Free Markets, Free People
I‘ve Just finished watching a documentary call "The End of the Road: How money became worthless" on Netflix. It’s 55 minutes long. It’s wonderfully educational, and horrifically frightening.
IT explains exactly why I’ve been harping on the coming hyperinflation for the last three years, and it tells you how close we are to seeing it happen. It explains the current situation we face extremely clearly and simply, so that anyone can understand it.
You need to watch it as soon as you possibly can.
Ever since the Fed began the first round of what is now called Quantitative easing, massively expanding the money supply, I’ve been worried about what would happen when demand began rising, and the Fed had to somehow try and draw all that extra cash out of the economy before it became inflationary—or even worse—hyperinflationary.
That’s still a worry for me, because I have, let us say, less than absolute confidence that Chairman Bernanke and his colleagues can pull that monetary sterilization off without a misstep.
Happily, that is becoming a secondary worry for me. Unhappily, that’s because it’s been replaced by a new worry, articulated by Paul Brodsky, bond market expert and co-founder of QB Asset Management. Mr. Brodsky maintains that the real inflationary danger lies elsewhere. I mean, it still lies at at the Fed and other Central Banks, but for a different reason.
The world has simply gotten itself into too much debt. There are creditors that expect to be paid, and debtors that are having an increasingly difficult time making their coupon payments. No amount of political or policy intervention is going to change that reality. (Unless a global "debt jubilee" transpires, which Paul thinks is unlikely).
Looking at the global monetary base, Paul sees it dwarfed by the staggering amount of debts that need to be repaid or serviced. The reckless use of leverage has resulted in a chasm between total credit and the money that can service it.
So how will this debt overhang be resolved?
Central bank money printing — and lots of it — thinks Paul.
The problem has been exacerbated by the fact that, when faced with an economic depression brought on by the collapse of a debt bubble—mainly in mortgages—the preferred policy solution pushed by governments all over the world, has been to try and re-inflate the debt bubble via stimulus spending. That is to say, overcoming the collapse of the mortgage debt bubble by creating a new, even bigger, sovereign debt bubble.
We have a pretty good idea of how much money there is in the world. We also have an idea of how much debt there is, from the sovereign debt of the united states, to credit cardholders in Finland. And it appears that there is not enough of the former, to pay off all the debts contained in the latter. If so, then that means a lot of banks—perhaps most of them—are in trouble. And we can’t have that.
What policy makers do not want to see is bank asset deterioration. That would lead to all sorts of bad things. You would see banks fail. You would see bank systems fail. You would see debtors fail and it would just feed on itself in an accelerating fashion. And so monetary policy makers have no choice but to deleverage in the other way, which is to colloquially print money; to manufacture electronic credits and call them bank reserves.
And to the degree that that extends into the private sector where debtors begin to fail en masse, that would increase failures of the bank assets in turn. And it would end the mortgage bond securities market, for example, and the leveraged loan markets, and end the private sector shadow banking system. So it does not work for anybody to have credit deteriorate. The only way to deleverage an economy is as we are saying: to create new base money with which to do it.
In other words, if central banks want to prevent entire banking systems from failing due to the collapse of the debts they hold as assets, they have no choice but to ensure that there is enough money available for everyone to meet their debt payments. To do that, they have to start printing out long sheets of beautifully engraved C-Notes. This will, of course, lead to massive inflation that will allow everyone to pay off their mortgages for the cost of a nice hat, while, at the same time, destroying the value of the world’s life savings.
This will clean up everyone’s balance sheets, and allow the world to create a brand new monetary base—let’s call it New Dollars—which, central banks having learned their lessons, will be impossible to over-borrow or inflate.
Hahahahahahahahahahahahaha! Woohoohoohoohoo! Hehehehehehehehehe. Heh heh. Ahhh. Sometimes I kill myself.
I’m just kidding with you. Seriously, they’ll try to start a new fiat currency that they’ll borrow on and debase until it collapses on our grandchildren, and screws them, too.
In this podcast, Bruce, Michael, and Dale discuss the Japanese Libyan no-fly zone and the strange case of a man convicted of creating “Liberty Dollars”.
The direct link to the podcast can be found here.
As a reminder, if you are an iTunes user, don’t forget to subscribe to the QandO podcast, Observations, through iTunes. For those of you who don’t have iTunes, you can subscribe at Podcast Alley. And, of course, for you newsreader subscriber types, our podcast RSS Feed is here. For podcasts from 2005 to 2010, they can be accessed through the RSS Archive Feed.
It has become an article of faith in modern economics that the gold standard just isn’t suitable for modern economies. Since the Great Depression started the movement away from the gold standard, we have moved towards a system of freely convertible fiat currencies whose values are, in the main determined by the ability of central banks to maintain control of inflation. Any talk of returning to the gold standard, therefore, is derided as some sort of fanatical return to a failed past.
Now, to be sure, there are problems with gold as money. Some of them are perceived problems, others are real.
Ultimately, gold, as a currency, tends to be deflationary. A country’s money supply is limited by the amount of gold on hand. Absent an increase in the amount of gold, any increase in real output must cause prices to decline.
Also, any balance of payments deficit reduces the country’s gold supply. For instance, during the Depression, England had a horrific balance of payments problem. The country was paying out so much money in foreign payments, that it was literally draining all the gold out of Britain. The only real remedy to this was to massively deflate British prices…in the midst of an already deflationary recession.
Monetary shocks are easily transmitted from one country to another via gold. Since countries who participate in the gold standard have fixed links, inflation or depression in one country can be quickly transmitted to another. For instance, the discovery of a large gold mine increases the supply of gold, without affecting real output. That inflationary effect is quickly felt throughout all the countries who share the standard.
But–and this is a big “but”–the change from a gold standard to freely convertible fiat currencies has solved those old problems by introducing entirely new ones. Governments and central banks have embarked on massive programs of public indebtedness, the inflationary–and sometimes hyperinflationary–printing of fiat currencies, and the wholesale selling of sovereign debt to foreign countries who may not have, as their primary interest, recouping the money on their investments, but rather the manipulation of an enemy’s economy, should it become necessary.
These problems bring us to Robert Zoellick, the head of the World Bank. In an Op/Ed in the Financial Times addressing our current economic woes, he suggests something that will no doubt be much discussed. In a discussion of how to create a monetary regime to succeed the clearly dying Bretton Woods II paradigm in which we’ve operated since 1971, he suggests, among other things:
This new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves towards internationalisation and then an open capital account.
The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.
If I’m not mistaken, the head of the World bank just called for the creation of a new gold standard for international trade.
This should be interesting.
In case you missed it, there’s a currency war going on. It may not be the sexiest thing in the world to talk about, but it is important to understand. Probably the most important thing to understand is, in the midst of all this financial upheaval, it’s not healthy for anyone. In fact that best thing right now would be to back off and let things chill for a bit.
That’s why the US Congress passed a bill calling China a “currency manipulator.” So much for cool heads. Blame it on election year politics and the need to seem to be sticking up for America … even if what you’re really doing is adding more heat to an already ferociously hot situation.
The baseline here is the US believes the Chinese yuan is undervalued by about 25%. And it has been on China’s case for some time to get them to revalue their currency upward. That would make US exports more competitive against China.
But, there’s more to the story than just that.
First thing to know is because of the horrific global financial climate, “Japan, Brazil, Peru and countries all over the world are trying to beggar thy neighbor (just as happened during the 1930s) and gain a leg up for their exports by cheapening their currencies,” according to The Market Oracle. So we have any number of countries trying to boost exports at the expense of their currencies.
You have to then dial it back to June of this year to understand the second part that makes this so complex. June 19th specifically. Jack Perkowski explains:
That is the day that China, by far the world’s largest currency trader, announced that it would no longer peg the yuan to the U.S. dollar, but would instead peg it to a basket of currencies. What China’s announcement meant in practice is that at the margin, beginning on June 19, China would tilt its purchases in favor of buying assets denominated in the euro, the Japanese yen, the British pound or some other major currency, rather than those denominated in the U.S. dollar. When an investor with $2.5 trillion of buying power makes such a statement, markets tend to listen.
Here is what has happened since.
As of the September month-end, the euro has increased in value by 10.3% against the U.S. dollar since June 19, the pound by 6.3%, and the yen by 7.8%. In fact China’s purchases of yen-denominated securities has heightened trade tensions between Japan and China to the point where the Japanese have complained publicly that China is effectively pricing Japanese products out of the market with its yen purchases, threatening to derail Japan’s economic recovery.
In the broadest measure possible, the United States Dollar Index (“USDX”) has declined by over 9.6% percent since June 19. The USDX measures the value of the US dollar against a basket of currencies that includes the euro, yen, pound, Canadian dollar, Swiss franc and the Swedish krona — exactly the currencies that China is most likely including in its own basket and which are now appreciating as a result. The USDX began in March 1973 with a value of 100.000 and has since traded as high as the mid-160s. At its current level of 78.691, the USDX is approaching its 33-year low of 70.698, which was reached on March 16, 2008.
On the one hand you have countries everywhere trying to cheapen their currencies to sell their exports (China wants theirs to stay right where it is) in order to boost GDP growth. And on the other you have China’s move away from pegging the yuan to the US dollar to pegging it to a basket of other currencies, and driving those currencies higher and making their exports less competitive.
Unpegging from the US dollar has also driven the dollar down relative to those other currencies but still much higher than the yuan, which has only appreciated 2%.
Back to the point about the bill just passed by Congress. It doesn’t really help:
But the former U.S. trade representative, Susan Schwab, says that – while there’s a very real problem in terms of China artificially keeping the renminbi low, this isn’t the way to solve anything. Schwab calls it "a signal-sending exercise during an election season". She says that the bill won’t really do anything, even if the Senate passes it and it is signed into law. Schwab says it "makes no sense", won’t solve any problems, will escalate tensions, and will only divert attention from the real trade problems between the U.S. and China.
In fact the “election signals” may blow up in our face:
Indeed, Schwab warns that other countries might decide that this U.S. bill means that it’s open season for addressing currency manipulation, and that other countries believe that the U.S. is manipulating our currency. She says there could be a "boomerang effect" from the legislation.
All we’d need now to kill our recovery as weak as it is, is to have a full blown, open season, take no prisoners currency war where the dollar would be weakened even more than it is now. And that’s especially true if the “quantum easing” (printing more money) the Fed has been hinting about is about to take place.
What no one seems to want to admit is now is not the time for any country to be revaluing its currency upward. The US is demanding of China what it wouldn’t do itself. Until the financial crisis has passed, these demands that China push the value of the yuan up should be on hold. Then, as Zachary Karabell explains, it is in China’s best interest to see the value of the yuan eventually increase:
China has been revaluing its currency, nearly 20% between 2005 and 2008 and now nearly 3% since June when the government resumed that policy having shelved it during the midst of the global financial crisis. It is in the domestic interest of the Chinese government to raise the value of their currency because they are focused on building up on internal, domestic consumption market. They have no wish to be dependent long-term of the vagaries and whims of American consumers, and higher purchasing power for Chinese consumers is the answer. They are not revaluing quickly enough to suit an America stuck in second gear and looking for someone to blame, but revaluing they are.
And there’s the bottom line – the US recovery isn’t going as well as we’d like it and as seems to be the penchant among US politicians, they have to have someone else to blame for the problem.
Solution: throw gas on a raging fire. I sure hope China has cooler heads at the helm.
In this podcast, Bruce, Michael and Dale discuss the special election in Massachussetts, the dangers of hyperinflation, and Haiti. The direct link to the podcast can be found here.
The intro and outro music is Vena Cava by 50 Foot Wave, and is available for free download here.
As a reminder, if you are an iTunes user, don’t forget to subscribe to the QandO podcast, Observations, through iTunes. For those of you who don’t have iTunes, you can subscribe at Podcast Alley. And, of course, for you newsreader subscriber types, our podcast RSS Feed is here. For podcasts from 2005 to 2009, they can be accessed through the RSS Archive Feed.
I’m not sure how you could call this anything else:
Venezuelan President Hugo Chavez said that businesses have no reason to raise prices following the devaluation of the bolivar and that the government will seize any entity that boosts its prices.
Chavez said he’ll create an anti-speculation committee to monitor prices after private businesses said that prices would double and consumers rushed to buy household appliances and televisions. The government is the only authority able to dictate price increases, he said.
“The bourgeois are already talking about how all prices are going to double and they’re closing their businesses to raise prices,” Chavez said in comments on state television during his weekly “Alo Presidente” program. “People, don’t let them rob you, denounce it, and I’m capable of taking over that business.”
Not only is he “capable” of taking the business over, but he’s turning out the army to monitor all of this. And he’s promised to “transfer the ownership” of any business raising prices “to the workers”. We’ve all seen how well those sorts of takeovers have worked out in the past.
To review, he’s devalued the bolivar which had been fixed at 2.15 to the U.S. dollar since 2005, to 4.3 to the dollar. He then declared that businesses – which own stock under the old currency value and which will have to restock using the devalued currency – must keep their prices at the old price and let consumers buy that stock with the devalued currency or lose their business. A unilateral decision on his part and the refusal, again unilaterally, to allow those who own the goods they’re selling to react to his decision.
Where I come from, that’s called totalitarianism.
While the Fed tries to assure us that when the time comes it can wring the excess money it has pumped into the economy without driving it into the ditch, Paul Krugman and others want more spending, and we’re staring at 9 trillion in additional debt, the rest of the worldhas seems to be quietly deciding that the dollar has become an unstable currency in which they’d rather not trade:
Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars.
The plans, confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong, may help to explain the sudden rise in gold prices, but it also augurs an extraordinary transition from dollar markets within nine years.
They’re talking about a whole range of different currencies to replace the dollar but the fact remains that the old buck ain’t what it used to be and those trading in oil are looking for a more stable means of trade.
The transitional currency in the move away from dollars, according to Chinese banking sources, may well be gold. An indication of the huge amounts involved can be gained from the wealth of Abu Dhabi, Saudi Arabia, Kuwait and Qatar who together hold an estimated $2.1 trillion in dollar reserves.
Which explains some of the growth in the price of gold. Of course this transition will take time as the various countries carefully get rid of their dollar reserves over the coming years. However, if they are as committed to this transition away from dollar as the base trading currency for oil as this article indicates, then obviously the strength of the dollar will be adversely effected over that transition period and beyond as dollars are dumped. Couple that with the excess dollars we’ve pumped into the system these past few months and you can begin to understand the possible economic disaster this may end portend.
Ever since the Bretton Woods agreements – the accords after the Second World War which bequeathed the architecture for the modern international financial system – America’s trading partners have been left to cope with the impact of Washington’s control and, in more recent years, the hegemony of the dollar as the dominant global reserve currency.
The Chinese believe, for example, that the Americans persuaded Britain to stay out of the euro in order to prevent an earlier move away from the dollar. But Chinese banking sources say their discussions have gone too far to be blocked now. “The Russians will eventually bring in the rouble to the basket of currencies,” a prominent Hong Kong broker told The Independent. “The Brits are stuck in the middle and will come into the euro. They have no choice because they won’t be able to use the US dollar.”
Chinese financial sources believe President Barack Obama is too busy fixing the US economy to concentrate on the extraordinary implications of the transition from the dollar in nine years’ time. The current deadline for the currency transition is 2018.
We’ve been talking and hinting about this since it first began surfacing and warning of the dire economic consequences such a move would have. Of course it is the result of our own profligate spending and financial mismanagement, but I don’t think, for the most part people understand the implications of this move to replace the dollar. And it also doesn’t appear we have ability (much less a plan) to reverse this trend toward this change of the economic guard.
What if the Treasury held a bond auction and nobody came? After today, that’s not a rhetorical question.
Weak demand at a Treasury bond auction touched off worries in the stock market Thursday about the government’s ability to raise funds to fight the recession.
The government had to pay greater interest than expected in a sale of 30-year Treasurys. That is worrisome to traders because it could signal that it will become harder for Washington to finance its ambitious economic recovery plans. The higher interest rates also could push up costs for borrowing in areas like mortgages.
We are moving closer to what I warned about in March, after the UK had a failed auction of 15-year gilts. Apparently, the Chinese didn’t turn out in force today. They did however, continue talking about a new reserve currency–one that isn’t the US Dollar. And apparently they’ve been doing more than talking about it.
As we learned last week, the Chinese–who haven’t announced anything about their gold holdings since 2003–casually dropped an announcement that they’d nearly doubled their gold holdings from 19 million to 34 million ounces. Moreover, this gold, which had previously been kept for foreign trade in an account at the State Administration of Foreign Exchange, has now been transferred to the bank of China, as part the country’s monetary reserves.
I don’t think they’re all that keen on lending us money any more.
This is important because it indicates the extent to which gold is being rehabilitated as a monetary reserve asset, not only by the Chinese monetary authorities but by central bankers around the world. It has been clear that gold was being restored as a more important part of the world’s financial system, with rising investment demand over the past nine years. The Chinese government’s decision to say that this gold belongs in its monetary reserves emphasizes that monetary authorities also are looking at gold with greater interest than they have since the 1960s.
There’s a new reserve currency in town, and it’s yellow and shiny. What it isn’t is green with pictures of dead presidents on it. Maybe the Fed’s doubling of
M2 the monetary base over the last eight months was a bit…intemperate.
So, the key take-aways here:
1) Higher interest rates possible as auctions fail to find bidders at lower yields.
2) Billions and billions of dollars floating around, with no place to go but back home. “Wouldn’t you like to wear $3,000 suits and smoke $75 cigars? I know I would.”
But, we probably shouldn’t worry. As Glenn Reynolds says, “The country is in the best of hands.”