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London G-20 meeting: the last chance?

by Luis de Sousa Wed Apr 1st, 2009 at 11:08:51 AM EST

On the 24th of March, Frank Biancheri, head of of the LEAP2020, published in the Financial Times the following open letter directed to the G20 leaders gathering in London on the 2nd of April:

Ladies and Gentlemen,

Your next summit takes place in a few days in London; but are you aware that you have less than a semester to prevent the world from plunging into a crisis that will take at least a decade to resolve, accompanied by a whole series of tragedies and ferment? Therefore, this open letter by LEAP/E2020, who saw the arrival of a « global systemic crisis » as early as three years ago, intends to briefly explain why it happened and how to limit further damage.

[...]


An audio version of this log entry can be downloaded here.

Until now you have merely been concerned with the symptoms and secondary effects of this crisis because, unfortunately, nothing prepared you to face a crisis of such an historic scale. You thought that adding more oil to the global engine would be enough, unaware of the fact that the engine was broken, with no hope of repair. In fact, a new engine must be built, and time is running out, as the international system deteriorates further each month.

[...]

LEAP'S THREE STRATEGIC RECOMMENDATIONS

1. The key to solving the crisis lies in creating a new international reserve currency!

The first recommendation is a very simple idea: reform the international monetary system inherited post-wwii and create a new international reserve currency. The US Dollar and economy are no longer capable of supporting the current global economic, financial and monetary order. As long as this strategic problem is not directly addressed and solved, the crisis will grow. Indeed it is at the heart of the crises of derivative financial products, banks, energy prices... and of their consequences in terms of mass unemployment and collapsing living standards. It is therefore of vital importance that this issue should be the main subject of the G20 summit, and that the first steps towards a solution are initiated. In fact, the solution to this problem is well-known, it is about creating an international reserve
currency (which could be called the « Global ») based on a basket of currencies corresponding to the world's largest economies, i.e. US dollar, Euro, Yen, Yuan, Khaleeji (common currency of oil-producing Gulf states, to be launched in January 2010), Ruble, Real..., managed by a « World Monetary Institute » whose Board will reflect the respective weight of the economies whose currencies comprise the « Global ». You must ask the imf and concerned central banks to prepare this plan for June 2009, with an implementation date of January 1st, 2010. This is the only way for you to regain some control over currently unwinding events, and this is the only way for you to bring about shared global management, based on a shared currency located at the centre of economic and financial activity. According to LEAP/E2020, if this alternative to the currently collapsing system has not been initiated by this summer 2009, proving that there is another solution than the « every man for himself » approach, today's international system will not survive this summer.

If some of the G20 states think that it is better to maintain the privileges related to the « status quo » as long as possible, they should meditate the fact that, if today they can still significantly influence the future shape of this new global monetary system, once the phase of global geopolitical dislocation has started they will lose any capacity to do so.

[...]

Further detail of LEAP2020's analysis was given by Frank in an interview to the Guns and Butter radio show.

There will be other issues discussed at the meeting: tax heavens, shadow accounting practices, reserve requirements, but the global reserve currency system, that, as was known during at least the last 40 years, seems to have ceased to exist, is the most important of all.

How did it get here.

The first attempt to reach a global monetary system was held at Bretton Woods in the US in the Summer of 1944, with the end of the Second World War in sight. An agreement was reached between 44 nations in the Allies' side, that enacted the IMF, the prototype of the World Bank and a new monetary system for commercial relations. This system (named Bretton Woods) established fixed exchange rates between currencies, defining narrow fluctuations of paper currencies against gold.

This Bretton Woods system lasted for more than two decades along which countries kept on increasing paper currency supply, but managed to maintain gold prices under control by injecting reserves into the market. The system began to fail in May of 1968 when world wide panic closed down most gold trading markets. Investors had lost faith in central banks' ability to redeem the fiat currency they had issued. In the Summer of 1971, bending on the weight of increasing energy imports and the Vietnam war, the US was forced to pull out of the Bretton Woods system, abandoning the direct convertibility of the US dollar into gold.

During the following months, with the dollar loosing half of its value against gold, most other countries abandoned fixed exchange rates against the dollar. A new system emerged, with major currencies used in international trade adopting floating exchange rates.

Following came a period of about ten years between the first oil shock and the pinnacle of the early 1980s recession, when currencies slowly depreciated without much economic growth happening in the western world. During this time the foundations of the present system were launched. Perhaps the most important action towards it was the birth of the Carter Doctrine. As the economic crisis was overcome, a symbiotic relationship developed between the Midde East and the West, in exchange for military protection (conserving the ruling elites) oil producers provided easy oil that fostered economic growth in its turn reinforcing that military power. Oil producing countries stored their wealth in US Treasury bonds and other debt instruments becoming creditors of the military power that kept them safe; the flow of cheap oil allowed the economic growth that justified the faith on the US currency. This was the Petro-dollar system.

While in a different stance, US allies in the NATO framework (also Japan and Oceania) ended up also benefiting from this new system. They couldn't export debt as the US did, but benefited both from the flow of cheap oil and of the rising protective military power at the western side of the Atlantic. Two decades of unprecedented economic stability and growth unfolded.

But History is relentless. By the mid 1980s this system was being used chiefly in the Atlantic - Middle East trade, with the USSR and its allied still in place, and in a trade environment much narrower than today. As oil prices collapsed in 1985, events were set in motion that brought down the USSR both in political, military and economic terms; in 1989 the Berlin wall fell and in 1991 Russia detached from the former republics of the Warsaw Pact. In 1992 the Maastricht Treaty created a new market of international dimension; in 1999 the Euro was born and in 2001 China joined the WTO, paving the way far a major, now liberalized, economy entering the world market. At the same time other important players emerged, with Russia becoming again the world's largest oil producer and a major energy exporter, not forgetting countries like Brasil or India.

What started as a bonding scheme between two regions, became the system that prices global trade today. Not only the usage of the US dollar as reserve currency became global, it became much more intense with imports and exports having far greater weight in individual economies than 20 years ago. This scheme resulted into the US Federal Reserve setting monetary policy for the whole world, while in fact its targets and gauges are solely on the US economy.

The recent years.

After 2000 the US embarked on a monetary and fiscal policy expansion with little parallel in history: interest rates were brought down to the floor, the monetary mass grew in excess of 10% annually, an expansionary budget stimulated demand for goods and services, many of them imported from countries that accumulated US bonds and other forms of fiat currency. From 2002 to 2007 reserve currency held by central banks grew in excess of 20% annually. In parallel, lax financial regulations and reserve requirements helped creating a pile of invisible debt (out of balance sheets) on that expanding demand and monetary mass, according to some amounting today to more than the world's annual GDP.

Did this incredible expansion ended because oil production plateaued? That's an interpretation, although other views are possible. Oil prices entered the rising phase in 2004, in 2005 were raw materials and 2006 food: no matter what the underlying reason, the supply side stopped following the demand expansion. When Ben Bernanke became chairman of the US Federal Reserve and tried to change course by raising interest rates, so that at least some strain would come to the monetary expansion, it was already too late: the US economy couldn't expand anymore in order to generate the wealth promised by all the debt issued in previous years.

Without that physical growth, the result was simply default on debt. Without the proper leadership from either the US government or the Federal Reserve, panic took over last September and during  two months the world assisted to one of the sharpest demand retractions in history. The awkwardness of the moment is that in order to stimulate demand once more the prescription in the US seems to be an expansionary budget and monetary policy. And here's the main problem: this policy threatens the value of US dollar reserves held abroad.

There is another side to the present crisis worth observing: countries that followed alternate monetary policies to those set by the Fed seem to be suffering the most. Those that opted for high interest rates in order to fend price inflation and/or demand enjoyed an influx of foreign investment lurking for easy profits. When the crisis hit that investment simply vanished, examples were Iceland, and Russia to some extent. At the other end were countries like Japan that during this decade had been battling problems of employment or lack of internal demand, employing expansionist measures even sharper than the US; they are now facing an influx of currency that threatens to engulf demand and massively destroy employment.

In conclusion: a regional currency running world trade had two main negative effects: impaired specific monetary policies in other regions, formating them to the issuing region, and pegged wealth in store to the economic health of a single region: the issuer. Exacerbating these problems is the hegemonic position the currency issuer gets, allowing it to leave beyond its means - what Frank Biancheri calls the reserve currency curse - the budget and trade deficits can apparently be expanded without limit, but at some point it makes foreigners wonder, and when that time comes the issuing region is engulfed in debt. A global economy running on a regional currency seems almost like a scheme designed to self destruct.

The confidence wanes.

The policies needed to bring the US economy back into contact with reality have thus the parallel effect of deriding the wealth stored by those economies that grew on exports during the past few years: be it expensive lasting goods (e.g. Germany, Japan), consumer goods (e.g. China) or energy (e.g. Middle East, Russia). The confidence on the US dollar as a reserve currency is severely demaged and as the LEAP2020 implies, it will probably never come back. No wonder then that China is openly calling for a new reserve currency system:

Zhou Xiaochuan, governor of China's central bank, has proposed to create a super-sovereign reserve currency as part of reform in the international monetary system.

The desirable goal of the international monetary system is to "create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies," he said.

Zhou said the Special Drawing Right (SDR) of the International Monetary Fund (IMF) has the potential to act as a super-sovereign reserve currency in a signed article posted on the website of the People's Bank of China Monday.

This backs up earlier calls from another major holder of reserve currency, Russia, that seems to be heading a group of nations with the same intent:

China and other emerging nations back Russia's call for a discussion on how to replace the dollar as the world's primary reserve currency, a senior Russian government source said on Thursday. Russia has proposed the creation of a new reserve currency, to be issued by international financial institutions, among other measures in the text of its proposals to the April G20 summit published last Monday.

[...]

Russia met representatives of China, India and Brazil ahead of the G20 finance ministers meeting last week, as the big emerging powers seek to up their influence on decision making globally. Their first ever joint communique did not mention a new currency but the source said the issue was discussed.
"They (China) did not formally put forward their position for the G20 summit but unofficially they had distributed their paper regarding the same ideas (the need for the new currency)," the source told Reuters, speaking on condition of anonymity.

But China has not sticked solely to articles in the western press and meetings with other reserve currency holders. Ever since the country announced its intention to make the Yuan a reserve currency, several currency swaps have been announced with its main commercial partners, Argentina being the last of a list that includes South Korea, Malaysia, Hong Kong and Belarus.

What could happen then if a new coordinated reserve currency fails to emerge? The answer is simple: the US dollar will stop being the world trading benchmark. A period will then unfold during which trading nations won't have a clear worldwide unit to value their goods, much less to store value for future trading. Possibly, some regional currencies might be tried on a geographically limited basis, and another alternative might emerge with a currency for which there isn't much policy to go about: gold. The consequences of such transition will be immense; an Hungarian mathematician called Antal Fekete, claims to already be getting signs in that sense, with gold futures entering backwardation late last year. This is a rather technical issue, way beyond the aims of this simple essay, but with or without backwardation, it is important to know what Fekete foresees [pdf!] in case the present system ceases to exist without a clear replacement:

I have to go back to the collapse of the Western Roman Empire  after  the  abdication  of  the emperor  Romulus  Augustus  on September 4, 476 A.D.    It was  followed by  the Dark Ages when  the rule of law, personal security, trade of goods against payment in gold and silver could no  longer be  taken for granted. Gold and silver went into  hiding,  never  to  re-emerge  during  the  lifetime  of  the  original holders. It  is plausible to see a causal relationship between the fading of  the  rule of  law and  the complete disappearance of gold and  silver from  trade. Virtually all observers  say  that  the  first event caused  the second.

I may be in a minority of one to say that causation goes in the opposite direction. The  disappearance  of  gold  and  silver  coins  as  a means  of exchange was a long-drawn-out, cumulative event. In the end, no one was willing to exchange gold and silver coins for the debased coinage of  the  empire.  At  that  point  the  empire  was  bankrupt;  it  could  no longer  pay  the  troops  that  defended  its  boundaries  against  the barbarians threatening with invasion. This is not to say that the empire did not have other weaknesses. It did, plenty of  it. But  the overriding
weakness was  the monetary weakness.  Centuries  after  centuries  the Mint of the empire could attract less and less gold and silver. Because of  this,  the  empire  was  forced  to  debase  its  coinage  and  the deterioration continued until the bitter end, when the gold flow to the Mint completely dried up.

[...]

The  history  of  the monetary  system  of  the  United  States [and of the World] shows  an ominous  parallel  to  that  of  the Western Roman Empire. As  long  as gold  and  silver  was  still  used  in  trade  at  least  to  some  extent,  the Western Roman Empire was limping along. The modern equivalent of the disappearance of gold and silver is epitomized by the progressive vanishing of the gold basis [meaning the vanishing confidence in the US dollar as an effective long term wealth storage medium].

Coming from a different perspective, this scenario ends up remarkably close to what Frank Biancheri calls "every man for himself": the break down of global commercial bonds, a drastic reduction in global trade and the emergence of several regions of influence deploying different economic and monetary policies, in a world resembling Europe in 1914.

A small but important sign of this unfolding change of the world's monetary system is the recent news that the US sate of Montana is considering a return to gold and silver as means of payment and state accounting units.

Europe.

Europe has possibly the most complex stake in this meeting. On the one hand it is home to about one third of the world's reserve currency, having to some extent benefited from the advantages of being a reserve currency issuer (although in its case the reserve currency issued is a relatively small fraction of total currency in circulation). On the other hand, it holds the third largest foreign currency reserve in the world, being a major creditor of the US.

Two other issues are worth nothing in Europe's stake, first, it is heavily dependent on energy imports, thus being highly vulnerable to world trade disturbances, and more so when its major fossil fuel suppliers are entering terminal decline: Norway, in the case of oil and gas, and Russia in the case of oil. Another important point is that about half of the world's reserve gold is in Europe, as so considerable sums in privately owned bullion and monetary jewelry.

All things considered, Europe is possibly the region having most to benefit (or more to lose in the opposite case) from a new reserve currency system not reliant on a single regional issuer. Up front, for it would prevent serious impact on world trade and the possible consequent disruption of energy imports, but also because it would prevent the Euro from somehow becoming a substitute for the dollar, shifting the "reserve currency curse" to the eastern side of the Atlantic.

Enter the Khaleeji.

There is still another possibility to unfold if a new reserve currency system isn't put in place. After several years of talks and on/off reports in the press about its arrival, the Gulf Cooperation Council states decided in the wake of the present crisis to precipitate the creation of its common currency, the Khaleeji. This is another sign of the confidence break up in the US dollar as a reserve currency, from countries that so far had their currencies pegged to it. It is shaping up to be something like the Euro, governed by a Middle East Central Bank. Interestingly, there's only one country from this block attending the G20 meeting, Saudi Arabia.

Speculation as come about on this new currency being backed by a physical entity, in contrast with the other fiat currencies of the main world trading blocks. Gold is the usual suspect, but that's unlikely, for the region doesn't hold much gold (compared to Europe) and a good part of what it has is non-monetary jewelry.

The important thing about the Khaleeji is that it will be backed by the economic health of countries whose main economic activity is energy production and export. This makes it a real improvement over the US dollar, the Yuan or the Euro, and a potentially emerging reserve currency in case an agreement fails at the G20.

Beyond a new reserve currency system.

The last paragraph contains an obvious caveat: if the Khaleeji comes to be a fiat currency, its backing by energy is purely abstract, shakily built on confidence. And that is the main problem world leaders face today, irrespective of what role energy prices had on the crisis unfolding, one thing is certain: if the energy flow to the world economy can't grow anymore, then all abstract currencies are condemned as long term wealth storage media.

Without economic growth to support their expansion, abstract currencies loose their main advantage over commodities: a supply totally detached from economic activity allowing for monetary policies supporting employment, wealth or international relations. As expansionary measures are put forward to revive an economic growth that might no longer be possible, paper currencies will rapidly deride in value, menacing public confidence invested on them.

A new world reserve currency, resembling the old Ecu for instance, could indeed re-instate balance in world trade, but it won't be in any way a solution for the deriding value of abstract currencies and the policies founded on them. But it would at least bound international players together into finding a way forward.

Display:
Are LEAP/E2020 to be taken seriously?

They read like crackpots



Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Wed Apr 1st, 2009 at 07:00:57 PM EST
Your choice. Everyone adopted the terms "systemic risk" and "systemic crisis". But everyone is not that smart a character.

luis_de_sousa@mastodon.social
by Luis de Sousa (luis[dot]de[dot]sousa[at]protonmail[dot]ch) on Thu Apr 2nd, 2009 at 03:48:23 AM EST
[ Parent ]
A lot of what they say sounds sensible and is more or less aligned with the ET conventional wisdom. However:
  1. they constantly tout their past prediction - they sound like a stock investment newsletter
  2. they often mention the fact that they were not listened to or were derided - this scores 20 poins in the crackpot index
  3. they talk a lot about their "team of experts"
  4. they do not give any details of their analysis - worse, they replace them with gonzo-weird charts like the one I posted


Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Thu Apr 2nd, 2009 at 04:06:31 AM EST
[ Parent ]
Thank you for this important post, Luis!  I especially recommend reading the Fekete pdf.  The prospects he presents are truly stark---"Back to the Dark Ages!"

I found your presentation of recent economic history a la Frank Biancheri to be enlightening and to make perfect sense, in retrospect.

After 2000 the US embarked on a monetary and fiscal policy expansion with little parallel in history: interest rates were brought down to the floor, the monetary mass grew in excess of 10% annually, an expansionary budget stimulated demand for goods and services, many of them imported from countries that accumulated US bonds and other forms of fiat currency. From 2002 to 2007 reserve currency held by central banks grew in excess of 20% annually. In parallel, lax financial regulations and reserve requirements helped creating a pile of invisible debt (out of balance sheets) on that expanding demand and monetary mass, according to some amounting today to more than the world's annual GDP.

Did this incredible expansion ended because oil production plateaued? That's an interpretation, although other views are possible. Oil prices entered the rising phase in 2004, in 2005 were raw materials and 2006 food: no matter what the underlying reason, the supply side stopped following the demand expansion. When Ben Bernanke became chairman of the US Federal Reserve and tried to change course by raising interest rates, so that at least some strain would come to the monetary expansion, it was already too late: the US economy couldn't expand anymore in order to generate the wealth promised by all the debt issued in previous years.

I suspect that the reserve currency created under the latter years of the Greenspan FED constitute much of the "counterfeit currency" of which Jerome has spoken.  The rest would have been created as part of the >$1 Quadrillion derivatives market that has grown like Topsy on steroids over the last ten years.

This diary is an excellent compliment to the insights contained in the Michael Hudson piece from which I so extensively quoted in my current Does US Face G20 Mutiny? diary.  Hudson shows how the existing scheme with the dollar as the de facto international reserve currency has been used by the US to force countries such as China and Russia to finance their own encirclement by US military bases!

I have nothing but well wishes for those foreign leaders who want to create a new reserve currency.  So doing would promote a better climate for world recovery even if the US does not participate.  If and when the US does find the will to save the economy from the elites, it will be easier if such a regime is in place.  I do not know how bad it will have to get for the US to break the grip of Wall Street financial interests over domestic policy, but I think it will eventually happen unless those interests voluntarily reform themselves, as the current policies all but guarantee an economic death spiral.

Very valuable diary!  

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Apr 1st, 2009 at 08:08:08 PM EST
Thanks for your words Geezer.

I've been following this particular issue for more than six years and I've read many articles like the one Michael Hudson pens. What I think is important to realise is that this system didn't evolve simply out of the US' evil.

These systems always emerged out of necessity: in 1944 the US was the world's largest oil producer and held the world's largest gold reserves. When the petro-dollar became the de facto world reserve currency the US was the only military power available to face the USSR and to guarantee the oil flows from the Middle East to the free world. Everyone this side of the iron curtain benefited.

Unfortunately, as the USSR dissolved, the US developed Reaganomics, Bushanomics and Greenspolicy, taking full advantage of their issuer status. It was a way of masking the declining power of the US as an energy producer. We had recently a post on TheOilDrum were Richard Wolff claims that this last phase of the US economic system allowed for rising profits while wages stood still.

The US wage curve describes a path almost equal to energy per capita.

luis_de_sousa@mastodon.social

by Luis de Sousa (luis[dot]de[dot]sousa[at]protonmail[dot]ch) on Thu Apr 2nd, 2009 at 04:41:54 AM EST
[ Parent ]
I do not know how bad it will have to get for the US to break the grip of Wall Street financial interests over domestic policy, but I think it will eventually happen unless those interests voluntarily reform themselves, as the current policies all but guarantee an economic death spiral.

Criminals voluntarily reforming themselves, outside of prison and without a pitchfork at their bellies?  Not betting on that one.

They tried to assimilate me. They failed.

by THE Twank (yatta blah blah @ blah.com) on Fri Apr 3rd, 2009 at 09:31:00 AM EST
[ Parent ]
I had an article in Asia Times in January about an Energy Standard

Gulf Takes Wrong Currency Path

which was also published in the Iranian press to coincide with this high-level presentation in Teheran

Introducing the Petro


"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed Apr 1st, 2009 at 08:52:18 PM EST
By the way Chris, do you have any new insight on the Khaleeji you can share?

luis_de_sousa@mastodon.social
by Luis de Sousa (luis[dot]de[dot]sousa[at]protonmail[dot]ch) on Thu Apr 2nd, 2009 at 03:59:39 AM EST
[ Parent ]
None. I'm dealing with the Iranians, not the Arabs.

But I'm hoping - an Iranian deputy minister woke me up the other morning to tell me so (they tend to forget the 3.5 hr time difference....) - to pitch a Petro energy standard proposal to

These People

in a couple of months. Mind you, that depends on the forthcoming June election in Iran, because ministers are of course political appointments.

It was in fact Kazakhstan's president who got the Russians kick-started on their current proposal for a new global reserve currency. Here's the Aussie press taking the piss out of him

Heavy akmetal: the Kazakh cure for the global economy

The Kazakh President, Nursultan Nazarbayev, has provided some welcome support to his comrade Kevin Rudd's economic essay writing efforts, by trotting out his own 5046-word piece on the state of the world economy.

Personally, I prefer Nazarbeyev's diagnosis and prescription to Rudd's......

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Thu Apr 2nd, 2009 at 05:07:12 AM EST
[ Parent ]
It would be quite ironic, the Persians coming up with an alternative to the dollar as reserve currency...if you allow me a bit of conspiracy theory.

The article by Nazarbayev in a way highlights Frank Biancheri's idea of a fragmented world, divided in several regions of influence. Just around the Gulf there's the GCC and the ECO.

Perhaps we could see several versions of the Ecu/Euro emerging throughout the world...

luis_de_sousa@mastodon.social

by Luis de Sousa (luis[dot]de[dot]sousa[at]protonmail[dot]ch) on Thu Apr 2nd, 2009 at 06:41:00 AM EST
[ Parent ]
Luis de Sousa:
Perhaps we could see several versions of the Ecu/Euro emerging throughout the world...

Quite likely there will be competing attempts at cross border currencies, and people will vote with their feet and use the one that works for them. To me, energy is the simplest and most universally acceptable.

National currencies with purely domestic redeemability for value are another issue: that's where I see a basis of land rental value as important.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Thu Apr 2nd, 2009 at 07:29:50 AM EST
[ Parent ]
Can we trust those G20 leaders to represent their own people, rather than an elite "multinational" ring? Their appearance as problem solvers for own peoples is diminishing fast.

Michael Hudson is good as always:

Strange as it may seem - and irrational as it would be in a more logical system of world diplomacy - the "dollar glut" is what finances America's global military build-up. It forces foreign central banks to bear the costs of America's expanding military empire - effective "taxation without representation." Keeping international reserves in "dollars" means recycling their dollar inflows to buy U.S. Treasury bills - U.S. government debt issued largely to finance the military ....

It is not "foreign faith in the U.S. economy" that leads foreigners to "put their money here." That's a silly cartoon of a more sinister dynamic. The "foreigners" in question are not consumers buying U.S. exports, nor are they private-sector "investors" buying U.S. stocks and bonds. The largest and most important foreign entities putting "their money" here are central banks, and it is not "their money" at all. They are sending back the dollars that foreign exporters and other recipients turn over to their central banks for domestic currency ....

The military overhead is much like a debt overhead, extracting revenue from the economy .... The U.S. media somehow neglect to mention that the U.S. government is spending hundreds of billions of dollars abroad - not only in the Near East for direct combat, but to build enormous military bases to encircle the rest of the world, to install radar systems, guided missile systems and other forms of military coercion ....

.... The U.S. economy can create dollars freely, now that they no longer are convertible into gold or even into purchases of U.S. companies, inasmuch as America remains the world's most protected economy. It alone is permitted to protect its agriculture by import quotas, having "grandfathered" these into world trade rules half a century ago. Congress refuses to let "sovereign wealth" funds invest in important U.S. sectors.

So we are confronted with the fact that the U.S. Treasury prefers foreign central banks to keep on funding its domestic budget deficit, which means financing the cost of America's war in the Near East and encirclement of foreign countries with rings of military bases. The more "capital outflows" U.S. investors spend to buy up foreign economies -the most profitable sectors, where the new U.S. owners can extract the highest monopoly rents - the more funds end up in foreign central banks to support America's global military build-up. No textbook on political theory or international relations has suggested axioms to explain how nations act in a way so adverse to their own political, military and economic interests. Yet this is just what has been happening for the past generation.

by das monde on Thu Apr 2nd, 2009 at 01:13:31 AM EST
What could happen then if a new coordinated reserve currency fails to emerge? The answer is simple: the US dollar will stop being the world trading benchmark. A period will then unfold during which trading nations won't have a clear worldwide unit to value their goods, much less to store value for future trading. Possibly, some regional currencies might be tried on a geographically limited basis, and another alternative might emerge with a currency for which there isn't much policy to go about: gold. The consequences of such transition will be immense; an Hungarian mathematician called Antal Fekete, claims to already be getting signs in that sense, with gold futures entering backwardation late last year. This is a rather technical issue, way beyond the aims of this simple essay, but with or without backwardation, it is important to know what Fekete foresees [pdf!] in case the present system ceases to exist without a clear replacement
Let me now quote Fekete (PDF):
Tom says that he does not see things evolving in the same catastrophic manner as I do. For example, he believes that "there will always be willing buyers and sellers of gold in some quantity if the price is right." Buyers - si, sellers - no! That's just the whole point. The lack of credibility of irredeemable currency will be such that no one in his right mind will accept it in exchange for gold, the ultimate liquidator of debt. Previously, people were willing to trade their gold because they could always replenish their supply from Comex warehouses. That means, in other words, that the irredeemable dollar could still be used as a liquidator of debt (i.e., gold still has a competitor). But let them close the Comex gold warehouses. This is a quantum jump; it means that the irredeemable dollar can no longer be used to liquidate debt, e.g., debt incurred by those holding short positions in gold futures. It is essential not to belittle the import of this observation.
He's considering a hypothetical scenario in which COMEX ceases to operate.
Tom thinks that I am an alarmist in believing that the permanent closing of the gold window at the Comex will mean a cessation in gold mining, loss of segregated metal deposits, and institutionalized theft of ETF holdings.

...

I have nowhere said that the end of the fiat money system will follow the closing of the gold window at the Comex in a matter of days. Sure, finance ministers and central bankers will try to "muddle through". It is not possible to predict how long the death throes of fiat money will continue. Tom may be right in suggesting that it will take many years, and claims of an imminent monetary and economic collapse will again turn out to be wrong.

And, just today (thanks to LEP in the open thread)
ECB is accused illegally selling

gold to Deutshe Bank so that the latter could deliver on its illegal naked shorts of gold.

Well, there is the technical point that taking a short position in a futures contract is not an illegal short. But the market for gold does seem to have become "cornered" spontaneously by "gold bugs" taking long positions in futures, in a scenario reminiscent of Fekete's.

Seeking Alpha: Did the ECB Save COMEX from Gold Default?

On Tuesday morning, gold derivatives dealers, who had sold short in the face of a fast rising gold price, faced a serious predicament. Some 27,000 + contracts, representing about 15% of the April COMEX gold futures contracts remained open. Technically, short sellers are required to give "notice" of delivery to long buyers. However, in reality, buyers are the ones who control the amount of gold to be delivered. They "demand" delivery of physical gold by holding futures contracts past the expiration date. This time, long buyers were demanding in droves.

In normal times, very few people do this. Only about 1% or less of gold contracts must be delivered. The lack of delivery demand allows the casino-like world of paper gold futures contracts to operate. Very few short sellers actually expect or intend to deliver real gold. They are, mostly, merely playing with paper. It was amazing, therefore, when March 30, 2009 came and passed, and so many people stood for delivery, refusing to part with their long gold futures positions.

Wow.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Fri Apr 3rd, 2009 at 08:58:31 AM EST
Migeru:
taking a short position in a futures contract is not an illegal short
Oops, I was wrong...

Did the ECB Save COMEX from Gold Default? -- Seeking Alpha

It is quite important to determine whether or not Deutsche Bank was bailed out by the ECB because that will answer a lot of questions about allegations of naked short selling on the COMEX. If the ECB knew that its gold would be used as post ipso facto "cover" for uncovered shorting, staffers at the central bank might be co-conspirators. At any rate, if the German bank did sell short on futures contracts without having enough vaulted gold it sold a naked short. It also means that the ECB has facilitated a major rule violation in a jurisdiction (the USA) with which Europe is supposed to have extensive joint regulatory agreements, any number of which may have been violated by this action of the ECB. At the very least, naked short selling is a blatant violation of CFTC regulations, which require 90% cover of all deliverable metals contracts. If the delivered gold came directly, or indirectly, from the ECB, it means that Deutsche Bank's gold short contracts were "naked" at the time they were entered into.
(my emphasis)

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Fri Apr 3rd, 2009 at 09:42:28 AM EST
[ Parent ]
I had a good read of it, and the good crop of comments.

The author is under a misconception as to the role of futures markets. Selling "naked short" contracts is what COMEX and all the other futures markets is for. The regulation he has fixed upon relates to forward physical/OTC contracts.

While I can only guess why DB were so massively short of the market, picking up the gold from a Central Bank (probably leased), to fulfil the contract, is routine, although the size of the transaction is not.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Apr 3rd, 2009 at 01:38:39 PM EST
[ Parent ]
Thanks.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Sat Apr 4th, 2009 at 04:40:12 AM EST
[ Parent ]
Thanks for pulling this together.

Putting it simple: as more trillions flow more likely  will it be for gold to replace paper as long term wealth store medium.

Continuing on this tack, at some point the wholesale gold market will break and the paper gold (futures) value goes down to zero. If that happens it is game over - governments lose the ability to perform monetary policy and parking wealth in gold will be the greatest investment of all, thus killing trade and industrial activity.

 

luis_de_sousa@mastodon.social

by Luis de Sousa (luis[dot]de[dot]sousa[at]protonmail[dot]ch) on Fri Apr 3rd, 2009 at 10:07:40 AM EST
[ Parent ]
The thing I don't understand is why the system still behaves as if gold backed fiat currencies.

Fekete ends with

I think Tom's greatest mistake is to interpret the move into backwardation, or gold to enter the `fever phase', as "gold's regaining fully-recognized monetary status". Unfortunately, just the opposite is the case. Whether officially recognized or not, gold's monetary status was never in doubt. Gold has always been the monetary commodity par excellence, due to the fact that it has constant marginal utility (or, if you will, the fact that the marginal utility of no other commodity declines at a rate slower than that of gold).

What we are witnessing is a transition that deprives gold of its monetary qualities. Gold in hiding cannot and will not act as money. More to the point, absent gold, nothing else can or will. The disappearance of money, that can be trusted, fatally undermines the legal system, the sanctity of contracts, habeas corpus, any and all provisions of law and order that we take for granted. Under these conditions nobody can operate a gold mine, nobody can run a gold refinery, nobody can guarantee segregated gold deposits, and nobody can prevent the institutionalized theft of ETF holdings. Welcome to the Madoff economy! (See References below: Paul Krugman's column in The New York Times). Jail one Madoff, two others will jump into his shoes.

Can someone explain what is meant by
Gold has always been the monetary commodity par excellence, due to the fact that it has constant marginal utility (or, if you will, the fact that the marginal utility of no other commodity declines at a rate slower than that of gold)
Also, I don't understand why
absent gold, nothing else can or will [act as money]
There is always a commodity with a slowest decay or marginal utility. If gold goes into hiding, some other commodity will take its place, surely?

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Fri Apr 3rd, 2009 at 10:42:24 AM EST
[ Parent ]
Probably semantics again but what utility has gold?

It may stay nice to look at for a million years, but you can't live on it, keep yourself warm with it, or use it to send emails - all of which I would call forms of utility.

The problem is that that a thousand economists probably have ten thousand definitions of money between them - certainly over time....

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Apr 3rd, 2009 at 11:06:05 AM EST
[ Parent ]
ChrisCook:
It may stay nice to look at for a million years, but you can't live on it, keep yourself warm with it, or use it to send emails - all of which I would call forms of utility.
I agree with that - which is why I can't understand gold bugs.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Fri Apr 3rd, 2009 at 11:10:41 AM EST
[ Parent ]
Probably semantics again but what utility has gold?
Actually, some of the ill effects of a spike or "new permanent plateau" for the value of gold have to do with the actual utility of gold.  

Among other uses, gold is the material par excellance for coating connectors where low noise performance is required.  I designed a connector that terminated 27 pair shielded audio cables into a connector socket with gold plated contacts.  I used 80 micro inches RMS gold plating on the printed circuit board that terminated the cable.  It terminated the cable for less than $1.00/shielded pair, including both connectors.  That was in 1978.  That would be over $10/ pair today.  There are many commercial uses for gold beyond jewelry.  These uses suffer from the consequences of gold also being seen as a de facto store of monetary value when gold prices surge.

Of course the drawbacks to gold as the standard of monetary value include its perverse inability to increase its quantity by a few percent per year.  Another (barely) conceivable drawback is that, given that it is a naturally occurring element, it is always possible that some new discovery could vastly increase the quantity of available gold.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Apr 3rd, 2009 at 01:46:29 PM EST
[ Parent ]
Of course you are correct.

I'd also point out that there is no reason to allow "gold to go into hiding." Governments have tanks and infantry divisions. Rich individuals have a pile of gold. I'm sure they can be persuaded to store said gold in the national bank for the duration of the emergency.

by Metatone (metatone [a|t] gmail (dot) com) on Fri Apr 3rd, 2009 at 01:22:53 PM EST
[ Parent ]
Gold has always been the monetary commodity par excellence, due to the fact that it has constant marginal utility (or, if you will, the fact that the marginal utility of no other commodity declines at a rate slower than that of gold)

My interpretation of this is: gold is a non-ferrous metal, a gold coin lasts forever.

absent gold, nothing else can or will [act as money]

I think this passage means exactly that, I don't agree with him on that ... you know energy at least should do the same, if not better job.

Mind here that Fekete is not your regular economist and his way of thinking is hard to grasp even to regular economists.

And thinking about what Chris wrote, there's one simple reason why gold is (has been?) the ultimate currency: it is effectively impossible to falsify. It was the heaviest metal known to man for millennia I believe; even today heavier metals are more expensive, you can try a fake gold coin, but it will be costlier.

Gold has the double the density of silver for instance, which in its turn is easily falsifiable with lead...

luis_de_sousa@mastodon.social

by Luis de Sousa (luis[dot]de[dot]sousa[at]protonmail[dot]ch) on Fri Apr 3rd, 2009 at 01:25:26 PM EST
[ Parent ]
Well, the conference is over, they celebrated a lot, but didn't achieve much... Positive note on tax heavens though.

Russia and China are serious with the new reserve currency system (really worth reading in full):

Russia and China back currency study

Russia proposed on Thursday an IMF or G20 study on creating a new international reserve currency and China reiterated support for a broader discussion of the dollar's role that was missing at the London G20 summit.

Strengthened regional currencies would be a basis for the new unit, which could also be partially backed by gold, Russia said in a statement released on the sidelines of the summit.

Let's hope that either Frank Biancheri is wrong on his timetable for the US$ collapse or that either Russia/China can bring a new system up before that.

luis_de_sousa@mastodon.social

by Luis de Sousa (luis[dot]de[dot]sousa[at]protonmail[dot]ch) on Fri Apr 3rd, 2009 at 01:30:06 PM EST


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