, bonds, and the yen. By autumn 1990, real estate prices also began to plummet. In this context, stock and real estate speculators could not repay loans from the Bank of Japan, leading to a rapid increase in non-performing assets. By 1995, the Bank of Japan's non-performing assets had reached $471 billion. Subsequently, several credit unions, commercial banks, and securities companies in Japan declared bankruptcy. Notably, in November 1997, four large financial institutions declared bankruptcy in just one month—Hokkaido Takushoku Bank, Tokai Bank, Sanyo Securities, and Yamaichi Securities.

The bankruptcy of Japanese financial institutions led to a contraction in credit, making it increasingly difficult for Japanese companies to operate. Additionally, the wealth effect from declining stock and real estate prices rapidly decreased consumer spending. In 1991, car sales in Japan experienced their first negative growth since 1981, and apartment sales dropped by 41.3% compared to the previous year, reaching their lowest level in 14 years. From 1991 to 2003, Japan fell into economic recession.

Inducing Mechanism#

If a country (or region) experiences a bubble economy, it is not due to mispricing of this or that financial asset, but rather that nearly all categories of financial assets are overpriced, making it easy to invite speculative attacks from financial capital. Since financial capital typically does not speculate on physical assets but primarily on financial assets, a bubble in a country's (or region's) stock market will provide financial capital with a clear opportunity to profit. Speculators can first sell a large number of stocks short to increase the supply in the stock market, driving down stock prices, expecting to repurchase the stocks at a lower price to profit from the difference.

Secondly, speculators will also sell stock index futures and stock index options in large quantities, betting on a decline in the stock price index with a small margin, thereby amplifying their existing capital advantage through financial leverage.

Finally, to further increase the downward pressure on the stock market, speculators often simultaneously attack other financial markets to create turmoil, undermining investor confidence and forcing them to sell their stocks. Given that a bubble economy already exists in that country (or region), it is nearly impossible for stock prices not to decline under such immense market pressure, indicating that financial capital has a high success rate.

International Balance of Payments Deficit#

In international economics, there is often an emphasis on the principle that a current account surplus is not necessarily a good thing, and a current account deficit is not necessarily a bad thing. Indeed, many examples can be cited to prove that a current account surplus is not necessarily beneficial, and a current account deficit is not necessarily detrimental.

For example, the United States has the most severe current account deficit in the world. In 2007, the U.S. current account deficit reached $731 billion. For the largest economy, trade, and financial power in the world, the trade deficit has brought significant benefits to the U.S. First, it has improved the actual standard of living in the U.S. The U.S. is a country with high wage levels; if labor-intensive daily consumer goods are produced in the U.S., prices will be high. The large export of cheap and high-quality daily consumer goods from developing countries not only enhances the living standards of American consumers but also suppresses inflation in the U.S. It is precisely these imports of foreign daily consumer goods that have greatly improved the welfare level in the U.S. Secondly, it has strengthened the U.S.'s capacity for sustainable development. The U.S. is a country rich in natural resources, but for so-called "national economic security" reasons, it does not extract much of its depleting natural resources domestically, opting instead to import large quantities from abroad. The imports of crude oil, raw coal, iron ore, and refined aluminum account for 26%, 23%, 25%, and 26% of the international market, respectively. Although the import of energy and raw materials results in a high current account deficit for the U.S., it protects domestic natural resources, allowing the U.S. to achieve greater sustainable development capacity. Thirdly, it is beneficial for the adjustment of the U.S. industrial structure. The U.S. is the country with the highest level of scientific and technological development, and to maintain its advantage in the field of science and technology, it needs to abandon labor-intensive industries and heavily polluting industries that are not advantageous to the U.S., focusing instead on developing technology-intensive industries and low-pollution, high-return service industries. Therefore, the U.S. imports a large number of labor-intensive products, resource-consuming products, and heavily polluting products while exporting technology-intensive products and services. This helps the U.S. adjust its industrial structure and maintain its technological advantage.

Finally, the U.S. gains export trade benefits from imports. The U.S. not only benefits from export trade but also from import trade. American multinational corporations hold a significant position among multinational companies worldwide, accounting for 40% of the total number of multinational corporations. A large portion of the imported goods in the U.S. is produced by American multinational corporations abroad and then sold back to the U.S. This means that American multinational corporations gain the benefits of exports to the U.S.

It should be noted that while the U.S. has a current account deficit, its capital account is in surplus. Many countries, including China, store their dollar reserves in the U.S. after obtaining them from trade surpluses, effectively financing the U.S. current account deficit. Even so, this conclusion is only valid within the acceptable current account deficit for the U.S. If the U.S. current account deficit becomes too large, it will also have adverse effects on the U.S. economy. While a current account surplus is not necessarily a good thing, a long-term current account deficit is undoubtedly a bad thing.

The inducing factor of financial wars is the current account deficit. The balance of payments records a country's foreign economic transactions, including the current account and capital and financial accounts. A current account deficit manifests when the foreign exchange income from the current account is less than the foreign exchange expenditure, which will impact the currency exchange rate of a country.

A country's currency exchange rate is the ratio at which it exchanges foreign currency. If a country's currency can exchange for more foreign currency, it is said to appreciate, while if it exchanges for less, it is said to depreciate. A country's currency exchange rate is determined by the demand and supply of that currency in the foreign exchange market. If the demand for that currency exceeds its supply, the currency will appreciate; conversely, it will depreciate.

Now we can relate the balance of payments to the supply and demand in the foreign exchange market. Since people need to convert foreign exchange income into their local currency, foreign exchange income will create demand for the local currency in the foreign exchange market. Conversely, when people spend foreign exchange, they need to buy foreign currency with their local currency, creating supply in the foreign exchange market. Therefore, when a country experiences a current account deficit, it will reflect in the foreign exchange market as the demand for the local currency being less than its supply, leading to depreciation of the local currency. Conversely, if the country has a current account surplus, its currency will appreciate.

In the real economy, a significant portion of the capital and financial account balance is caused by short-term capital flows. For example, when foreign banks lend to domestic companies, it results in foreign exchange income for the country. However, short-term capital flows are unstable; capital inflow leads to foreign exchange income, while outflow leads to foreign exchange expenditure. Therefore, the state of the current account has a significant impact on a country's currency exchange rate. In developing countries, if a current account deficit occurs, even if the capital account surplus exceeds the current account deficit, the overall balance of payments may show a surplus, but due to the potential for short-term capital to flow out of the country at any time, the local currency may still face depreciation pressure. Additionally, if a country has excessive external debt, the repayment of that debt may lead to a severe current account deficit in a short period. The government must use foreign exchange reserves to repay external debt, while companies must purchase foreign exchange in the foreign exchange market using local currency, ultimately relying on the government's foreign exchange reserves. If a country’s external debt burden is too heavy, the repayment of external debt will increase the demand for foreign exchange in the foreign exchange market and deplete the government's foreign exchange reserves. When the government’s foreign exchange reserves decrease to a certain extent, people will anticipate that the local currency exchange rate cannot be maintained and will decline, leading to turmoil in the foreign exchange market.

When a country or region experiences a current account deficit, it can lead to depreciation of the local currency. If a country or region experiences a severe current account deficit, it can result in significant depreciation of the local currency, providing favorable speculative opportunities for institutional investors. They can easily sell the local currency in the foreign exchange market and buy foreign currency, driving down the local currency exchange rate, and then repurchase more of the local currency with the foreign currency. This can lead to a large-scale speculative frenzy.

What is a Rigid Exchange Rate System?#

The inducing factor of financial wars is also a rigid exchange rate system. A rigid exchange rate system refers to a fixed exchange rate system. In the current international monetary system, a rigid exchange rate system mainly refers to a system that pegs the local currency to a single foreign currency or a basket of currencies.

A single currency peg means that a country (or region) selects a specific foreign currency and establishes a fixed exchange rate between its local currency and that foreign currency, maintaining this exchange rate. This means that if the foreign currency appreciates against other currencies, the local currency will also appreciate against other currencies, and vice versa.

A basket currency peg means that a country (or region) selects a group of currencies, determines their weights based on their importance, calculates the weighted average exchange rate of this group of currencies against a standard currency, and maintains a fixed exchange rate between its local currency and this weighted average. This means that if the weighted average increases, the local currency will appreciate; conversely, it will depreciate.

The existence of a rigid exchange rate system has its rationale. For example, Hong Kong has long implemented a peg to the U.S. dollar, allowing this highly open economy to achieve stability and rapid development. However, the problem with a rigid exchange rate system is that it loses the mechanism of exchange rate adjustment for external economic activities.

Under the current international monetary system and the domestic monetary system of a country (or region), if a country (or region) experiences a current account or balance of payments deficit, the main adjustment methods are as follows: borrowing funds from abroad, implementing restrictive trade policies, adopting contractionary fiscal and monetary policies, and adjusting the local currency exchange rate.

Among these four methods, borrowing funds from abroad does not eliminate the current account or balance of payments deficit; it merely uses foreign funds to maintain a superficial balance. Implementing restrictive trade policies, such as limiting imports and encouraging exports, not only violates World Trade Organization agreements but also risks retaliation from trading partners, making it an ineffective measure. Therefore, the primary methods for adjusting current account or balance of payments deficits are to implement contractionary fiscal and monetary policies and adjust the local currency exchange rate.

However, if a country (or region) adopts a fixed exchange rate system, it effectively relinquishes the effective mechanism of exchange rate adjustment for addressing current account or balance of payments deficits and can only rely on contractionary fiscal and monetary policies. However, theoretical research and practical experience indicate that macro fiscal and monetary policies are prone to conflicts between internal and external government objectives.

Suppose a country (or region) experiences inflation internally while facing a current account or balance of payments deficit externally. In that case, the government may adopt contractionary fiscal policies, such as reducing the money supply and raising interest rates, to curb overall social demand. These policies can simultaneously control inflation by reducing social demand while eliminating the current account or balance of payments deficit by decreasing imports and increasing capital inflows, allowing the government to achieve both internal and external objectives.

However, if a country (or region) experiences economic stagnation internally while facing a current account or balance of payments deficit externally, the government’s contractionary fiscal and monetary policies may alleviate the current account or balance of payments deficit but exacerbate internal economic stagnation. Conversely, if the government adopts expansionary fiscal and monetary policies to alleviate internal economic stagnation, it may worsen the current account or balance of payments deficit. In this case, the government’s internal and external objectives will conflict.

It should be noted that a country (or region) implementing a fixed exchange rate system not only fails to utilize the exchange rate to adjust current account or balance of payments deficits but may, in some cases, worsen the current account or balance of payments deficit. If a country (or region) pegs its currency to the U.S. dollar and experiences a current account or balance of payments deficit while the dollar continues to appreciate, the local currency will also appreciate according to the fixed exchange rate system, thus worsening the current account or balance of payments deficit.

Inducing Mechanism#

Under a fixed exchange rate system, the economy of a country (or region) pegged to a currency will frequently experience overvaluation or undervaluation of its currency due to the inherent economic discrepancies between the pegged currency's issuing country and the pegging country. This situation easily provides speculative opportunities for institutional investors, inducing large-scale speculative frenzies.

For example, suppose a country (or region) with a pegged exchange rate system experiences a current account deficit; its currency should depreciate. However, if the currency it is pegged to experiences a current account surplus and appreciates, the pegged currency cannot depreciate and must instead appreciate, leading to overvaluation of the pegged currency. This means that the local currency is worth less foreign exchange than it should be, as it is artificially maintained at a higher value.

Conversely, if a country (or region) with a pegged exchange rate system experiences a current account surplus, its currency should appreciate. However, if the pegged currency experiences a current account deficit and depreciates, the pegged currency cannot appreciate and must instead depreciate, leading to undervaluation of the pegged currency. This indicates that the local currency should be worth more foreign exchange than it is currently valued at, as it is artificially maintained at a lower value.

This situation illustrates that the stable operation of a pegged exchange rate system requires that the economy of the pegging country (or region) synchronously changes with the economy of the pegged currency's issuing country, a condition that can only exist in small, open economies that are highly flexible and can adapt to changes in the pegged currency's economy.

Achieving complete synchronization with the economy of the pegged currency's issuing country is impossible. Once a pegged currency experiences overvaluation or undervaluation, especially undervaluation, speculators may sell the local currency en masse. According to the pegged exchange rate system, the currency authority of that country or region must use foreign exchange reserves to buy back the local currency. If the local currency is ultimately destined to depreciate, it effectively becomes a "cash machine" for speculators.

These financial crises or financial frenzies include: the 1992 British pound crisis, the 1994 Mexican peso crisis, the 1997 Thai financial crisis, the 1997 Hong Kong financial frenzy, the 1998 Hong Kong financial frenzy, and the 2001 Argentine financial crisis.

The UK was a member of the European Monetary System, implementing a joint floating exchange rate system with other member countries, fixing their currencies against each other while allowing them to float against non-member currencies. In the early 1990s, due to lower interest rates in the UK compared to higher rates in Germany, large amounts of capital flowed from the UK to Germany, creating downward pressure on the pound. Speculators seized this opportunity to launch a speculative frenzy in the UK foreign exchange market. Despite the German government lowering the mark's interest rate and the UK government significantly raising the pound's interest rate, as well as the Bank of England using foreign exchange reserves to buy pounds, the speculative frenzy could not be contained. On September 16, 1992, the UK Chancellor of the Exchequer was forced to announce the UK's exit from the European Monetary System, leading to a significant depreciation of the pound.

Mexico implemented a fixed exchange rate system pegging the peso to the dollar, allowing the peso to float with the dollar against other currencies. In the mid-1990s, Mexico experienced a current account deficit, and the banking system became unstable due to high levels of bad debts. Under the influence of speculative attacks and massive capital outflows, the Mexican central bank was forced to abandon the fixed exchange rate system on December 22, 1994, leading to the peso crisis.

Thailand operated a fixed exchange rate system pegging the baht to a basket of currencies, adjusting the baht's exchange rate according to the weighted average of this basket. Due to the significant role of the dollar in this basket, the baht's exchange rate was effectively influenced by the dollar. In the mid-1990s, Thailand experienced a current account deficit, and with the collapse of the bubble economy, speculators launched a large-scale speculative frenzy in Thailand. The Thai central bank, unable to counter the speculators, was forced to abandon the fixed exchange rate system on July 2, 1997, allowing the baht to float freely, which led to a financial crisis in Thailand.

A country or region's choice of exchange rate system must consider multiple factors. The above analysis merely indicates that from the perspective of speculative attacks by international financial capital, a flexible floating exchange rate system is a better choice. If a country or region believes that the benefits of a fixed exchange rate system, such as enhancing the status of its currency or strengthening economic ties with the pegged currency country, outweigh the potential losses from speculative attacks, it may still choose to adopt a fixed exchange rate system. However, regardless of the chosen exchange rate system, how to prevent speculative attacks from financial capital is a crucial factor in determining the exchange rate system.

Note: [Barton Biggs, "Hedge Fund Chronicles II," Zhang Hua, et al. Translated. Beijing: CITIC Press, 2012. Gregory Zuckerman, "The Greatest Trade Ever," Shi Yi, Translated. Beijing: Renmin University Press, 2010. Li Chong, "Financial Warfare: The Way of Wealth Plunder in the Era of Virtual Economy," Beijing: Capital University of Economics and Business Press, 2009. Yang Weilong, "The Great Collapse," Shantou: Shantou University Press, 2008. Yu Yang, "Chaos on Wall Street," Beijing: Renmin University Press, 2011.