iBusiness, 2011, 3, 76-87
doi:10.4236/ib.2011.31013 Published Online March 2011 (http://www.SciRP.org/journal/ib)
Copyright © 2011 SciRes. iB
The Fundamental Principle of Conservation of
Physical Money: Its Violation and the Global
Financial System Collapse
Murad Al-Shibli
Mechan ical Engi neering Department, C ollege of Engineering, U nited Arab Emirates Universit y, Al Ain, United Arab Emirates.
Email: malshibli@uaeu.ac.ae
Received December 8th, 2010; revised January 17th, 2011; accept ed Janu ar y 17th, 2011.
Over the last two years the world has witnessed a financial tsunami that rocked the global financial systems. This paper
presents the fundamental principle of conservation of physical money of the global financial system that guarantees its
equilibrium and stability. Similar to the princ iple of conservatio n of mass-energy systems and based on the commodity
money concept, then the physical money cannot be created from nullity nor can be destroyed. As a result, violation of
such a system will lead to a deficit in the financial system which cannot be paid off. Additionally, violation of gold
standard and the breakage of the Bretton Woods system are the reason behind the current world financial crisis. Paying
non-zero interest on money loans will violate this principle as well. The international banking system is volatile and
over-valued since it is based on the fractional banking technique that banks do not actually need to have the money to
back up the deposits their clients have made into their accounts. Instead, the banks are required only to keep a small
fraction of such deposits on hand. The world Todays reserves wealth of Gold, Silver and Copper is estimated by 8.63
Trillion US$ compared to 4.3 Trillion US$ in Currencies. Moreover The Bank of International Settlements (BIS) in
Switzerland has recently reported that global outstanding derivatives have reached 1.14 quadrillion dollars: $548 Tril-
lion in listed credit derivatives plus $596 trillion in notiona l O TC d e rivatives. Furthermore, by 2007 credit default swap
total value has dramatically increased to an estimated $45 trillion to $62 trillion. Subprime mortgage crisis, credit cri-
sis and banking closure all have resulted from the violation of conservation money. Taking into the account that the
Wo rl d s GD Ps for all nations is approximately $50 trillion and all of the asset valu e of the world is only $190 Trillion,
it can be seen easily that the over-valued $1140 trillion financial d erivatives wil l lead in the n ear future to the colla pse
of the international financial system similar to Iceland, Greece, Ireland crises and potentially in Spain, Portugal, and
Keywords: Conservation of Money, Fiat Money, Commodity Money, Gold St and ar d, Fractional Banking, Financial
Derivatives, Credit Default Swap, Ponzi Scheme, Iceland Cri sis, Greece Crisis
1. Introduction
In the last two years world has exposed to a financial
tsunami waves that rocked the financial systems and na-
tions all over the world. Many international banks and
companies have bankrupted, nations has sank into a se-
vere debts obligations. Layoff has almost cracked all
sectors, millions of home mortgage have been closed,
and millions of individuals had claimed bankruptcy.
What a financial crisis has the Globe witnessed! What
are the major reasons have caused it? This paper intro-
duces the fundamental principle of conservation of phys-
ical money of the global financial system. Based on the
commodity money concept, the physical money cannot
be created from null nor can be destroyed. Violation of
such a system wi ll le a d to a deficit in the financial system
which cannot be paid off. The cha nge in the net physic al
money in a financial system is equal to the amount of
money transferred to the system (gained) minus the
amount transferred out of it (lost). In other words, the
law of conservation of money can be stated that the
change in your current balance must be equal to the dif-
ference between the credits to your account and the de-
bits to it. For this reason paying interest on money loans
will violate this principle as well.
Additionally, violation of standard gold and the brea-
The Fundamental Principle of Conservation of Physical Money: Its Violation and the Global Financial System Co llapse
Copyright © 2011 SciRes. iB
kage of the Bretton Woods system are the reason behind
the current world financial crisis. The international
banking system is volatile since it is based on the frac-
tional banking technique which means that banks do not
actua lly have t he mone y to ba ck t he de po sits t heir clie nts
have made into their accounts. Instead, the banks are
required only to keep a small fraction of such deposits on
hand. Moreover, data on the five-fold growth of deriva-
tives to $1140 trillion in five years comes from the most
rec ent surve y by the Bank o f Inter natio nal Settlements in
Switzerland. Additionally, subprime mortgage crisis,
credit crisis and banking system run all have resulted
from the violation of conservation money. Taking into
the account that the Worlds GDPs for all nations is ap-
proximately $50 trillion, it can be seen easily that the
$1140 trillion financial derivatives system will lead into
the collapse of the internation a l financial system.
This paper is organized as follows, in Section 2, basic
definitions of money and standard gold are presented.
Section 3 introduced the principle of conservation of
money. Meanwhile, fractional banking system is de-
scribed in Section 4, then Madoff (Ponzi) scheme is pre-
sented in Section 5. Section 6 shows how the financial
derivatives are overvalued, in Section 7 credit default
swap explained. Section 8 gives summarizes the mort-
gage crisis. Banking closures and US debt challenge are
detailed in Sections 4 and 5, respectively. Greece and
Iceland crises are discussed in Sections 6 and 7, respec-
tively. Finally conclusions and recommendations are
2. Money and Gold Standard
Money can be defined as is anything that is generally
accepted as a payment for goods and services and re-
payment of debts. The main functions of money are dis-
tinguished as: a medium of exchange, a unit of account, a
store of value, and occasionally, a standard of deferred
payment. In 1875, economist William Stanley Jevons
described what he called representative money as money
that consists of token coins, or other physical tokens such
as certificates, that can be reliably exchanged for a fixed
quantity of a commodity such a s gold or si l ver. The value
of representative money stands in direct and fixed rela-
tion to the commodity that backs it, while not itself being
composed of that commodity. Money originated as
commodity money, but nearly all contemporary money
systems are based on fiat money [1,2].
2.1. Commodity Money
Commodity money is money whose value comes from a
commodity out of which it is made [3]. It is objects that
have value in themselves as well as for use as money.
Examples of commodities that have been used as me-
diums of exchange include gold, silver, copper, salt. The
system of commodity money eventually evolved into a
system of representative money. This occurred because
gold and silver merchants or banks would issue receipts
to their depositors redeemable for the commodity
money deposited. Eventually, these receipts became
generally accepted as a means of payment and were used
as money. The gold standard, a monetary system where
the medium of exchange are paper notes that are con-
vertible into pr e-set, fixed qua ntities o f gold , re place d the
use of gold coins as currency in the 17th-19th centuries
in Europe. These gold standard notes were made legal
tender, and redemption into gold coins was discouraged.
By the beginni ng o f the 20t h centur y almo st all co untrie s
had adopted the gold standard, backing their legal tender
notes with fixed amounts of gold.
2.2. Fiat Money
Fiat money is without value as a physical commodity,
and derives its value by being declared by a government
to be legal tender; that is, it must be accepted as a form
of pa yment wi thin the b ounda ries of the c ountry, for “all
debts, public and private. Fiat money or fiat c urrenc y is
money whose value is not derived from any intrinsic
value or guarantee that it can be converted into a valua-
ble commodity such as gold. Instead, it has value only by
government order (fiat). Usually, the government dec-
lares the fiat currency (typically notes and coins from a
central bank, such as the Federal Reserve System in the
U.S.) to b e legal tender, making it unla wful to not accept
the fiat currency as a means of repayment for all debts,
public and private [4].
2.3. Gold Standard
Gold Standard: prior to and during most of the 1800s,
international trade was denominated in terms of curren-
cies that represented weights of gold. Most national cur-
rencies at the time were in essence merely different ways
of measuring gold weights (much as the yard and the
meter both measure length and are related by a constant
conversion factor). Hence some assert that gold was the
world’s first global currency. The emerging collapse of
the international gold standard around the time of World
War I had significant implications for global tr a de.
Not such a long time ago paper receipts for gold in
storage were used as currency, and people would trade
these receipts because it was more convenient than car-
rying around a lot of gold. Over time, those who held the
gold and issued the receipts noticed that physical gold was
seldom claimed even thought the receipts changed hands
several times. The temptation to issue more receipts than
the gold in storage became too large to resist, and frac-
tional banking was invented. This allowed the issuers to
78 The Fundamental Principle of Conservation of Physical Money: Its Violation and the Global Financial System Collapse
Copyright © 2011 SciRes. iB
charge interest and increase the amount of currency in
The scheme would work as long as everyone did not
claim his or her gold at the same time. Those issuers (or
later, banks) who egregiously abused the system suffered
from bank-runs, in which receipt holders claimed their
gold. Since there was not enough gold to cover all the
outstanding receipts, only the first folks through the door
would get any gold .
The system was based on the faith the public had in the
gold receipts, with all issuers not being equal. So instead
of the most conservative extreme of a gold standard
without the ability of debt creation, lets consider what
would happen if we accepted fractional banking, but just
took away governmentsright to seigniorage. If we add
together all the currency in circulation (notes and coins)
in the US, Japan, China, Britain, Canada, Russia, Austra-
lia and the European Union, converted to US dollars for
simplicity, we arrive at $2.6 trillion. These countries rep-
resent roughly 80% of the worlds GDP so by extrapola-
tion we can estimate that all the currency in circulation in
the world today is approximately $3.25 trillion.
Total historical gold production is about 5 billion
ounces and most of it is still aro und. If all the gold in the
world were converted to money to replace existing notes
and coins, it would imply a gold price of $650 an ounce.
Bac k in the 19 40 s the U nited States alone held about one
third of all the gold in the world and two thirds of the
offici a l r es er ve s ( go ld hel d b y go ver n me nt s). At t he t i me,
governments held approximately 50% of all the gold. If
we assume that only half the gold in the world could be
converted into money then it would imply a gold price of
$1,300 an ounce. The emerging collapse of the interna-
tional gold standard around the time of World War I had
significant implications for global tra de.
2.4. Bretton Woods System
In the period following the Bretton Woods Conference of
1944, exchange rates around the world were pegged
against the United States dollar, which could be ex-
changed for a fixed amount of gold. This reinforced the
dominance of the US dollar as a global currency. The
Bretton Woods system of monetary management estab-
lished the rules for commercial and financial relations
among the worlds major industrial states i n the mid 20th
centur y. The chief feature s of the Bretton Woods system
were an obligation for each country to adopt a monetary
policy that maintained the exchange rate of its currency
within a fixed value in terms of gold and the ability of the
IMF to bridge temporary imbalances of payments [5].
2.5. Nixon Shock
Since the collapse of the fixed exchange rate regime and
the gol d stand ard a nd the in stitut ion o f floati ng excha nge
rates following the Smithsonian Agreement in 1971, most
currencies around the world have no longer been pegged
against the United States dollar. However, as the United
States remained the world’s preeminent economic su-
perpower, most international transactions continued to be
conducted with the United States dollar, and it has re-
mained the de facto world currency.
Then, on August 15,1971 the United States unilaterally
terminated convertibility of t he dollar to gold. This actio n
created the situation whereby the United States dollar
became the sole backing of currencies and a reserve cur-
rency for the member states. In the face of increasing
financial strai n, the syste m collap sed in 197 1. The Nixon
Shock was a series of economic measures taken by U.S.
President Richard Nixon in 1971 including unilaterally
canceling the direct convertibility of the United States
dollar to gold that essentially ended the existing Bretton
Woods system of international financial exchange. Be-
cause of the excess printed dollars, and the negative U.S.
trade balance, other nations began demanding fulfillment
of America’s “promise to pay” - that is, the redemption
of their dollars for gold [6].
Switzerland redeemed $50 million of paper for gold in
July. France, in particular, repeatedly made aggressive
demands, and acquired $191 million in gold, further
depleting the gold reserves of the U.S. In May 1971, in-
flation-wary West Germany was the first member coun-
try to leave the Bretton Woods system unwilling to def-
late the Deutsche Mark to prop up the dollar Still Swit-
zerland withdrew the Swiss franc from the Bretton
Woods system.
2.6. Calls for New International Supernational
Nowadays, many of the world’s currencies are pegged
against the dollar. Some countries, such as Ecuador, El
Salvador, and Panama, have gone even further and elim-
inated their own currency (see dollarization) in favor of
the United States dollar. The dollar continues to domi-
nate gl ob al currency reserves, with 63.9% held in dollars,
as compared to 26.5% held in euros.
On March 16, 2009, in connection with the April 2009
G20 summit, the Kremlin called for a supranational re-
serve currency as part of a reform of the global financial
system. On March 24, 2009 Peoples Bank of China,
called for creative reform of the existing international
monetary system towards an international reserve cur-
ren cy, ” believing it would significantly reduce the risks of
a future crisis and enhance crisis manage ment c apab ility.
It is suggested that the IMFs Special Drawing Ri ghts (a
currency basket comprising dollars, euros, yen, and ster-
ling) could serve as a super-sovereign reserve currency [7].
The Fundamental Principle of Conservation of Physical Money: Its Violation and the Global Financial System Co llapse
Copyright © 2011 SciRes. iB
Figure 1 shows the most d ominant c urrencies.
Indeed, on March 26, 2009, a UN panel c alled f or a n ew
global currency reserve scheme which with “greatly ex-
panded SDR (Special Drawing Rights), with regular or
cyclically adjusted emissions calibrated to the size of
reserve accumulations, and could contribute to global
stability, economic strength and global equity [8]. On
March 30, 2009, at the Second South America-Arab
League Summit in Qatar, Venezuelan President Hugo
Chavez proposed the creation of the Petro as a suprana-
tional currency, in order to face the instability that the
generation of fiat currency has caused in the world
economy. The petro-currency would be backed by the
huge oil reserves of the oil producing countries [9].
2.7. Global Metalic Commodity Reserves
The silver standard is a monetary system in which the
standard economic unit of account is a fixed weight of
silver. The silver specie standard was widespread from
the fall of the Byzantine Empire until the 19th century.
The total silver reserve is estimated by 569000 tons.
Considering the latest price of silver as 25 US$/Ounce,
then the world wealth of silver is approximately 500 Bil-
lion US$ (0.5 Trillion). It has been estimated that all the
gold mined by the end of 2009 totaled 165,000 tonnes.
At a price of US$1300/oz just recently, one tonne of gold
has a value of approximately US$45.87 million. The total
value of all gold ever mined would exceed US$7.57 Tril-
lion at that valuat io n [10]. A gold reserve is the gold held
by a central bank or nation intended as a store of value
and as a guarantee to redeem promises to pay depositors,
note holders (paper money), or trading peers, or to secure
a currency. At the end of 2004, central banks and in-
vestment funds held 19% of all above-ground gold as
bank reserve assets. Iro n total reserve is 7 30 billion tons.
Copper total r eserve is 2 b illion tons. Zinc tota l reser ve is
1.6 billion tons. Lead total reserve is 1.4 billion tons by
US Geological Sur ve y, Mineral Co mmoditie s Summarie s
2006 [11]. The total copper wealth is estimated by 561
Billion US$ (0.561 Trillion US$). Tabl e 1 lists the global
metallic reserves.
Figure 1 . World domi na ting currencies.
Table 1. Global commodity reserves [12].
Reserves Tonnes
Year Supplies left
32 350 M
1027 years
Arseni c
1 M
20 years
3.86 M
30 years
1.6 M
70 years
779 M
143 years
937 M
61 years
1000-1500 M
5-8 years
500 0 00
5 yea rs
Gol d
89 700
45 years
20 years
13 years
144 M
42 years
143 M
90 years
49 750 M
345 years
79 840
360 years
170 0 00
120 years
569 0 00
29 years
153 0 00
116 years
650 0 00
65 years
11.2 M
40 years
3.3 M
59 years
Zin c
460 M
46 years
3. Fractional Banking System
The banki ng s yste m is c all ed a frac tiona l ba nki ng s ystem
because banks do not actually have the money to back the
deposits their clients have made into their accounts. In-
stead, the banks are required only to keep a small fractio n
of suc h depo sits on hand. When so methi ng with in herent
value, such as gold, is used for money banks often go
bankr upt und er a fract iona l ba nki ng s yste m si nce t he y do
not have sufficient reserves to repay their depositors’
money. However, in a fractional banking system based on
fiat money banks need ne ver go bankrupt, since the ce n-
tral bank can create an unl imited amount of new money to
repay any dem ands from deposi tors . The lim it ing fact or is
only the public’s acceptance of fiat money.
In the absence of a fractional banking system all the
money in the system is physical money, such as notes and
coins. We would know at all times exactly what the
money suppl y is: it is the total o f all the notes and co ins.
We would also know exactly what the inflation rate is: it is
the rate at which the total amount of notes and coins in-
creases. In such a system inflation can only occur by the
creation of more physical notes and coins, whether it is
fiat money or hard money, such as gold. However, in a
fractional banking system defining what constitutes the
money suppl y is not so simple , which is why it is s uch an
enigma and why the real inflat ion rate is so obscure. Whi le
central banks can influence the money supply directly,
most of the money that is created is actually created by
commercial banks when they make loans to borrowers.
It is because our finan cial system is based on something
called fractional reserve banking. When you go over to
your local bank and deposit $100, they do not keep your
$100 in th e bank. Instead, they keep only a small fracti on
US Dollar
2.8 1.1 0.4
Dom inated W or ld Curre ncy 2008
80 The Fundamental Principle of Conservation of Physical Money: Its Violation and the Global Financial System Collapse
Copyright © 2011 SciRes. iB
of your mo ney there a t the b ank and they lend out the rest
to so meo ne else. T hen, if that perso n deposits t he mone y
that was just borrowed at the same bank, that bank can
loan o ut most o f that mone y onc e aga in. In t his wa y, th e
amount of mo neyq uickly gets multiplied. But in re al-
ity, only $100 actually exists. The system works because
we do not all run down to t he b ank a nd d e mand a ll o f o ur
money at the same time.
4. Principle of Conservation of Physical
Based on the former analysis, it can be seen that all
commo dity mone y has fi xed r eserve s and c onser ved. For
example the total world reserves of gold is 165000
tonnes. Meanwhile, reserve is 520000 tonnes. Since this
commodity money is conserved then applying an i ntere st
rate on a given metal of the same entity will violate the
pri ncip l e o f p hys ica l mo ne y co nse r vati o n. As a n e xample ,
assume that the total amount of gold is
then imple-
menting an interest rate of 3% gold on that quantity
implies that
1 03.Q
with an extra amount of
needed that the system cannot provide since the system
has only quanti ty
Assume now the overall financial fiat system
composed of
financ ia l s ub -system
, ,
F, then
F FFFFconst.=++++=
Let us consider that all subsystems are involved in a
simple annual interest rate investment of 5% for a period
of time of 1 year, then the future c a pital would be
( )
11 05
FFit. F= +=
It yields that the system shall provide
with 5% extra money out of its capacity, where the sys-
tem can supply only F fiat money. This fundamentally
violates the conservation of physical money. For genera-
lization let us take the rate of change (time-derivative) o f
the simple inter e st equation
dF dF dconst.
dt dtdt
= +==
Since both
are conserved and their cor-
responding derivatives are zeros, yields that
. So
for any physical money, zero interest should be enforced.
This paper presents the fundamental principle that the
financial system must be based on so as to keep it in an
equilibrium state. The change in the net physical money
in a financial system is equal to the amount of money
transferred to the system (gained) minus the amount
transferred out of it (lost). In other words, the law of
conservation of money can be stated that the change in
your current balance must be equal to the difference be-
t ween the credits to your account and the debits to it.
Based on this principle it can easily be seen that paying
(or taking) intere st on mo ney loa ns will definitel y violate
such a funda mental principle.
Every single financial transaction on your account
must obey this law, which is the fundamental law of ac-
countancy and book keeping. This is based on the fact
that money is discrete and countable. Every physical
transaction obeys the law of conservation of mass-energy
principle and presents the fundamental law of bookkeep-
ing in nature. For any global financial system the gross
physical money is conserved and equal to the sum of all
sub-systems amounts. For a global human financial sys-
tem, the physical money cannot be created from null nor
can be destroyed. Violation of such a system will lead to
a deficit in the fina ncial syste m which cannot be p a id off.
5. Maddof (Ponzi) Scheme
A Ponzi scheme is a fraudulent investment operation
that pays returns to separate investors from their own
money or money paid by subsequent investors, rather
than from any actual profit earned [13]. The Ponzi
scheme usuall y entices ne w investors b y offering retur ns
other investments cannot guarantee, in the form of
short-term returns that are either abnormally high or un-
usually consistent. The system is destined to collapse
because the earnings, if any, are less than the payments
to investors. While the system eventually will collapse
under its own weight, the example of Bernard Madoff
illustrates the ability of a Ponzi scheme to delude both
individual a nd institutional investors as well as sec urities
authorities for long periods: Madoffs variant o f the P on-
zi Scheme stands a s t he l ar ge s t fi nanc i al i nve st or fr aud i n
history committed by a single person. Prosecutors esti-
mate losses at Madoff’s hand totaling $64.8 billion.
6. The 1140 Trillion Financial Derivatives
Today there is a horrific derivatives bubble that threatens
to destr oy not only the U.S . economy but the entire world
financial s ystem as well. Basicall y, derivatives are finan-
cial instruments whose values depend upon or is derived
from the price of something else. A derivative has no
underlying value of its own. Moreover, both the hedge-
fund and the derivatives markets are almost totally unre-
gulated, either by the U.S. government or by any other
government worldwide and in recent years it has bal-
looned t o su ch en ormous propor tion s t hat it is almos t hard
to believe. Today, the worldwide derivatives market is
approximately 80 times the size of the entire global
economy. Well, the truth is that the danger that we face
from derivatives is so great that Warren Buffet has called
them “financial weapons of mass destruction”.
What had happened is that a subsidiary of AIG had lost
more than $18 billion on Credit Default Swaps (deriva-
The Fundamental Principle of Conservation of Physical Money: Its Violation and the Global Financial System Co llapse
Copyright © 2011 SciRes. iB
tives) it had written, and additional losses from derivatives
were on the way which could have caused the complete
collapse of the insurance giant. So the U.S. government
stepped in and bailed them out - all at U.S. taxpayer ex-
pense of course. But the AIG incident was actually quite
small compared to what could be com ing. The derivativ es
market has become so monolithic that even a relatively
minor imbalance in the global economy could set off a
chain reac tion that woul d have devastating consequences.
A derivative is a financial instrument whose value de-
pends on something else such as a share of stock, an in-
terest rate, a foreign currency, or a barrel of oil, for example.
One kind of derivative might be a contract that allo ws you
to b uy o il a t a give n pr ice si x mo nt hs fro m no w. B ut si nce
we dont yet know how the price of oil will change, the
value of that contract can be very hard to estimate. One
method simply adds up the value of the assets the deriva-
tives are based on. In other words, if my contract allows me
to buy 50 barrels of oil and the current price is $100, its
notiona l val ue” is said to be $5,000. Si nce th at’s the value
of the assets from which my contract derives. The notional
value of the worlds over-the-counter derivatives at the
end of 2007, according to the Bank of International Set-
tlements is around $1140 trillion. Over the counter deriva-
tives refer to contracts that are negotiated between two
parties rather than through an exchange.
But the notional value is not usually a very good re-
presentation of what a contract might really be worth to
the parties involved, or how much risk they are taking.
And it isn’t easily compared with other measures of fi-
nancial wealth - after all, owning the right to buy $5 000
worth of oil isn’t the same as actually owning $5 000 of
oil. Within that $596 trillion there are derivatives that
effectively relate to the same assets [14]. For example, if
you have a contract to buy Euros in January and I have one
to buy Euros in April, we may end up buying the same
currency, but its notional value will get cou nted twice.
The Ba nk of International Sett lements, which seems to
be the only institution that tracks the derivatives market,
has recently reported that global outstanding derivatives
have reached 1.14 quadrillion dollars: $548 trillion in
listed credit derivatives plus $596 trillion in notional
(over-the-counter) OTC derivatives. Figures 2 and 3
show the notional OTC derivatives, gross market value
of the OTC derivatives, respectively. Two thirds of con-
tracts b y volume or $3 93 trillion fell into the categor y of
interest rate derivatives. Credit Default Swaps had a no-
tional volume of $58 trillion, seeing the sharpest relative
increase after a volume of $43 trillion a year earlier.
Currency derivatives reached a volume of $56 trillion.
Figures 4 and 5 displa y the notional OTC derivatives of
foreign exchange and gross market value OTC foreign
exchange, respectively. Unallocated derivatives with a
notional amount of $71 trillion. Data on the five-fold
growth of derivatives to $596 trillion in five years grew
into a massive bubble comes from about $100 trillion to
$596 trillion by 2007.
Over-the-counter (OTC) derivatives are contracts that
are traded (and privately n egotiated) directly between two
parties, without going through an exchange or other in-
termediary. Products such as swaps, forward rate agree-
ment s, and exotic options are a lmost always trade d in this
way. The OTC derivative market is the largest market for
derivatives, and is largely unregulated with respect to
disclosure of information between the parties, since the
OTC market is made up of banks and other hi ghl y sophi-
sticated parties, such as hedge funds. Reporting of OTC
amounts are difficult because trades can occur i n pri vate,
Figure 2 . Notional over-th e-co unter deri vativ es (Trillion US$) esti mated by BIS.
Total contracts
Foreign …
Forwards and …
Currency swaps
Interest rate …
Forward rate …
Interest rate swaps
Equity-linked …
Forwards and …
Commodity …
Other commodities
Forwards and …
Credit default …
Single-name …
Multi-name …
OTC Notional Der ivatives Amounts O utstanding (Billion US$): Dec 2009
82 The Fundamental Principle of Conservation of Physical Money: Its Violation and the Global Financial System Collapse
Copyright © 2011 SciRes. iB
Figure 3 . Gross market value over-the-counter d erivative s (Trillion US$) estimated by BIS.
Figure 4 . Notional over-the-counter derivatives of forei gn exchange (trillion us$) estimated by BIS.
without activity being visible on any exchange. According
to the Bank for International Settlements, the total out-
standing notional amount is $684 trilli on (as of Ju ne 2008) .
Of this total notional amount, 67% are interest rate con-
tracts, 8% are credit default swaps (CDS), 9% are foreign
exchange contracts, 2% are commodity contracts, 1% are
equity contracts, and 12% are other. Because OTC deriv-
atives are not traded on an exchange, there is no central
The new derivatives bubble was fueled by five key
econo mic and po litic a l trends:
Increased corporate disclosures.
Federal Reserves cheap money policies created the
subprime-housing boom.
Total contracts
Foreign exchange
Forwards and forex
Currency swaps
Interest rate contracts
Forward rate
Interest rate swaps
Forwards and swaps
Commodity contracts
Other commodities
Credit default swaps
Memorandum Item:
Gross Credit Exposure
OTC Derivatives: Gross Market Values (Billion US$): Dec. 2009
Notional Amounts Outstanding of OTC Foreign Exchange Derivatives (Billion US$):
Dec. 2009
The Fundamental Principle of Conservation of Physical Money: Its Violation and the GlobalFinancial System Collapse
Copyright © 2011 SciRes. iB
Figure 5 . Gross market value over-the-counter d erivatives (Trillion US$) estimated by BIS.
Figure 6 . Total US derivatives and US wealth compared to total world wealth in year 2007.
War budget s burde ned the U.S. Tre asury and futur e
entitlements pr ograms.
Trade deficits with China and others destroyed the
value of the U.S. dollar.
Oil and commodity rich nations demanding equity
payments r ather than debt.
To grasp how si gnifica nt this five-fold bubble increase
is, lets put that $516 trillion in the context of some other
domestic and international monetary data (See Figure 6
and Ta b l e 2):
U.S. annual gro ss d omestic product is $15 tr illion.
U.S. money supply is also about $15 trillion.
Current proposed U.S. federal budget is $3 trillion.
U.S. government’s maximum legal debt is $9 trilli on.
U.S. mutual fund companies a bout $12 tr illion.
World’s GDP s for a ll nations is almost $50 trillion.
Unfunded Social Security and Medicare benefits
$50 tr illion to $65 trillion.
Total value of the world s real estate is estimated at
about $7 5 trillion.
Total value of worlds stock and bond markets is
more than $100 trillion.
BIS valuation of worlds derivatives back in 2002
was about $100 trillion.
BIS 2007 valuation of the worlds derivatives is
now a whopping $596 trillion.
7. Credit Default Swap Crisis
A credit default swap (CDS) is a swap contract in whic h
the buyer of the CDS makes a series of payments to the
seller and, in exchange, receives a payoff if a credit in-
strument (typically a bond or loan) undergoes a defined
Gross Market Values
of OTC Foreign Exchange Derivatives
(Billion US$): Dec 2009
Derivative in US Banks US Net WorthTotal World Wealth
Global Finacial
170 58 164
Comparsion of Global Wealth and Global Finacial Derivatives (Billion US$)
84 The Fundamental Principle of Conservation of Physical Money: Its Violation and the Global Financial System Collapse
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Table 2. Economy of the world [15].
(Feb 11, 20 1 0)
GDP (PPP) US$70.21 trillion (2009 )
GDP (Currency) $58.07 trillion (2009 )
GDP/capita (PPP)
GDP/capita (Currency) $7,178
Annual growth of
per capita GDP (PPP) -0.8% (2009 est .)
People Paid Below $2 per day 3.25 billion ( ~50%)
Millionaires (US$) 9 million i.e. 0. 15% (2006 )
Billionaires (US$)
793 (2009)
“Credit Event, often described as a default (fails to pay).
However the contract ty pically construes a Credit Event as
being not only Failure to Paybut also can be triggered
by the “Reference Credit” undergoing restructuring, bank-
ruptcy, or even by having its credit rating downgraded.
Credit default swaps may be used for emerging market
bonds, mortgage backed securities, corporate bonds and
local government bond [16,17].
The first credit default swap was introduced in 1995 by
JP Morgan. By 2007, their total value has increased to an
estimated $ 45 trillion to $62 trillion. Altho ugh since only
0.2% of investment companies default, the cash flow is
much lo wer than this act ual amount. J.P. Morgan contin-
ues to dom inate the world of derivat ives. It has deriv atives
contracts tied to $90 trillion of underlying securities. Of
that, $10.2 trillion are credit-derivatives contracts. Those
mind-boggling totals are somewhat misleading. They
reflect what is called the “notional” amount in the world of
derivatives, based on the underlying amount of the con-
tract, not its current value. When offsetting contracts are
taken into acco unt, that figure is whittled do wn to a much
smaller - tho ugh still e normo us - $109 billion of deriva-
tives, of which $26 billion are credit d e rivatives.
8. Subpri me Mortgag e C ris is
The subprime mortgage crisis is an ongoing real estate
crisis and financial crisis triggered by a dramatic rise in
mortgage delinquencies and foreclosures in the United
States, with major adverse consequences for banks and
financ ial mar kets aro und the glo be. T he crisis, which has
its roots in the closing years of the 20th century, became
apparent in 2007 and has exposed pervasive weaknesses in
financ ial ind ustry re gulatio n and the global fi nancial s ys-
tem [18,19]. The value of USA subprime mortgages was
estimated at $1.3 trillion as of March 2007, with over 7.5
million first-lien subprime mortgages outstanding. The
value of all outstanding residential mortgages, owed by
USA households to purchase residences housing at most
four families, was US$9.9 trillion as of year-end 2006, a nd
US$10.6 tri l l i on as of mi dy ea r 2008. By Au gu st 2008, 9.2%
of all U.S. mortgages outstanding were either delinquent
or in foreclosure. By September 2009, this had risen to
14.4%. Between August 2007 and October 2008, 936,439
USA residences completed foreclosure.
9. Banking Closure Crisis
A bank run occurs when a large number of bank cus-
tomers withdraw their deposits because they believe the
bank is, or might become, insolvent. As a bank run
progresses, more people withdraw their deposits, the li-
keli hood o f defa ult increa ses, and this enco urages f urther
withdrawals. This can destabilize the bank to the point
where it faces bankruptcy [20].
The year 2010 has also started on a bad note for the US
banking industry with eleven banks closing down so far
this year, in the first two weeks which bring the total banks
closure up to 140. The US regular had come out with a list
of over 450 banks which were below the standard capital
ade quac y norms, in Au gust 20 09. Histo rically, at leas t 20%
to 25% of t h es e banks go bankru pt i n the su bs equ en t yea r.
So we can expect the total bank closures in 2010 to be at
least 90 to 130 banks.
9.1. U.S. Bailout, Stimulus Pledges Total $11.6
In its first effort at quantitative easing, the Fed in 2009
and early 2010 bought $1.25 trillion in mortgage-backed
securities, and another $200 billion in debts owed by
government-sponsored enterprises, primarily Fannie Mae
and Freddie Mac, and completed the purchases in March.
The Fed had planned to allo w the size of that p ortfolio to
shrink gradual ly o ver time as the debts matured [21].
The Federal Reserve Wednesday announced its latest
effort to spur economic growth: a plan to purchase up to
$600 billion of government bonds through June 2011. It
wants to lower interest rates, in the hopes that doing so
will loosen the supply of credit and spur more economic
activity. The central bank’s main tool for reducing rates
is to slash the short-term overnight lending that banks
charge to one another, the so-called Federal Funds rate.
Bring short-term rates down, and long-term rates tend to
follow. In normal times, that’s as far as the Fed usually
goes. In the past three years, the Fed has reduced the Fed
Funds target rate 10 times, from 5.25 percent to between
zero and .25 percent. It’s been at that extremely lo w level
since the fall of 2008.
The following table details how the U.S. government
has pledged more than $11.6 trillion on behalf of Ameri-
can taxpayers over the past 19 months, according to data
The Fundamental Principle of Conservation of Physical Money: Its Violation and the Global Financial System Co llapse
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compiled by Bloomberg. It Includes a $787 billion eco-
nomic stimulus package. The Federal Reserve has new
lending commitments totaling $1.8 trillion. It expanded
the Term Asset-Backed Lending Facility, or TALF, by
$800 billion to $1 trillion and announced a $1 trillion
Public-Private Investment Fund to buy troubled assets
from banks. The U.S. Treasury also added $200 billion to
its support commitment for Fannie Mae and Freddie Mac,
the country’s two largest mortgage-finance companies
[22]. Table 3 details are as by Feb 24, 2009.
10. US Debt Crisis and Volatile Fractional
The U.S. government does not issue U.S. currency - the
Federal Reserve does. The Federal Reserve is a private
bank owned and operated for profit by a very power-
ful group of elite i nternational bankers. If you will pull a
dollar b ill out and take a look at it, you will notice that it
says “Federal Reserve Noteat the top. It belongs to the
Federal Reserve. The U.S. government cannot simply go
out and create new money whenever it wants under our
current system. Instead, it must get it from the Federal
Reserve. So, when the U.S. government needs to borrow
more mo ney it goes over to the Federal Table 3: Sample
of 2009 U S Bailout and Retur ns (in Billions)
Reserve and asks them for more called Federal Re-
serve Notes. So that is how the U.S. government gets
more green pieces of paper called U.S. dollarsto put
into circulation. B ut by doing so, the y get themselves into
even more debt which they will owe even more interest
on. So ever y time the U.S. go vernment does this, the na-
tional debt gets even bigger and the interest on that debt
gets even b igger.
As you read this, the U.S. national debt is approx-
imately 12 trillion dollars, although it is going up so ra-
pidly that it is really hard to pin down an exact figure. So
how much money actually exists in the United States
today? Well, there are several ways to measure this.
Table 3. US bailout sample.
Sector Ou tlay Returned
Total (Billions) $447.76 $75.33
Capital Purchase Program $204.55 $70.56
General Mo tors, Chr ysler $79.97 $2.14
American International Group $69.84 $0.00
Making Home Affordable $23.40 $1.13
Investmen t Bank of
Am er i ca
$20.00 $0.00
Targeted Invest m ent
Citigroup $20.00 $0.00
Te rm Asset-Backed Loan $20.00 $0.00
Total world wealth is somewhere around $160 trillion,
and total world debt, public and private, is about the same
amount, $150 trillion. Current world GDP is about $60
trill ion. Mor e and more , the debt i s beginning t o drag the
world down into a dark hole of endless interest payments
and more new debt to service old debt. By 2010, total
debt of the US Fede ral Go ver nment will fina lly reac h one
year of GDP, about 15 trillion dollars. Japan is well
beyond that already and European countries like Greece,
Spain, Ireland and Iceland are close to financial chaos
due to overwhelming amounts of debt.
So will the U.S. government come to the rescue? The
U.S. has allo wed the total federal debt to balloon by 50%
since 2006 to $12.3 trillion. During the administration
of President George W. Bush, the total debt increased
from $5.6 trillion in January 2001 to $10.7 trillion by
December 2008, rising from 54% of GDP to 75% of GDP.
During March 2009, the Congressional Budget Office
estimated that pub lic debt will r ise from 40.8% of GDP in
2008 to 70.1% in 2012 [23].
The total debt is projected to continue increasing sig-
nificantly during President Obama’s administration to
nearly 100% of GDP. The 2010 U.S. budget indicates
annual debt increases of nearly $1 trillion annually
through 2019, with an unprecedented $1.0 trillion debt
increase in 2009. By 2019 the U.S. national debt will be
$18.4 trillion, approximately 148% of 2009 GDP, up
from its approximately 80% level in April 2009. Further,
the subprime mortgage crisis has significantly increased
the financial burden on the U.S. government, with over
$10 trillion in commitments or guarantees and $2.6 tril-
lion in investments or expenditures as of May 2009, only
so me of wh ich are included in the bud get do cument. T he
U.S. also has a large trade deficit, meaning imports ex-
ceed exports. Financing these deficits requires the USA
to borrow large sums from abroad, much o f it fro m co un-
tries running trade surpluses, mainly the emerging
economies in Asia and oil-expo rt ing na tio n s.
U.S. official gold reserves, totaling 261.5 million
troy ounces, have a book value as of 30 November 2009
of approximately $11 billion, vs. a commodity value as of
17 December 2009
The Strategic Petroleum Reserve had a value of $69
billion as of December 2009
of approximately $288.5 billion.
Total U.S. household debt, including mortgage loan
and consumer debt, was $11.4 trillion in 2005.
, at a Market Price of
$104/barrel with a $15/barrel discount for crude.
By comparison, total U.S. household assets, includ-
ing real estate, equip ment, and financial instru ments such
as mutual funds, was $62.5 trillion in 2005.
In 2008, $242 billion was spent on interest pay-
ments servicing the debt, out of a total tax revenue of
$2.5 trillion, or 9.6%. Including non-cash interest accrued
86 The Fundamental Principle of Conservation of Physical Money: Its Violation and the Global Financial System Collapse
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primarily for Social Security, interest was $454 billion.
Total U.S Consumer Credit Card revolving credit debt
was $931.0 billion in April 2009.
Total third world debt was estimated to be $1.3 tril-
lion in 1990.
The global market of all stoc k markets of the Wo rld
Federation Exchanges was $32.5 trillion by end of 2008.
11. Greece Debt Crisis and Goldman Sachs
Financial Derivatives
The crisis in Greece poses the most significant challenge
yet to Europ e and it s commo n curr ency, the euro, and its
economic unity. Greece owes the world $300 billion, and
major banks are on t he hook for much of that de bt.
European governments and the International Monetary
Fund committed to pull Greece back from the brink of
default, agreeing on Euro110 Billion in emergency loans
on the c o nd iti o n At hen s ma ke p ai nful budge t cuts and tax
increases. The rescue is aimed at keeping Greece from
defaulting on its debts and preventing its financial crisis
from infecting other indebted countries just as Europe is
struggling out of recessio n.
In 2001, just after Greece was admitted to Europe’s
monetary union, Goldman Sachs helped the government
quietly borrow billions. That deal, which was hidden from
public view because it was treated as a currency trade
rather than a loan, helped Athens to meet Europe’s deficit
rules while continuing to spend beyond its means. Such
financial derivatives, which are not openly documented or
disclosed, add to the uncertainty over how deep the
troubles go in Greece and which other governments might
have used similar off-balance sheet accounting.
The 2001 transaction involved a type of derivative
known as a swap. One such instrument, called an interest-
rate swap, can help companies and countries cope with
swings in their borrowing costs by exchanging fixed-rate
payments for floating-rate ones, or vice versa. Another
kind, a curren cy swap, can m inimize the im pact of v olatile
foreign exchange rates.
Aeolos, a legal entity created in 2001, helped Greece
reduce the debt on its balance sheet that year. As part of
the deal, Greece got cash upfront in return for pledging
future lan ding fees at th e country’s airports. A simi lar deal
in 2000 called Ariadne devoured the revenue that the
government collected from its national lottery. Greece,
however, classified those transactions as sales, not loans,
despite doubts by many critics. In 2002, accounting dis-
closure was required for many entities like Aeolos and
Ariadne that did not appear on nations’ balance sheets,
prompting governments to restate such deals as loans
rather than sales.
In 2005, Goldman sold the interest rate swap to the
National Bank of Greece, the country’s largest bank. In
2008, Goldman helped the bank put the swap into a legal
entity called Titlos. But the bank retained the bonds that
Titlos issued. While Greece did not take advantage of
Goldman’s proposal in November 2009, it had paid the
bank about $300 million in fees for arranging the 2001
transaction. Financial derivatives Instruments developed
by Goldman Sachs (JPMorgan Chase) are raising ques-
tions about Wall Street’s role in the world’s latest financial
12. Iceland Crisis: Credit and Fractional
Banking Problems
On November 19, 2008, Iceland and the International
Monetary Fund (IMF) finalized an agreement on a $6
billion economic stabilization program supported by a
$2.1 billion loan from the IMF. Following the IMF deci-
sion, Denmark, Finland, Norway, and Sweden agreed to
provide an additional $2.5 billion. Iceland’s banking sys-
tem had collapsed as a culmination of a series of deci-
sions the banks made that left them highly exposed to
disruptions in financial markets.
The collapse of the banks also raises questions for
leaders and others about supervising banks that operate
across national borders, especially as it becomes increa-
singly difficult to distinguish the limits of domestic fi-
nancial markets. Such supervision is important for banks
that are headquartered in small economies, but operate
across national borders. If such banks become so over-
exposed in foreign markets that a financial disruption
threatens the solvency of the banks, the collapse of the
banks can overwhelm domestic credit markets and out-
strip the ability of the central bank to serve as the lender
of last resort.
A combination of economic factors over the early to
mid-2000s led to Iceland’s current economic and banking
distress. In particular, access to easy credit, a boom in
dome stic c onstr uc tion t hat f ue led rap id eco nomic gr o wth,
and a broad deregulation of Iceland’s financial sector
spurred the banks to expand rapidly abroad and even-
tually played a role in the eventual financial collapse.
Iceland benefitted from favorable global financial condi-
tions that reduced the cost of credit and a sweeping libe-
ralization of its domestic financial sector that spurred
rapid growth and encouraged Iceland’s banks to spread
quickly throughout Europe.
In 2004, Iceland’s commercial banks increased their
activity in the country’s mortgage market by competing
directly with the state-run Housing Financing Fund
(HFF), which had been the major provider of mortgage
loans. In contrast to the Housing Financing Fund, the
commercial banks began offering loans with lo wer inter-
est rates, longer maturities, and a higher loan to value
ratio. Also, the banks did not require a real estate pur-
The Fundamental Principle of Conservation of Physical Money: Its Violation and the Global Financial System Co llapse
Copyright © 2011 SciRes. iB
chase as a precondition for a loan, which made it possible
for homeowners to refinance existing mortgages and to
access the equity in their homes for consumption or in-
vest ment purp oses.
Iceland has five commercial banks: Glitnir, Kaupthing,
Nyi Landsbanki, Straumur Investment Bank, and Icebank,
which serves as the clearing house for the 20 locally-run
savings banks. The three largest banks, Kaupthing,
Landsbanki, and Glitnir, have total assets of more than
$168 billio n, or 14 times Icela nd’s GDP. Icela nd also has
20 savings banks, with assets at the end of 2007 valued at
$9 billion.
13. Recommendations and Conclusions
In this paper the principle of conservation of physical
mone y ha s b e en i nt ro d uc ed . D efi ni n g commo di t y and f ia t
money as well as gold standard is presented. Major caus-
es of the international financial crisis such as fractional
banking system financial derivatives and lacking a com-
modity money standard are discussed. Examples of in-
ternational crisis such as mortgage crisis, credit default
crisis, debt c risis, financial de rivative crisis, ban king clo-
sures all resulted from the violation of conservation of
physical money. The international financial system is
very complex and fixing it needs a major sacrifice. The
world Today’s reserves wealth of Gold, Silver and Cop-
per is estimated by 8.63 Trillion US$ compared to 4.3
Trillion US$ in Currencies. And global outstanding de-
rivat i ves ha ve r e ac hed 1 .1 4 qua dr il lio n d o lla r s. T aki ng no
action of implementing comprehensive overhaul main-
tenance of the financial system, the world will witness
the collapse of such an existing system and a rush to re-
serve gold and silver.
The proposed solution to avoid such an international
financial Tsunami is proposed as follows:
1) Cancelation of Fractional Banking System.
2) Implementatio n Zero Interest.
3) Applying Commodity Gold/Silver Standard
4) Dropping t he Overvalued Debts
5) Prohibiting Credit Swap
6) Freezing all Derivatives and re-evaluate values
7) Enforcing Ethical Financial A ud iting
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