Ron Hera- Currency Wars Continue

The Fiasco of Fiat Money [Mises Daily]

I.

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.

II.

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]

III.

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 [dollarcollapse.com]

by JOHN RUBINO

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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