Ron Hera- Currency Wars Continue

The Fiasco of Fiat Money [Mises Daily]


Today’s worldwide paper-, or “fiat-,” money regime is an economically and socially destructive scheme — with far-reaching and seriously harmful economic and societal consequences, effects that extend beyond what most people would imagine.

Fiat money is inflationary; it benefits a few at the expense of many others; it causes boom-and-bust cycles; it leads to overindebtedness; it corrupts society’s morals; and it will ultimately end in a depression on a grand scale.

All these insights, however, which have been put forward by the scholars of the Austrian School of economics years ago, hardly play any role among the efforts of mainstream economists, central banks, politicians, or bureaucrats in identifying the root cause of the current financial and economic crisis and, against this backdrop, formulating proper remedies.

This should not come as a surprise, though. For the (intentional or unintentional) purpose of policy makers and their influential “experts” — who serve as opinion molders — is to keep the fiat-money regime going, whatever it takes.


The fiat-money regime essentially rests on central banking — meaning that a government-sponsored central bank holds the money-production monopoly — and fractional-reserve banking, denoting banks issuing money created out of thin air, or ex nihilo.

In The Mystery of Banking, Murray N. Rothbard uncovers the fiat-money regime — with central banking and fractional-reserve banking — as a form of embezzlement, a scheme of thievery.[1]

Rothbard’s conclusion might need some explanation, given that mainstream economists consider the concept of fiat money as an economically and politically desirable, acceptable, and state-of-the-art institution.

An understanding of the nature and consequences of a fiat-money regime must start with an appreciation of what money actually is and what it does in a monetary exchange economy.

Money is the universally accepted means of exchange. Ludwig von Mises emphasized that money has just one function: the means-of-exchange function; all other functions typically ascribed to money are simply subfunctions of money’s exchange function.[2]

With money being the medium of exchange, a rise in the money stock does not, and cannot, confer a social benefit. All it does is reduce, and necessarily so, the purchasing power of a money unit — compared to a situation in which the money stock had remained unchanged.

What is more, an increase in the money stock can never be “neutral.” It will necessarily benefit early receivers of the new money at the expense of the late receivers, or those who do not receive anything of the new money stock — an insight known as the “Cantillon effect.”

Because a rise in the money stock benefits the money producer most — as he obtains the newly created money first — any rational individual would like to be the among the money producers; or even better: to be the sole money producer.

Those who are willing to disrespect the principles of the free market (that is, the unconditional respect of private property) will want to obtain full control over money production (that is, holding the money production monopoly).

Once people have been made to think that the state (the territorial monopolist of ultimate decision making with the right to tax) is a well-meaning and indispensible agent, money production will sooner or later be monopolized by the state.

The (admittedly rather lengthy) process through which government obtains the monopoly of money production has been theoretically laid out by Rothbard in What Has Government Done to Our Money?.[3]

Having obtained the monopoly of money production, government will replace commodity money (in the form of, say, gold and silver) with fiat money, and the regime of legalized counterfeiting gets started.

Commercial banks will press for fractional-reserve banking, meaning that they should be legally allowed to issue new money (fiduciary media) through credit extension in excess of the reserves they obtain from their clients. Fractional-reserve banking is a rather attractive profit-making scheme for lenders; and it provides government with cheap credit for financing its handouts (well) in excess of regular tax receipts.

Fiat money will be injected through bank-circulation credit: banks extend credit and issue new money balances which are not backed by real savings. Economically speaking, this is worse than counterfeiting money.

Fiat money is not only inflationary, thereby causing all the economic and societal evils of eroding the purchasing power of money and leading to a non-free-market related redistribution of income and wealth among the people; banks’ circulation credit expansion also artificially lowers the market interest rate to below the rate that would prevail had the credit and fiat-money supply not been artificially lowered, thereby making debt financing unduly attractive, especially for government.

It is the artificial lowering of the market interest rate that also induces an artificial boom, which leads to overconsumption and malinvestment, and which must ultimately end in a bust. Mises put it succinctly:

The boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances.[4]


A fiat-money regime depends essentially on the demand for money. As long as people are willingly holding fiat money (and fiat-money-denominated government, bank, and corporate bonds, for that matter), the fiat-money regime can be run quite smoothly, for then people raise their demand for fiat money as its supply increases.

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Escaping the dollar trap

By Zhang Monan (China Daily)

Direct yen-yuan trading is another step in China’s bid to extricate itself from excessive dependence on US currency

As part of efforts to boost bilateral trade and investment, China and Japan started direct trading of their currencies in Shanghai and Tokyo on June 1.

Allowing the yuan to directly trade with another major currency other than the US dollar will help China in its efforts to acquire a wider trading and financial presence.

The biggest lesson China has learned from the global financial crisis is that it should push for reforms of the international monetary system and accelerate the internationalization of the yuan. It has also become increasingly evident that the dollar-dominated global monetary system has not only interrupted the world’s normal economic growth mechanism, but also caused global economic and financial chaos. The “dollar trap” can be found in every corner of the world.

The establishment of the “dollar era” during the latter half of the 20th century was to a large degree a consequence of the United States’ decisive role in the making of global market rules and institutions. The US dollar has thus become the center of the world’s monetary system while other countries, either export or resources-dependent, have to peg their currencies to the dollar, thus weakening the independence of their monetary policies.

Such an imbalance has resulted in “appreciation against the dollar, but depreciation at home” for some currencies and aggravated the imbalances in global trade. Against this backdrop, how to gradually depeg their currencies from the dollar and increase their monetary independence has become a pressing concern for some countries.

For a long time, China only allowed the yuan to be directly traded with the dollar and all transactions with other currencies had to be via the greenback. As a result, the value of the yuan and its issuance have been influenced by the monetary policies of the US. This has made it difficult for a real exchange rate of the yuan to be established.

The internationalizing of the yuan has accelerated since 2010, especially this year with the HSBC issuing yuan bonds in London in April, a move that started the establishment of another offshore financial center of the yuan besides Hong Kong, and the World Bank’s agreement with China’s central bank for commissioned investment in China’s inter-bank securities market.

China remains Japan’s largest trading partner. In 2011, the bilateral trade volume increased to a record high of $344.9 billion, an increase of 14.3 percent year-on-year. However, 60 percent of the bilateral trade volume between the two countries is settled via the dollar, thus bringing both countries increased transaction costs and settlement risks and prompting them to raise the ratio of trade settlements via their own currencies.

There have been great motivations within Japan for direct trading of yen with the yuan. Japan’s accelerated industrial and population ageing over the past decade has been a key factor in its failure to pull out of a lingering recession. To alleviate the impact of the yen’s appreciation upon its economy, Japan began moving its focus of economic growth overseas in the 1980s. Under such a strategy, some Japanese enterprises that have lost advantages at home have moved their manufacturing and operation bases overseas in pursuit of bigger profits.

Since the catastrophic earthquake and the ensuing tsunami in March last year, Japan has accelerated the shift of its industrial development and investment to other countries, especially to China. In this context, direct yuan-yen trading without the involvement of the US dollar will not only offer more opportunities for Japan’s industrial and trade growth, it will also promote deeper Asian economic integration.

Past practices indicate that if a currency is to become a leading international currency, it starts from acquiring pricing and settlement position in the trade of international bulk commodities, especially energy sources, as indicated by the establishment of the dollar’s hegemony in world’s energy trade over the past decades. The formation of a “dollar, oil dollar and commodity dollar” cycle, a closed cycle of global capital flow, has to a large extent decided the distribution of global wealth.

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Guest Post: A Central Bank Running Suicide? SNB Prints At Pace Not Seen Since EUR/CHF Parity In August 2011 [Zerohedge]

Submitted by George Dorgan

A Central Bank Running Suicide? SNB Prints At Pace Not Seen Since EUR/CHF Parity In August 2011

The most recent money supply data from the Swiss National Bank (SNB) has shown increases of huge amounts. As compared with its loss of 19 bln. francs in 2010 (3% percent of the Swiss GDP), the central bank printed tremendous 17.3 bln. in the week ending in June 1st and 13 bln. in the one ending in May 25th.

These numbers were not seen since August 2011 when the SNB increased money supply by 50 bln and 40 bln per week buying the EUR/CHF at rates between 1.00 and 1.13. Now, however they are buying at 1.20 and are risking extreme losses, especially because many other central banks are dumping euros.

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Iran designs alternative system for SWIFT: CBI

Governor of the Central Bank of Iran (CBI) Mahmoud Bahmani says the country has designed and implemented a new system for conducting international transactions.

Head of the Central Bank of Iran (CBI) Mahmoud Bahmani

Bahmani said on Saturday the new system, which has already been activated, would replace Worldwide Interbank Financial Telecommunication (SWIFT)

On March 15, SWIFT CEO Lazaro Campos said in a statement that the society has decided to discontinue offering services to Iranian banks which are subject to financial sanctions imposed by the European Union.

On January 23, the EU foreign ministers approved new sanctions on Iran’s financial and oil sectors, which prevent member countries from importing Iranian crude or dealing with its central bank.

Experts believe that SWIFT’s new action is meant to fully enforce EU sanctions, as global financial transactions are impossible without using SWIFT.

Bahmani rejected reports about a Japanese bank freezing transactions with Iranian banks.

On May 17, the Reuters reported that Bank of Tokyo-Mitsubishi UFJ has frozen USD 2.6 billion of assets of Iranian banks under an order by the New York District Court earlier this month.

Jim Rogers Interview about Hard Assets, Oil, and Currency Diversification

Welcome to the Currency War, Part 1: Iceland and the Tragedy of the Commons []


Think of devaluation as the monetary equivalent of the “tragedy of the commons”. In a nutshell, if everyone shares ownership of or has access to a given resource, it is in each individual’s interest to grab what they can as quickly as possible, which soon depletes the resource.

With currency exchange rates, as with fisheries and sheep pastures, there’s an advantage for those who move first and pain for those who dither. Consider Iceland’s nearly-instantaneous recovery from its epic banking crash:

In European Crisis, Iceland Emerges as an Island of Recovery 
VESTMANNAEYJAR, Iceland—Three and a half years after Iceland collapsed in a heap, Dadi Palsson’s fish-processing plant has the air of a surprising economic recovery.

Mr. Palsson arrived at 4 a.m. on a recent workday. Twelve tons of cod were coming in. Soon, his workers would bone, slice and pack the fish for loading onto towering container ships headed abroad.

In 2008, Iceland was the first casualty of the financial crisis that has since primed the euro zone for another economic disaster: Greece is edging toward a cataclysmic exit from the euro, Spain is racked by a teetering banking system, and German politicians are squabbling over how to hold it all together.

But Iceland is growing. Unemployment has eased. Emigration has slowed.

Iceland has a significant advantage over stressed euro-zone countries—a currency that could be devalued. That has turned its trade deficit into a surplus and smoothed its recovery.

So brisk is the fish business that Mr. Palsson’s factory draws Polish workers to this island off an island, a heart-shaped dollop of volcanic rock five miles from Iceland’s south coast.

“Every house is full because we can offer so many jobs,” said Mr. Palsson, 37 years old. On his humming factory floor, cod whip through machines that lop off heads and slice out bones. Rows of workers in Smurf-blue smocks lean over illuminated tables to cut the filets.

Iceland—with its own currency, its own central bank, its own monetary policy, its own decision-making and its own rules—had policy options that euro-zone nations can only fantasize about. Its successes provide a vivid lesson in what euro countries gave up when they joined the monetary union. And, perhaps, a taste of what might be possible should they leave.

Iceland fell hard in 2008. Its engorged banking system sunk and unemployment soared. The government was jeered out of office by dispirited voters in angry street protests. Young people packed their bags. As in the euro zone, the International Monetary Fund parachuted in with a bailout.

Its currency devalued by half. That boosted exports, like Mr. Palsson’s fish, and trimmed costly imports, like cars. The weakened krona was hard on homeowners who borrowed in foreign currency, but Iceland’s judges and policy makers orchestrated mortgage relief. Expensive foreign goods also ignited inflation. Consumer prices have risen 26% since 2008.

That rescue, in turn, weighed on the financial system. But unlike Ireland, for example, Iceland let its banks fail and made foreign creditors, not Icelandic taxpayers, largely responsible for covering losses.

Iceland also imposed draconian capital controls—anathema to the European Union doctrine of open financial borders—that have warded off the terrifying capital and credit flights that hit Greece, Ireland and Portugal, and now test Spain and Italy.

And instead of rushing into the sort of spending cuts that have ravaged Greece and Spain, Iceland delayed austerity. Initially, the country even increased social-welfare payments to its poorest citizens, whose continued spending helped cushion the economy.

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China responds to economic weakness by letting RMB depreciate [SoberLook]

by Walter Kurtz

Further signs of economic slowdown in China have shown up in the HSBC China PMI index.

WSJ: – The preliminary May reading marks the seventh straight month the index has been in contractionary territory. A reading below 50 indicates contraction from the previous month, while anything above that indicates growth.

“China’s real economy is getting weaker,” Citi Investment economist Ding Shuang said following the release of the PMI.

“The likelihood that May industrial production and fixed-assets investment, two major gauges of economic activity, will improve is slight. The data are likely to stay weak,” he added.

Ding expects growth in China’s gross domestic product to slow to 7.5% in the second quarter from a year earlier, slowing from the first quarter’s 8.1% expansion, which was the weakest in more than three years.

: – … the government had asked for project proposals by the end of June, even for those initially earmarked for the end of the year, said the China Securities Journal, one of the country’s top financial papers.To address this slowdown, we’ve already seen China accelerating infrastructure projects approvals.

Citing government sources, the article said Beijing did not rule out bringing forward next year’s projects, if it thought more investments would be needed to stimulate the economy.

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Currency Wars – James Rickards

Inflation or Hyperinflation? [FOFOA]

Whilst discussing the demise of the Canadian penny in front of a Congressional panel, Fed Chairman Ben Bernanke demonstrates that “transactional currency is simply a notional, purely symbolic token medium of exchange, much more replaceable, resource-efficient and environmentally friendly than mining stupid metals for stupid coins.”
(NotReal News)

Remember my post around this same time last year titled Deflation or Hyperinflation? At that time, the debate between deflation and hyperinflation was all the rage, and so I wrote a post to a prominent and long-time deflationist named Rick Ackerman, who later stopped by in the comments. In fact, most of my hyperinflation posts have been written in the context of the deflationists’ arguments.

I can’t say that the debate has shifted from deflation to inflation over the last year, but it sure seems that the arguments coming across my desk these days are for rising inflation with the exclusion of hyperinflation. My position hasn’t changed. But this does give me the opportunity to present my position against a different premise, that of inflation without currency collapse. I would guess that some of you will have a completely different view of hyperinflation by the time you finish this post. If so, please let me know in the comments.

But first I need to make it clear once again that this hyperinflation discussion is not about timing. It’s about how it all ends, and it’s better (for a saver) to be a decade too early than a minute too late. The other side (whoever it may be) often tries to make the debate about timing. It is not about timing and I don’t do timing, but that doesn’t mean the end is far away. If anything, it’s overdue in the same way a big earthquake can be overdue. In ‘Deflation or Hyperinflation?’ I wrote:

The whole point of the [hyperinflation] debate is about the denouement, the final outcome of this 100-year dollar experiment. It is about the ultimate end, and the debate has been going on ever since the 70s when the dollar was separated from gold and it became clear that there would be an end. The debate is about determining the best stance someone should take who has plenty of net worth. And I do mean PLENTY. People of modest net worth, like me, can of course participate in the debate. But then it can become confusing at times when we think about shortages or supply disruptions of necessities like food. Of course you need to look out for life’s necessities first and foremost. But beyond that, there is real value to be gained by truly understanding this debate.

Here is FOA on timing, from a post in which he specifically predicted dollar “hyper price inflation”:


We, and I, as physical gold advocates, don’t need timing for this position! Timing is for poor, paper traders. We are neither and our solid, long term, one call over several years to hold physical gold will confirm our reasoning. There is no stress for me to own this ancient asset as it is in a good proportion to all my other wealth.

There is no trading an economic system whose currency is ending its timeline. Smart, quick talking players will joke at our expense until fast markets and locked down paper gold positions block their “trading even” move into physical at any relative cheap price. Mine owners will see any near term profits evaporate into a government induced pricing contango that constrains stock equity with forced selling at paper gold prices. 

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Currency Debasement and Social Collapse


[In a recent debate between Ron Paul and Paul Krugman, Dr. Paul said, "Professor Krugman indicates we just want to go back 100 years or so. That's not exactly true. We want to improve on what life was like back then. But he wants to go back 1,000 years or 2,000 years, just as the Romans and the Greeks … debased their currency."

In Human Action, Ludwig von Mises explained how currency debasement contributed to the fall of the classical civilization of antiquity.]

Knowledge of the effects of government interference with market prices makes us comprehend the economic causes of a momentous historical event, the decline of ancient civilization.

It may be left undecided whether or not it is correct to call the economic organization of the Roman Empire capitalism. At any rate it is certain that the Roman Empire in the 2nd century, the age of the Antonines, the “good” emperors, had reached a high stage of the social division of labor and of interregional commerce. Several metropolitan centers, a considerable number of middle-sized towns, and many small towns were the seats of a refined civilization.

The inhabitants of these urban agglomerations were supplied with food and raw materials not only from the neighboring rural districts, but also from distant provinces. A part of these provisions flowed into the cities as revenue of their wealthy residents who owned landed property. But a considerable part was bought in exchange for the rural population’s purchases of the products of the city dwellers’ processing activities.

There was an extensive trade between the various regions of the vast empire. Not only in the processing industries, but also in agriculture there was a tendency toward further specialization. The various parts of the empire were no longer economically self-sufficient. They were interdependent.

What brought about the decline of the empire and the decay of its civilization was the disintegration of this economic interconnectedness, not the barbarian invasions. The alien aggressors merely took advantage of an opportunity which the internal weakness of the empire offered to them. From a military point of view the tribes which invaded the empire in the 4th and 5th centuries were not more formidable than the armies which the legions had easily defeated in earlier times. But the empire had changed. Its economic and social structure was already medieval.

The freedom that Rome granted to commerce and trade had always been restricted. With regard to the marketing of cereals and other vital necessities it was even more restricted than with regard to other commodities. It was deemed unfair and immoral to ask for grain, oil, and wine, the staples of these ages, more than the customary prices, and the municipal authorities were quick to check what they considered profiteering. Thus the evolution of an efficient wholesale trade in these commodities was prevented.

The policy of the annona, which was tantamount to a nationalization or municipalization of the grain trade, aimed at filling the gaps. But its effects were rather unsatisfactory. Grain was scarce in the urban agglomerations, and the agriculturists complained about the unremunerativeness of grain growing.[1]

The interference of the authorities upset the adjustment of supply to the rising demand.

The showdown came when in the political troubles of the 3rd and 4th centuries the emperors resorted to currency debasement. With the system of maximum prices, the practice of debasement completely paralyzed both the production and the marketing of the vital foodstuffs and disintegrated society’s economic organization. The more eagerness the authorities displayed in enforcing the maximum prices, the more desperate became the conditions of the urban masses dependent on the purchase of food.

Commerce in grain and other necessities vanished altogether.


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So Long, US Dollar

By: Marin Katusa

There’s a major shift under way, one the US mainstream media has left largely untouched even though it will send the United States into an economic maelstrom and dramatically reduce the country’s importance in the world: the demise of the US dollar as the world’s reserve currency.

For decades the US dollar has been absolutely dominant in international trade, especially in the oil markets. This role has created immense demand for US dollars, and that international demand constitutes a huge part of the dollar’s valuation. Not only did the global-currency role add massive value to the dollar, it also created an almost endless pool of demand for US Treasuries as countries around the world sought to maintain stores of petrodollars. The availability of all this credit, denominated in a dollar supported by nothing less than the entirety of global trade, enabled the American federal government to borrow without limit and spend with abandon.

The dominance of the dollar gave the United States incredible power and influence around the world… but the times they are a-changing. As the world’s emerging economies gain ever more prominence, the US is losing hold of its position as the world’s superpower. Many on the long list of nations that dislike America are pondering ways to reduce American influence in their affairs. Ditching the dollar is a very good start.

In fact, they are doing more than pondering. Over the past few years China and other emerging powers such as Russia have been quietly making agreements to move away from the US dollar in international trade. Several major oil-producing nations have begun selling oil in currencies other than the dollar, and both the United Nations and the International Monetary Fund (IMF) have issued reports arguing for the need to create a new global reserve currency independent of the dollar.

The supremacy of the dollar is not nearly as solid as most Americans believe it to be. More generally, the United States is not the global superpower it once was. These trends are very much connected, as demonstrated by the world’s response to US sanctions against Iran.

US allies, including much of Europe and parts of Asia, fell into line quickly, reducing imports of Iranian oil. But a good number of Iran’s clients do not feel the need to toe America’s party line, and Iran certainly doesn’t feel any need to take orders from the US. Some countries have objected to America’s sanctions on Iran vocally, adamantly refusing to be ordered around. Others are being more discreet, choosing instead to simply trade with Iran through avenues that get around the sanctions.

It’s ironic. The United States fashioned its Iranian sanctions assuming that oil trades occur in US dollars. That assumption – an echo of the more general assumption that the US dollar will continue to dominate international trade – has given countries unfriendly to the US a great reason to continue their moves away from the dollar: if they don’t trade in dollars, America’s dollar-centric policies carry no weight! It’s a classic backfire: sanctions intended in part to illustrate the US’s continued world supremacy are in fact encouraging countries disillusioned with that very notion to continue their moves away from the US currency, a slow but steady trend that will eat away at its economic power until there is little left.

Let’s delve into both situations – the demise of the dollar’s dominance and the Iranian sanction shortcuts – in more detail.

Signs the Dollar Is Going the Way of the Dodo

The biggest oil-trading partners in the world, China and Saudi Arabia, are still using the petrodollar in their transactions. How long this will persist is a very important question.

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Floating Exchange Rates: Unworkable and Dishonest []

By Keith Weiner

Milton Friedman was a proponent of so-called “floating” exchange rates between the various irredeemable paper currencies that he promoted as the proper monetary system.  Many have noted that the currencies do not “float”; they sink at differing rates, sometimes one is sinking faster and then another. This article focuses on something else.

Under gold, a nation or an individual cannot sustain a deficit forever.  A deficit is when one consumes more than one produces.  One has a negative cash flow, and eventually one runs out of money.  The economy of a household or a national is therefore subject to discipline—sooner or later.

Friedman asserted that floating exchange rates would impose the same kind of forces on a nation to balance its exports and imports.  He claimed that if a nation ran a deficit, that this would cause its currency to fall in value relative to the other currencies.  And this drop would tend to reverse the deficits as the country would find it expensive to import and buyers would find its goods cheap to import.

Friedman was wrong.

To see why, one must look at the concept known to economists as “Terms of Trade”.  This phrase refers to the quantity of goods that can be purchased with the proceeds of the goods exported.  For example, country X uses the xyz currency.  It exports xyz1000 worth of goods and it can thereby pay for xyz1000 worth of imports.  But what happens if the xyz drops relative to the currency’s of X’s trading partners, because X is running a trade deficit?

The country exports the same goods as before, but they are now worth less on the export market.  So X can pay for fewer goods than before.  Buying the same amount of goods will result in a larger deficit.

At this point, one may be tempted to say “Ahah, Friedman was right!”  But remember, we are not talking about a gold standard.  We are talking about an irredeemable paper money system.  Money is borrowed into existence. Looking at the trade deficit from the perspective of Terms of Trade, we see that trade deficits lead to budget deficits, which leads to a falling currency, which leads to increased trade deficits.  It is not a negative feedback loop, which is self-limited and self-correcting.  It is a positive feedback loop.

There is no particular limit to this vicious cycle until the country in question accumulates so much debt that buyers refuse to come to its bond auctions. And this is not a correction or a reversal of the trend; it is the utter destruction of the currency and the wealth of the people who are forced to use it.

And, of course, Friedman had to be aware that America was likely to be biggest trade deficit runner in the world.  Its currency, the dollar, was (and is) the world’s reserve currency.  That means that every central bank in the world held dollars as the asset, and pyramided credit in their own currencies on top of the dollars.

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Keiser Report: Too Broke To Go Broke

Visibly Annoyed and Aloof Obama Gets Slammed by Brazilian President Over U.S. Monetary Policy [shtfplan]


In a meeting where neither looks very happy with the other, Brazil’s President Dilma Rousseff lambastes President Obama over expansionist monetary policies that are having a direct impact on the currencies of emerging economies, including her own.

Throughout the clip, as Rousseff discusses her concerns over US monetary policy, President Obama seems visibly annoyed and distant, giving the impression he’d rather be teeing off than discussing the critical monetary, fiscal and economic issues facing the world. The President’s body language – his twiddling of the thumbs, rubbing the corners of his mouth, inability to remain focused – overtly indicates either his complete disinterest in how US monetary policy affects our global trading partners, or that he simply doesn’t understand what this woman is talking about.

I also voiced to President Obama Brazil’s concern regarding the monetary expansion policies that ultimately mean that countries that have a surplus be able to strike a balance in those economic monetary expansion policies through fiscal policies that are ultimately based on expanding investments.  Such expansionist monetary policies in and of themselves, in isolation regarding the fiscal policies, ultimately lead to a depreciation  in the value of the currency of developed countries, thus impairing growth outlooks in emerging countries.

Full video:

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Rules, Discretion, or No Central Bank []

Chameleon Logo


Recent discussions in the econ blog world on whether the Fed keeping interest rates too low for too long from 2003-2005 was a significant factor in the most recent boom-bust episode, triggered by John B. Taylor’s March 31, “Policy Failure and the Great Recession,” reinforces how important and useful Austrian insights are for properly interpreting causes of the current crisis and guiding discussions of appropriate reforms in monetary institutions.

In his post, Taylor used his interpretation of Robert Hetzel’s in his new book, The Great Recession: Market Failure or Policy Failure?  as platform to attempt to bolster his positions that 1. Rules are preferred to discretion and 2. Excessive discretion allowed the monetary authorities led to two significant policy errors during the Greenspan/Bernanke watch; interest rates were too low for too long in 2003-05 leading to a boom and a necessary consequent bust and 3. The bust was compounded and/or triggered by interest rates being too high in 2007-08. While point 3 does not appear to be controversial among defenders of Central Bankers, many commentators, especially supporters of nominal GNP targeting and market monetarism, reacted defensively relative point 2.  The general impression one gets from these criticisms of Taylor is essentially if a Central bank policy did not lead to significant price inflation or increases in inflationary expectations, loose monetary policy generates no problems for the economy. Problems for the economy due to policy errors are Friedman plucks which pull the economy below its potential. Taylor, who has the elements essentially correct, rates were too low for too long, but working from a highly aggregated model, has no really adequate response to his critics except to argue that while Hetzel in his book defends Fed policy in 2003-05, gives away the “too easy policy” when later in the book he (Hetzel) argues, “In 2003-2004, the Greenspan FOMC did make a decision that would later have enormous implications. At this time, The FOMC backed off its long-run objective  of returning to price stability and instead adopted an ill-defined objective of positive inflation.” To Taylor, given this interpretation of policy circa 2003-2005, “there is a clear connection between the ‘go’ and the ‘stop’ in a ‘go-stop’ monetary policy, which those who warn of too much discretion warn about.

Taylor, unlike his critics, who see the only errors by the Fed as the “Great Moderation ended as being on the too tight side, recognizes, as do the Austrians, that the “Fed’s action in 2003-2005 should be considered as possible part of the problem.” Too bad he is unfamiliar with or unwilling to use Austrian analysis to support his position relative to 2003-2005.

Austrian monetary theory and business cycle theory with its emphasis on Cantillon effects, mis-directions of production, and misallocations of investment spending which distort the structure of production, provides a much clearer understanding of why expansionary monetary policy, even during periods of no or low inflation and even as a tool to speed recovery from a recession, sow the seeds for a new bust.

As I have argued elsewhere (“Hayek and the 21st Century Boom-Bust and Recession-Recovery,” Quarterly Journal of Austrian Economics 14, no. 3, Fall 2011: 261-285):

 The macroeconomic developments in the U.S. economy from 1995 to present cannot be understood without a reference to a capital-structure based macroeconomic framework.  The first boom-bust of the period, 1995–2000, should have provided evidence that Hayek was premature in de-emphasizing the empirical importance of distortions in the structure of production caused by money and credit creation in a growing economy with relatively stable prices. A monetary shock which accommodated a produc­tivity shock generated a significant boom as exhibited by real GDP above potential GDP. The resulting “bust,” at least measured in terms of the cycle impact on GDP, was relatively mild.

The significance of this cycle for the role of monetary policy was perhaps missed because it occurred at the end of the relatively long period of growth and stability known as the “Great Moderation.” This period was a time of better—at least compared to monetary policy of the 1960s and 1970s—but not necessarily good policy (Garrison, 2009). During this period, central banks were heavily influenced by macroeconomic events of the 1970s which seemed to discredit the prevailing neo-classical synthesis/Keynesian consensus. A vast economic literature from the consequent policy effectiveness debate emphasized central bank policies that—at least in the long run—aimed at price stabilization as a dominant policy goal. The Fed, while not explicitly inflation targeting, followed a policy that mimicked a Taylor Rule policy. Garrison (2009) characterizes this as a “learning by doing policy” which, based on events post-2003, would be better classified as “so far so good” or “whistling in the dark.”

The mildness of the first recession of the 21st century was followed by a relatively slow, jobless recovery, which could be viewed as trading depth for duration. This led many economists and pundits to encourage the Fed to re-inflate—create another boom or bubble—to ignite growth and employment. Thus the Fed turned to monetary excess. Interest rates were kept too low for too long, which led to “a boom and an inevitable bust[emphasis mine]” (Taylor, 2008). This housing bubble-led boom-bust is an excellent example of Hayek’s ([1939b] 1975) misdirection of production that results from monetary stimulus of an economy currently operating below potential. This attempt to use monetary policy to reduce unemployment in the short run, as predicted, became a cause of “moreunemployment than the amount it was originally designed to prevent” (Hayek, 1979, p. 11). Following this extended period of historically low federal funds rate circa 2002–2004, investment and GDP recovered relatively rapidly as employment also eventually increased. The economy appeared healthy and at least temporarily returned to its potential GDP growth path. The health was only apparent.

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Eurozone’s banks cutting dollar businesses [Sober Look]

As predicted back in February, European banks are beginning to exit their dollar businesses. They’ve reduced dollar denominated loans and sold dollar assets.

MarketWatch/Business Wire: This reduced appetite for MMF funding has likely contributed to a significant dip in Eurozone bank lending to project and trade finance, sectors that historically have largely been USD-denominated.

That in turn has led to a reduced need for the Fed’s dollar swap facility, which has fallen off sharply.

Fed Liquidity Swap Facility

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The Royal Canadian Mint develops its own digital currency

The Royal Canadian Mint (100% owned by government of Canada) develops its own digital currency. This only further strengthens bitcoin as a currency.

MintChip – The Evolution of Currency

Today’s digital economy is changing faster than ever, and currency has to change too. It is, introducing MintChip, from the Royal Canadian Mint – the evolution of currency.

MintChip brings all the benefits of cash into the digital age. Instant, private and secure, MintChip value can be stored and moved quickly and easily over email, software applications, or by physically tapping devices together.

Change is good, this is better.

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YOU AIN’T SEEN NOTHING YET – PART ONE [theburningplatform]


“Human history seems logical in afterthought but a mystery in forethought. Writers of history have a way of describing interwar societies as coursing from postwar to prewar as though people alive at the time knew when that transition occurred.” – Strauss & Howe The Fourth Turning


Watching pompous politicians, egotistical economists, arrogant investment geniuses, clueless media pundits, and self- proclaimed experts on the Great Depression predict an economic recovery and a return to normalcy would be amusing if it wasn’t so pathetic. Their lack of historical perspective does a huge disservice to the American people, as their failure to grasp the cyclical nature of history results in a broad misunderstanding of the Crisis the country is facing. The ruling class and opinion leaders are dominated by linear thinkers that believe the world progresses in a straight line. Despite all evidence of history clearly moving through cycles that repeat every eighty to one hundred years (a long human life), the present generations are always surprised by these turnings in history. I can guarantee you this country will not truly experience an economic recovery or progress for another fifteen to twenty years. If you think the last four years have been bad, you ain’t seen nothing yet.

Hope is not an option. There is too much debt, too little cash-flow, too many promises, too many lies, too little common sense, too much mass delusion, too much corruption, too little trust, too much hate, too many weapons in the hands of too many crazies, and too few visionary leaders to not create an epic worldwide implosion. Too bad. We’ve experienced horrific Crisis periods three times in the last 250 years and winter has arrived again exactly as forecasted by Strauss & Howe in 1997. The linear thinkers will continue to predict a recovery that never arrives. We have awful trials and tribulations, dreadful sacrifices of blood and treasure, and grim choices awaiting our country over the next fifteen years. Linear thinkers will scoff at such a statement as they irrationally view the world as a never ending forward progression towards a glorious future. History proves them wrong. We stand here in the year 2012 with no good options, only less worse options. Decades of foolishness, debt accumulation, and a materialistic feeding frenzy of delusion have left the world broke and out of options. And still our leaders accelerate the debt accumulation, while encouraging the masses to carry-on as if nothing has changed since 2008. Sadly, millions of lemmings want to believe they will not drown in the sea of un-payable commitments. Truth is a scarce resource on the planet today.

“Sometimes people don’t want to hear the truth because they don’t want their illusions destroyed.” – Friedrich Nietzsche


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The Decline And Fall Of The USD


The SWIFT Settlement System

In our previous article we looked at whether the U.S. Dollar was headed for a major fall or not. We demonstrated how the dominance of the U.S. dollar was almost entirely dependent on the grip it had over oil producers and this allowed the oil price to be designmnated in the U.S. dollar. The U.S. has gone to war in Kuwait and Iraq over this issue under the guise of destroying “weapons of Mass Destruction” as it appears on the verge of doing in Iran. It is no coincidence that Iran has long since ceased using the dollar to price its oil. It has also eliminated the U.S. dollar from its reserves. But of greater importance to the emerging world has been the use of the Belgian-based SWIFT system of international settlements. Not only has the move stopped the sale of Iranian oil, but it has also interfered with an important source of oil to the emerging world.

Right now there are ongoing discussions between the BRICS (Brazil, Russia, India, China and South Africa) countries over ther use of the SWIFT system of international settlements as a ‘weapon’ against Iran. The full extent of the impact of this appears to have been ignored. With China and India as two of Iran’s clients, they found that the U.S. could hurt them considerably with this action. If they can hurt them in this way, then they can hurt them the same way on other issues. So the question that the BRIC nations are now asking is, “Must we be subject to the financial will of the U.S.?”

The question has long-term implications that could affect these nation’s freedom of financial activity. The question demands to see just how powerful the U.S. really is. It is very clear to these emerging nations that if they are to keep on growing, unfettered by the U.S. will, they must set up a system that is not vulnerable to U.S. influence and to reduce the influence of the dollar itself.

What is being realized slowly is that the actions that come out of this conference may well mark a watershed in the shift of power from West to East and the significant reduction in the power of the U.S. as the globe’s main financial influence. Consequently, these nation’s will have to lower the influence of the U.S. dollar on their affairs if they are to achieve real financial independence. This has to be a future and extremely negative influence on the international value of the U.S. dollar.

While the SWIFT settlement system is a Belgian-based international banking settlement agency, the U.S. influence over it was sufficient to halt all Iranian interbank transfers. It is not the system that is faulty but the influence of the U.S. over it that is the danger to the BRIC nations.

China, the Rising Dragon

China, for the last two years has been moving to expand the influence of her currency around the globe, initially with her main trading partners. She has been developing her banking system, using the Yuan in a limited way in her trade with outside nations, from whom she imports a great deal and is developing her monetary systems so that the Yuan will become a global reserve currency one day.

That day is still expected to take up to a decade to achieve, but as history has shown so far, China is moving far faster than all expectations have thought. Nation by nation, strategic item by strategic item, China has been introducing the Yuan as the payment currency in a series of ‘swap’ arrangements. The latest is Australia with South Africa coming on stream by 2015. This will take the Yuan deep into the heart of Africa. By then we fully expect to see the Yuan an internationally acceptable currency in which to deal.

Her progress to date has targeted growth-markets, mainly other rapidly developing economies, as well as the whole Asian continent, and no longer just the U.S. and Europe. One of her key strategies through the Shanghai Cooperation Organization is to build a pan-Asian security and trade bloc in partnership with Russia. The last element of this 10-year old plan is to settle cross-border trade without using the West’s financial system. China expects to play a major part with her currency, which explains why she is adding to her gold reserves. The relevance of gold is that China will have to show to the people of Asia that her currency has better long-term prospects than the dollar, which goes some way to explaining why so many of the countries associated with the S.C.O. are now also accumulating gold.

To date, China has had to be extremely careful in moving away from the dollar, for the value of over $3.18 trillion in her reserves needs to be maintained. A sudden withdrawal would badly damage this, which China cannot afford right now. At worst, a global systemic collapse of the monetary system could happen if the evolution away from the dollar were handled badly.

The latest moves by the U.S. are deeply disturbing to China, as they have the power to directly hurt the spread of the Yuan on a global basis, if the U.S. so decides. Consequently, China is threatened right now! China has been working on alternatives so far, but the moves on the SWIFT system by the U.S. have made the issue urgent as she now faces a security threat. As China continues to develop, she will face a massive demand to be able to provide financing for expensive capital goods. China can no longer afford to depend on the U.S. dollar as the financing currency for its goods, as it is technically possible, although unlikely, at the moment, to face threats from the U.S. even on this subject.

It is clear to the BRICS nations that they need to set up institutions at the heart of the present world financial systems to act as an alternative to the World Bank and the International Monetary Fund and perhaps a replacement to the SWIFT system for transactions with the emerging world. It will not be sufficient to just have an important role in the developed world institutions. It will also be inappropriate to rely on the U.S. dollar as the currency of the emerging world as it is now.

Gold is Critical to any Change in Currencies on the Global Monetary Scene

Perhaps the largest flaw in the current global monetary system is its reliance on foreign acceptance of national currencies. When the U.S. was unquestionable and unchallengeable, there was no doubt that it ruled the global monetary system completely.

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BRICs Bank To Rival World Bank and IMF and Challenge Dollar Dominance [goldcore]

Outgoing President of the World Bank, Robert Zoellick, after just three days ago dismissing the idea of a BRICs created, new global multi lateral bank, has come around and endorsed a BRICs bank in an interview with the FT.

Zoellick had initially said that a BRICs bank and potential rival to the western and U.S. dominated IMF and World Bank, would be difficult to implement given competing BRIC interests.

He acknowledged that a BRICs bank was being created and said that the World Bank supported such a bank. He said that not having Russia and China as part of “the World Bank system” would be a “mistake of historic proportions”.

Leaders of the BRICS nations meeting in India appear to have made much progress in creating a new global bank as the emerging economies seek to convert their growing economic might into collective diplomatic influence.

The five countries now account for nearly 28% of the global economy, a figure that is expected to continue to grow.

On Thursday morning, President Hu Jintao of China, President Dmitry Medvedev of Russia , President Dilma Rousseff of Brazil, President Jacob Zuma of South Africa and Prime Minister Manmohan Singh of India shook hands at the start of the one day meeting in New Delhi.

BRICS leaders, from left, Brazil’s President Dilma Rousseff, Russian President Dmitry Medvedev, Indian Prime Minister Manmohan Singh, Chinese President Hu Jintao and South African President Jacob Zuma. Photo: AP

Top of the agenda was the creation of the grouping’s first institution, a so-called “BRICS Bank” that would fund development projects and infrastructure in developing nations.

The initiative would allow the countries to pool resources for infrastructure improvements, and could also be used in the longer term as a vehicle for lending during global financial crises such as the one in Europe, officials said.

Less noticed and commented upon is the aspirations of the BRIC nations to become less dependent on the global reserve currency, the dollar and to position their own currencies as internationally traded currencies.

The leaders of BRIC nations and other emerging market nations have adopted the idea of conducting trade between the five nations in their own currencies. Two agreements, signed among the development banks of Brazil, Russia, India, China and South Africa, say that local currency loans will be made available for trade between these countries.

The five fast growing nations participating in local currency trade will allow participants to diversify their foreign exchange reserves, hedging against the growing risk of a euro or dollar crisis.

The BRICS want to have easy convertibility of currency to make it easier to use the real, ruble, rupee, renminbi and rand amongst themselves without having to always use the US dollar. Higher intra-Brics trade, conducted in their own currencies would shield their economies from economic dislocations in the west.

In the long run, if global dependence and exposure to the dollar is to be reduced, then the BRICs currencies will have to trade amongst themselves, creating an intra Brics currency market. This could lead to a special reserve BRICs currency that could rival the IMF’s Special Drawing Rights (SDRs) and in time a regional currency could emerge. However, the EU’s experience of a single currency may make this less likely.

Left unsaid so far is the possibility that one of the BRICs or the BRICs in unison might peg the value of their respective currencies to the ultimate store of value and money – gold.

Having a gold standard enforces a form of fiscal self or national control and does not allow any one nation to have an exorbitant privilege in terms of monetary affairs that can be used in order to further selfish national or national corporate or banking interests.

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Ben Bernanke and the Case of the Missing Jobs

by Gary North

Bernanke’s speech on March 26 began with a familiar analytical error. Specifically, he continued to give the impression that the Federal Open Market Committee (FOMC) is the cause of today’s low short-term interest rates. It isn’t. The .25% rate is the result of Federal Reserve policy, but not FOMC policy. The FED pays commercial banks .25% on excess reserves. If it did not pay an interest rate of .25%, the rate would be even lower. He always gives the impression that, without the FED’s intervention, rates would be higher.


The causes of today’s low rates are the widespread decisions of commercial bankers to hold excess reserves with the FED, which is what the FedFunds rate reflects. Banks are not borrowing overnight money from other banks in order to meet bank reserve requirements set by the FED. They do not need the money. They have plenty of excess reserves. So, because there is no rival demand for this money, banks put their money with the FED, which pays .25%. Better to earn something than nothing.


His speech focused on the rate of unemployment, as well it should. This rate is also called the “Presidential incumbent’s chance in election years.” In the post-World War II era, an unemployment rate above 7% at the time of the election is the kiss of death.

Bernanke said this: “We have seen some positive signs on the jobs front recently, including a pickup in monthly payroll gains and a notable decline in the unemployment rate.” The unemployment rate is 8.3%. “That is good news.” For Republicans, yes. Not for Obama.


Importantly, despite the recent improvement, the job market remains far from normal; for example, the number of people working and total hours worked are still significantly below pre-crisis peaks, while the unemployment rate remains well above what most economists judge to be its long-run sustainable level.


Correct on both points. “Of particular concern is the large number of people who have been unemployed for more than six months.” Also correct. Not having anything else to do, they are likely to vote in November.

He raised the question of whether this unemployment is cyclical or permanent. He defines “cyclical” as every Keynesian does, that is, incorrectly: the result of a temporary lack of aggregate demand. “Is the current high level of long-term unemployment primarily the result of cyclical factors, such as insufficient aggregate demand. . . .?”

The cause of high unemployment is not insufficient aggregate demand in general. Rather, it is the high aggregate demand to stay home and watch TV. The problem is that some of the unemployed workers refuse to work for lower (non-labor union) wages. They do not want available jobs. Other unemployed workers are no longer worth the minimum wage. They cannot find jobs. All of them are getting paid not to work by the federal government’s unemployed workers’ bailout program, called unemployment insurance, which the government keeps extending.

He also mentioned “a worsening mismatch between workers’ skills and employers’ requirements.” He did not mention the key phrase, which every economist should always use when discussing gluts: “at the prevailing market price.” Had he done so, his audience would have expected him to discuss prevailing market wages in specific labor markets. He did not want to do this. To do so would point to the causes of unemployment: government interference with wages.


If cyclical factors predominate, then policies that support a broader economic recovery should be effective in addressing long-term unemployment as well; if the causes are structural, then other policy tools will be needed. I will argue today that, while both cyclical and structural forces have doubtless contributed to the increase in long-term unemployment, the continued weakness in aggregate demand is likely the predominant factor. Consequently, the Federal Reserve’s accommodative monetary policies, by providing support for demand and for the recovery, should help, over time, to reduce long-term unemployment as well.


Bernanke was justifying the FED’s inflationary policies, which bankroll the Federal government, which in turn spends the newly counterfeited money to “increase aggregate demand.” This has been the Keynesian solution ever since 1936. It will be the Keynesian solution forever. The Keynesian sees unemployment in terms of insufficient aggregate demand, which means insufficiently large federal deficits and insufficiently inflationary central bank policies.

Jobs are increasing in the private sector, he said. Layoffs are moderating in the public sector. But currently, hours worked are 4% less than in 2007. The job market remains weak, he said. Private sector employment is down by 5 million jobs. But the population has increased. The unemployment rate was 3 percentage points above its average over the past 20 years. Let me put it another way. The difference between 8.3% and 5.3% is 3 percentage points. What percent of 5.3% is 3%? It is about 57%. That means that the present unemployment rate is 57% above what has been normal for 20 years. Put this way, the present unemployment rate in 2012, over three years after the recession began, is a disaster.

“Moreover, a significant portion of the improvement in the labor market has reflected a decline in layoffs rather than an increase in hiring.” In short, the job-creation process is not recovering. “Taking the difference between gross hires and separations, the net monthly change in payrolls during this period was, on average, less than 100,000 jobs per month – a small figure compared to the gross flows.”


We need more hiring, he said. Quite true. How will this come about? With more rapid economic growth. Terrific. How will this growth take place?


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That’s the only way to describe the reaction that future historians will have when they look back and study the utter perversion that is our global financial system.

We live in a time when a tiny handful of people have their fingers on a button that can conjure trillions of dollars, euro, yen, and renminbi out of thin air. In the United States, it comes down to one man. Just one.

With a single decision, he controls the lever that dominates the entire economy. When you control the money, you control everything– financial markets, consumer prices, risk perceptions, investment habits, savings rates, hiring decisions, pay raises, sovereign debt, housing starts, etc.  One man.

This irrational, arrogant system presupposes by design that a central banker is smarter than everyone else; that markets are incapable of determining appropriate risk and value; that he is more effective at allocating our time, capital, and labor than we are.

Future historians will probably also be dumbfounded when they see how long people allowed worthless, unbacked fiat paper to pass as money.  It’s extraordinary that most people today happily accept a digital abstraction of paper currency controlled by a single individual as ‘valuable’.

It was more than 5,000 years ago that primitive commodity money was used in Mesopotamia, and it’s been over 3,000 years since metal coins began circulating.  For more than 99.2% of human civilization, money actually meant something… right up until 1971 when Richard Nixon ended any remaining link between the dollar and gold.

Ever since, the US government has refused to acknowledge precious metals as money… yet if the Treasury’s financial statements are to be believed, Uncle Sam is still holding  261,498,900 troy ounces of gold. Let’s dismiss the tungsten possibilities for now and presume that it’s real gold. At today’s prices, the value would be about $437 billion.

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Currency Wars: Why The United States Cannot Return To A Gold Standard

From Victor The Cleaner also featured in Fofoa

The book Currency Wars by James G. Rickards (Penguin, 2011) quickly became a bestseller not only in goldbug circles. One of the main theses presented by Rickards is that the United States ought to return to a Gold Standard.

Have you ever wondered whether this would be possible? The answer is No. But why not? The reason we give might strike you as rather unexpected, but it leads you right into the question of what will be the future international monetary system. The answer is that it is the existence of the Euro that prevents the United States from returning to a gold standard.

The Euro zone is set up in such a way that it values gold at its free market price. Since the Euro zone is a major global trade hub, they are in fact in a strong position to block any attempt by the United States at returning to a gold standard. They can rather force the US to value gold at its free market price, too. Any attempt at linking the US dollar to a fixed weight of gold is futile in the long run because this would eventually lead to an under-valuation of gold in US$ and thereby irreversibly drain gold reserves from the United States. In the present article, we explain these ideas in greater detail.

1. Gold Standard

In order to understand the question of returning to a gold standard, we first need to understand how gold can be valued in terms of a currency. Let us therefore summarize the main results of Sections 5 to 9 of our article The Many Values of Gold.

In the following, it does not matter much whether the proposed gold standard is modelled after the Gold Coin Standard that existed in the United States until 1922, after the Gold Exchange Standard that lasted until 1933 or after the system that used to be in place between 1933 and 1971, including the Bretton Woods period, in which only foreigners or only foreign central banks and governments were allowed to redeem US dollars for gold while domestically in the United States, private gold ownership was illegal.

In each of these flavours of what is commonly called a Gold Standard, there existed credit money with deposits, loans, account balances and bank notes. This credit money circulated as currency and was generally accepted as a form of payment, for example, in the form of cash, i.e. tangible bank notes, or in the form of cheques. Today, it would be accepted as payment in the form of electronic account-to-account balance transfers, too.

In addition to the use of such credit money as currency, some institution, either the local banks, the central bank, or a government department, kept a gold reserve in stock and promised to exchange one unit of currency for a certain fixed weight of gold. In other words, all of the circulating currency, including the credit money created by the banking system, was denominated in a weight of gold. Before 1933, gold coins freely circulated along with various forms of credit money. Between 1933 and 1968, although private gold ownership was illegal in the United States, foreigners could still redeem US dollars for gold bullion. Between 1968 and 1971, redemption was possible only for foreign central banks and governments, but not for foreign private entities.

During each of these periods, the banking system was able to create credit, i.e. the total volume of currency units in circulation was variable, but the amount of gold held in reserve, was almost fixed or even declined substantially. As long as one currency unit could still be exchanged for a fixed weight of gold, both credit money and physical gold traded at the same price. Both are very different things though:

  • Physical gold is a tangible asset, free of counterparty risk if in your possession, and it forms an excellent long-term store of value. The globally available quantity changes very little.
  • Credit money, in contrast, is a contract and does involve counterparty risk. Its volume keeps changing, depending on the credit creation in the banking system, for example, depending on GDP, on the variations in economic activity, and on the prevalent debt level.

Let us assume that at some point in time, the value of the currency unit agrees precisely with the intrinsic value of the corresponding weight of gold. The parameters of the new gold standard that we are designing, are therefore fine-tuned in the optimum way. Rickards proposes to determine this value and then to return to the gold standard at this fixed exchange rate between credit money and gold. He mentions backing one US$ by 1/7000 of an ounce of gold as a good guess for this initial value.

Once this new gold standard has been established, GDP, economic conditions and debt levels change. The banking system creates new credit, some existing credit is paid back, defaulted on or is bailed out. The total volume of currency units in circulation which includes both the circulating gold coins (if there are any) and the circulating credit money, therefore keeps changing. This means that over time, the currency unit might be worth either less or more than the intrinsic value of the weight of gold to which it is linked.

In the former case, it would be profitable to redeem credit money for gold and hoard the gold because as part of the currency, it can be acquired at a discount to its intrinsic value. This can be seen as a variant of Gresham’s Law. In the latter case, it would be profitable to purchase gold bullion in the free market and to deposit it with the central bank in exchange for credit money because its value as currency is higher than its intrinsic value.

Firstly, let us recall which one was the prevalent situation in the history of the gold standard. How often have you seen people purchase gold bullion in the free market, take it to the central bank and deposit it there for newly issued bank notes? Never? At least not in a century? This is no surprise because the banking system typically creates additional credit over time – this is their job after all. When the total volume of credit expands, the real value of the currency unit is devalued, and so the currency unit will eventually be worth less than the intrinsic value of the weight of gold to which it is linked. Periods of shrinking credit volume, in contrast, have been the exception and have typically been brief. So we have to accept the fact that, historically, the currency unit was often cheaper than the corresponding weight of gold would have been, had it not been linked to the currency.

Secondly, one can nevertheless still argue that just the option of redeeming credit money for gold inspires confidence in the credit money, enough confidence in order to avert a run on the physical gold. In other words, one might acknowledge that the banking system creates credit over time while the amount of gold is fixed or changes little, and that the redemption of all credit for gold would eventually be impossible to guarantee. But one may still argue that just by allowing redemption at the margin, i.e. in not too large quantities at any time, one might be able to protect the currency from a loss of confidence.

The question we wish to answer is whether this is possible for the United States as of 2012, i.e. whether they can succeed in backing the US dollar with a fixed weight of gold per unit of credit money, even if this would undervalue gold in terms of the currency unit during some periods in the future. The answer will be a clear ‘No‘ as long as there exists a major competing currency which values gold at its free market price: the Euro (€). The existence of the Euro will eventually force the United States to value gold at its free market price, too, and to let the price of gold in US dollars float freely. The mechanism by which this is enforced is a kind of arbitrage using international trade. But let us first consider the question of whether a new gold standard is necessary in order to inspire confidence in the US dollar and what the United States can possibly gain from this step.

2. Confidence from ‘Gold Backing’

One primary argument for the gold backing proposed by Rickards is confidence. As long as the banks, the Federal Reserve or the United States Government guarantee that one US$ can be redeemed for a fixed weight of gold, say 1/7000 of an ounce as suggested by Rickards, no market participant should need to fear holding US dollars for the long run.

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Currency war update

Faber Exposes Unprecedented Perils of Our Currency Crisis

Posted by Brittany Stepniak – Tuesday, March 20th, 2012

According to Dr. Faber, there are some rather dire unintended consequences associated with the U.S. currency crisis.

Moreover, Marc Faber asserts that downward spiraling inflationary trends all across the globe maintain a direct correlation with the Federal Reserve’s money printing policies.

While we’re all aware of the danger of printing too much fiat money, Faber stresses that the world’s fiat currencies are in greater danger than any of us realize…

Here’s how Faber views inflation:

If you start to print, it has the biggest impact. Then you print more — it has a lesser impact, unless you increase the rate of money printing very significantly. And, the third money-printing has even less impact. And the problem is like the Fed: They printed money because they wanted to lift the housing market, but the housing market is the only asset that didn’t go up substantially.

In general, I think that the purchasing power of money has diminished very significantly over the last ten, twenty, thirty years, and will continue to do so. So being in cash and government bonds is not a protection against this depreciation in the value of money.

Additionally, Faber explains how the Fed can’t possibly forecast the economy with accuracy because they are “academics,” and have “never worked a single day in their lives.”

Essentially, they lack the experience to understand the big picture.

They aren’t businessmen balancing books; they don’t go shopping and spend time at the local pub; they don’t need to sell products or services to make a living for themselves… The are paid by the government and lack an insider’s understanding of the way the U.S. economy truly functions.

Perhaps this is why they print money and their naive idealism lets them believe it will bring wealth back into our nation.

Unfortunately, that’s simply not true. If it were, every country in the world would thrive in prosperity and live happily ever after.

There are no Utopian societies. Printing endless amounts of paper money won’t change that fact.

And the unintended consequences of firing up the printing presses time and again will lead to unprecedented hardships in America — and across the globe.

Again, Marc Faber tackles this issue stating:

We know one unintended consequence, and this is that the middle class and the lower classes of society, say 50% of the US, has rather been hurt by the increase in the quantity of money in the sense that commodity prices in particular food and energy have gone up very substantially. And, since below 50% of income recipients in the US spend a lot, a much larger portion of their income on food and energy than, say, the 10% richest people in America and highest income earners, they have been hurt by monetary policy. In addition, the lower income groups, if they have savings, traditionally they keep them in safe deposits and in cash because they don’t have much money to invest in the first place. So the increase in the value of the S&P hasn’t helped them, but it helped the 5% or 10% or 1% of the population that owns equities. So it’s created a wider wealth inequality, and that is a negative from a society point of view.

Amidst extreme currency devaluation, this crisis has the potential to lead to malinvestment which will, in turn, create asset bubbles that’ll explode in chaos when the bubbles burst.

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China yuan could be reserve currency with reform: IMF

BEIJING (Reuters) – China’s yuan could become a reserve currency in future if the country undertakes further economic reform, International Monetary Fund managing director, Christine Lagarde, said in a speech on Sunday.

The IMF chief, speaking to a gathering of leading Chinese policymakers and global business leaders, added that China needed a roadmap for a stronger, more flexible exchange rate system.

China operates a closed capital account system and its yuan currency is tightly controlled, although Beijing has said it wants to increase the international use of the yuan to settle cross border trade and has undertaken a series of reforms in recent years to that end.

(Reporting by Koh Gui Qing; Writing by Nick Edwards; Editing by Jonathan Thatcher)

Analysis: Turning point in the currency war

By Mike Dolan

LONDON | Wed Mar 21, 2012 3:01am EDT

(Reuters) – A counteroffensive of sorts may be underway this year in what has seemed like a one-sided “global currency war” as developing economies slow, western money-printing pauses and the heat comes out of pumped-up emerging marketcurrencies.

The three-year-old “war”, as Brazil dubs the devaluationist policies of developed nations seeking relief from home-grown credit crunches, may well just come full circle and burn itself out as a result.

But the reverse course of emerging currency depreciation carries its own significant risks, from skewing investment decisions to aggravating trade diplomacy.

What’s more, it’s Japan’s success this year in finally weakening its supercharged yen, by fresh rounds of money-printing from its central bank, which may prove pivotal by disturbing the delicate balance in Asia.

Some economists warn the yen’s more than 10 percent retreat since January is already forcing China’s hand on its own controversial policy of yuan capping in a way that could cause consternation in Washington in an election year.

Far from seeing a sharply rising yuan emerge from China’s policy of greater exchange rate flexibility – core U.S. and multilateral demands – the yuan has actually weakened this year as China’s economy and inflation rates slow, its trade account worsens and fears of a “hard landing” there persist.

Even though the tightly-controlled yuan has gained more than 10 percent against world currencies over the past five years, it’s one of the few major emerging market currencies to remain lower against the U.S. dollar so far in 2012. Bouncing back smartly from a dire 2011, Russia’s rouble, India’s rupee, Mexico’s peso and South Africa’s rand are all up 5-10 percent.


BRIC currencies since 2007:

Currency performance in 2012:

Chinese yuan vs Japan yen:

China trade in deficit:

Japan exports to China vs US:


China recorded its biggest trade deficit in more than a decade in February and signs of slowing economic activity are mounting in everything from real estate prices to ore demand to foreign direct investment. But if it allowed or engineered a lower yuan, then it’s unlikely the other emerging giants – never mind the west – could ignore that.

Long-term global markets bear and Societe Generale strategist Albert Edwards says it’s vitally important global investors put the possibility of a weaker Chinese yuan on their radars because consensus thinking is disregarding the risk.

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