"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Sunday, October 31, 2010

On the Upcoming US Congressional Elections

Carroll Quigley, mentor to former President Bill Clinton and chronicler of the Anglo-American establishment's influence on world affairs, once wrote in his book Tragedy and Hope:

The argument that the two parties should represent opposed ideals and policies, one, perhaps, of the Right and the other of the Left, is a foolish idea acceptable only to the doctrinaire and academic thinkers. Instead, the two parties should be almost identical, so that the American people can "throw the rascals out" at any election without leading to any profound or extreme shifts in policy.
When it comes to wars, or the relationship between banking elites and government, that statement rings true.  But I'm not so sure these upcoming elections will be business as usual.  At least not for the US Dollar.

It remains to be seen how the Republicans act if/when they take control of the US House of Representatives, and possibly narrow the gap in the US Senate.  The Republicans are promising to be the party of responsible financial stewardship, yet has anyone told these politicians running for office how our monetary system really works?  Maybe they, or at least their party leadership already knows and they are only spewing forth what the electorate believes to be the truth?

It seems like it was merely yesterday that a recent Democrat takeover of the Congress found itself working with a Republican White House, under George Bush, to "save" the banking system, if not Western Civilization as we knew it.  All it took was for the Democrat leaders to be rounded up by Hank Paulson, then Treasury Secretary, and then lectured as to how our monetary system actually worked, how growing debt is required to keep the system from collapsing, and how spending incredible amounts of money was necessary or else, as George Bush put the impending economy's condition: "This sucker could go down."

I wonder if Ben Bernanke is following this election closely.  After all, if the Republicans take control, Keynesian fiscal spending will be curtailed and it will be Friedman Monetarism that will be in the spotlight.  What does that mean to the size of QE2, 3, 4, and so on?  What has the market priced in already? 

Either way, we are merely delaying the inevitable failure of a monetary system that seems to be nearing a tragic end.  Printing more money only makes the future servicing of the debt that much more difficult to handle, and cutting Congressional spending now only accelerates the deflationary aspects of a severe depression.  Damned either way as it will be the dollar that becomes the last victim.

It is important to keep in mind that never in world history has any monetary system not collapsed.  Eventually, monetary systems always do.  It's the consequences of a monetary system's failure that are difficult to predict.  We live in a world of extreme fragility - as Nassim Taleb has described.  Money whirls around the world at lightning speed.  Prices of everything are monitored and adjusted in milliseconds.  Nations export inflation in mere days.  And Monday thru Friday, there is always a market that is open somwhere.

To borrow a phrase:  The Sun never sets on the markets, but it does set on monetary systems.  How will this upcomg election chnage things? 

We'll see.

Rebalancing Global Trade Before The Whole Thing Topples Into Currency Collapse and War

In a prior post I described the developments that ocurred in the latest G20 Meeting of the Finance Ministers.  The final topic covered by the G20 was the suggestion put forth by US Treasury Secretary Timothy Geithner that nations adopt "caps" on severe trade imbalances, i.e. to limit extreme trade surpluses and deficits.

The suggestion went somewhat like this:  Consistent trade imbalances are unsustainable and need to be adressed.  A 4% amount of GDP should be used as a ceiling (or floor) for judging trade imblances.  Sounds novel, I have to agree.  However, who exactly measures GDP?  Why is GDP always revised?  Does anyone really believe most nations' GDP figures?  What I'm getting at is the obvious opportunity that exists to game the system.  Nonetheless, this suggestion has been debated extensivley since last weekend.  Even China is no longer ruling it out.

But before we continue, shouldn't we examine WHY trade imblances have gotten so lopsided?   Policymakers all too often accept the current monetary system as a given of sorts in their analysis, and look elsewhere for the "design flaws" of the current system.  They never question the fiat system we have, they just address what they deem as design flaws and unsuccessfully try to add more layers of global regulation, money printing, and taxes to a system that can never act like historical money.  What is historical money?  Gold.

Here is an excellent description by economist Michael Hudson of how trade used to be conducted prior to 1971, and why the system collapsed, emphasis mine:

This crisis provides an opportunity – indeed, a need – to step back and review the longue durée of international financial evolution to see where past trends are leading and what paths need to be re-tracked. For many centuries prior to 1971, nations settled their balance of payments in gold or silver. This “money of the world,” as Sir James Steuart called gold in 1767, formed the basis of domestic currency as well. Until 1971 each U.S. Federal Reserve note was backed 25 per cent by gold, valued at $35 an ounce. Countries had to obtain gold by running trade and payments surpluses in order to increase their money supply to facilitate general economic expansion. And when they ran trade deficits or undertook military campaigns, central banks restricted the supply of domestic credit to raise interest rates and attract foreign financial inflows.

As long as this behavioral condition remained in place, the international financial system operated fairly smoothly under checks and balances, albeit under “stop-go” policies when business expansions led to trade and payments deficits. Countries running such deficits raised their interest rates to attract foreign capital, while slashing government spending, raising taxes on consumers and slowing the domestic economy so as to reduce the purchase of imports.

What destabilized this system was war spending. War-related transactions spanning World Wars I and II enabled the United States to accumulate some 80 per cent of the world’s monetary gold by 1950. This made the dollar a virtual proxy for gold. But after the Korean War broke out, U.S. overseas military spending accounted for the entire payments deficit during the 1950s and ‘60s and early ‘70s. Private-sector trade and investment was exactly in balance.

By August 1971, war spending in Vietnam and other foreign countries forced the United States to suspend gold convertibility of the dollar through sales via the London Gold Pool. But largely by inertia, central banks continued to settle their payments balances in U.S. Treasury securities. After all, there was no other asset in sufficient supply to form the basis for central bank monetary reserves. But replacing gold – a pure asset – with dollar-denominated U.S. Treasury debt transformed the global financial system. It became debt-based, not asset-based. And geopolitically, the Treasury-bill standard made the United States immune from the traditional balance-of-payments and financial constraints, enabling its capital markets to become more highly debt-leveraged and “innovative.” It also enabled the U.S. Government to wage foreign policy and military campaigns without much regard for the balance of payments.

The problem is that the supply of dollar credit has become potentially infinite. The “dollar glut” has grown in proportion to the U.S. payments deficit. Growth in central bank reserves and sovereign-country funds has taken the form of recycling of dollar inflows into new purchases of U.S. Treasury securities – thereby making foreign central banks (and taxpayers) responsible for financing most of the U.S. federal budget deficit. The fact that this deficit is largely military in nature – for purposes that many foreign voters oppose – makes this lock-in particularly galling. So it hardly is surprising that foreign countries are seeking an alternative.

Misthos here.  I'm not saying that we should immediately go to a gold standard and all the world's economic woes will be instantly cured as some Austrian economists suggest.  What I have been saying is that ultimately, a gold standard of sorts will naturally evolve to replace the current system.  Capping trade surpluses and deficits in a debt based fiat world will never be a solution to the current unsustainable system.  There's just too much room for Enron/Wall Street style accounting tricks that are available to nations to game the system.  And they will game it.

To me, Hudson makes two extremely important observations that are often overlooked:

1) "What destabilized this system was war spending."

2) "But replacing gold – a pure asset – with dollar-denominated U.S. Treasury debt transformed the global financial system. It became debt-based, not asset-based."

What makes these two observations so important?  In a world of limited resources and potential unlimited demand, a debt based system naturally favors the nations or economic areas that benefit the most by having reserve currencies that the rest of the world uses.  These nations can export inflation, easily finance resource wars, and disproportionately consume the economic output of other nations without creating a similar amount of economic output.

But this current system we have is unsustainable as well.  There are extreme global wage imbalances that are not "correcting" anytime soon.  Same with cost of  living imbalances.  And  when nations replaced an asset (gold) with someone else's liability (government bonds) as a means to store their trade surplus, they also put at risk the future value of that "wealth storage."  Germany is an EU success, right?  But the periphery countries such as Greece and Italy and Portugal have been consuming Germany's economic output without creating the same amount of wealth.  And in a fiat debt-based world, who really is the success?  

And let's not forget what happened in the 1920s-1930s.  In that time period, the USA was the world's largest manufacturing nation, it was the world's biggest creditor (not debtor) nation, and it was the largest exporter of oil.  Basically, the US was both at the same time the world's China and Saudi Arabia of the 1920s and 1930s, while still having the largest GDP.  And guess what?  With the onset of the Great Depression, it too, was on its knees.  My point is that when global imbalances are severe, when the banking system is essentially insolvent, and when nations address these issues with trade and currency wars, even the "winners" are not immune to economic collapse.

War and Economic policy are political tools that nations use to exert power to disproportionately consume the world's resources.  This will never change.  We now find ourselves at an historic moment where trade and debt imbalances can no longer continue.  When a system is no longer sustainable, it must end, or at least change.  This happened in 1971, when debt-based fiat replaced gold.  And it will happen again soon.

No one wants to face this fact, so the West and Japan will continue to print money and delay addressing their banking systems' issues and their sovereign debt and currency issues until the system can no longer function.  What the G20 is trying to do is to create a "soft landing" of the current system by instituting novel policies and possibly preparing the IMF, along with its currency, the SDR, to become a global bank.

But again, with such disproportionate wage disparities, global trade imbalances, sovereign debt imbalances, and limited resources, will every nation play along to create the circumstances for a "soft landing?"  Is a "peaceful" transition possible? 

If the system breaks apart on its own, all sovereign debts will be suspect.  And by default, not design, gold will once again figure prominently on the balance sheets of sovereigns.  The question is, at what price?

Saturday, October 30, 2010

Hathaway: Gold Will Outlive the Dollar Once Slaughter Comes

I was on the road visiting familythis week only to come home to see that my new internet provider is still having issues with the DSL line they installed at the house.  Hopefully this will be resolved soon and I will get back to posting much more frequently. There are still some loose ends regarding the G20 finance ministers meeting I wanted to address.

As for this article, from Bloomberg, it is interesting to see such topics covered on main stream media.  Just a few years ago, such ideas would have been seen as extreme.  The theory of this blog is well summed up by Hathaway in this Bloomberg article.  The end of the dollar, if not fiat, is not a kooky topic covered by financial blogs.  It is reality.  It is an historical re-ocurrence, that is not unusual when one studies the broad history of money.  We have only recently been "programmed" to think otherwise. 

Here's the article in its entirety:

The world’s monetary system is in the process of melting down. We have entered the endgame for the dollar as the dominant reserve currency, but most investors and policy makers are unaware of the implications.
The only questions are how long the denouement of the dollar reserve system will last, and how much more damage will be inflicted by new rounds of quantitative easing or more radical monetary measures to prop up the system.

Whether prolonged or sudden, the transition to a stable monetary system will become possible only when the shortcomings of the status quo become unbearable. Such a transition is, by definition, nonlinear. So central-bank soothsaying based on the extrapolation of historical data and the repetition of conventional wisdom offers no guidance on what lies ahead.

It’s amazing that there is no intelligent discourse among policy leaders on the subject of monetary rot and its implications for the future economic and political landscape. Until there is fundamental monetary reform on an international scale, most economic forecasts aren’t worth the paper on which they are written.

Telltale signs of future trouble aren’t hard to spot. Only a few months ago, Federal Reserve Chairman Ben Bernanke and a chorus of other high-ranking Fed officials were talking about exit strategies from the U.S. central bank’s bloated balance sheet and the financial system’s unprecedented excess liquidity. Now, those same officials are talking about pumping more money into the system to stimulate growth.

Risky Targets

And they’re not alone: Six months ago, the chief economist of the International Monetary Fund, Olivier Blanchard, suggested that raising inflation targets to 4 percent from 2 percent wouldn’t be too risky.

This sort of talk must grate on the nerves of our trading partners, China, India, Russia and others, who have accumulated pyramids of non-yielding Treasury debt. No haven there. Return- free risk may be a better way to put it. And bickering among central bankers over currency manipulation and rising trade tensions doesn’t exactly reinforce one’s confidence in a scenario of sustained economic growth and a return to prosperity.

The prospects for an orderly unwinding of the extreme posture of global monetary policy are zero. Bernanke, Jean- Claude Trichet and Mervyn King, his counterparts in Europe and the U.K. respectively, are huddling en masse upon the most precarious perch in the history of monetary affairs. These alleged guardians of monetary stability, in their attempts to shore up the system, have simply created the incinerator for paper money. We are past the point of no return. Quantitative easing may well become a way of life.

No Freak Occurrence

The consensus investment view seems to be that the credit crisis of 2008 was a freak occurrence, unlikely to repeat. That is wishful thinking. Monetary policy has painted itself into a corner. Based on our present course, there will be more bubbles and more meltdowns.

Financial markets and institutions sense trouble, as reflected in the flight to supposedly safe assets such as Treasuries and corporate-debt instruments with paltry yields, as well as the reluctance to lend by commercial banks. We are stuck in an epic liquidity trap. The irony is, if global central banks succeed in creating inflation, the value of these safe assets will be destroyed. It is a slaughter waiting to happen.

In the pedantic mentality of central bankers, their playbook creates just the right amount of inflation. As inflation accelerates, consumers will spend to get rid of their dollars of diminishing value and spur the economy. Once consumers start spending, it will be time to raise interest rates because a solid foundation for prosperity will have been established, they say.

Slender Thread

But whatever the playbook promises, the capacity of financial markets to overshoot can’t be overestimated. The belief among policy makers and financial markets in the possibility of this sort of fine-tuning is preposterous, but it is the slender thread on which remaining investment and business confidence rests.

The breakdown of the monetary system will be chaotic. When inflation commences, it will be highly disruptive. The damage to fixed-income assets will seem instantaneous. Foreign-exchange markets will become dysfunctional. The economy will become even more fragile and unpredictable.

Gold is an imperfect, but comparatively reliable, market gauge for the extent of current and future monetary destruction. The recent acceleration in the dollar price of the metal to $1,381, a record high in nominal terms, coincided with talk of a new round of quantitative easing and highly visible discord among major nations on trade and currency-valuation issues.

Naysayers’ Bubble

Naysayers point to gold’s price and see a bubble, without understanding that the only acceleration that is taking place is in the rate of decline of paper currency. The Fed is organizing an attack on the dollar’s value, believing that this is the most expedient way to defuse deflationary market forces. The man in the street is unaware, a perfect setup. Inflation can only be successful when the public doesn’t see it coming.

The sudden torrent of commentary on gold isn’t the sign of a bubble. Anti-gold pundits provide a great service to those who grasp this historical moment: They facilitate the advantageous positioning of the one asset most likely to be left standing when the dust settles.

(John Hathaway is a managing director of Tocqueville Asset Management LP in New York. The opinions expressed are his own.)

To contact the writer of this column: John Hathaway at JHathaway@Tocqueville.com


Tuesday, October 26, 2010

On the Road

Sorry for the recent lack of posts.  I have limited internet access and will be following up on my prior post, as well as new posts, hopefully tomorrow.

Sunday, October 24, 2010

The G20 Meeting of Finance Ministers. Success, Failure, or Irrelevant?

The G20 meeting of Finance Ministers has ended, and as usual, despite the fanfare and “historic” agreements there are now more question than answers on what exactly, was accomplished. The major topics covered were: the existing currency war that needs to be dealt with that apparently doesn’t exist in the eyes of the IMF, banking reform, IMF representation, and a US “solution” to the dilemma of rebalancing world trade.

I will not cover banking reform, as the point of this blog is to focus on the major geopolitical topics. So let’s look at the easiest topic first: IMF representation.

During the G20 meeting in Pittsburgh back in September, 2009 the G20 leaders agreed to eventually tackle the issue of emerging countries such as China’s and India’s underrepresentation. Since that meeting, there has been disagreement on who should sacrifice what, with Germany even suggesting that in return for Europe losing seats, the US should give up its veto. That did not happen, but it has been agreed by Europe to give up seats to the emerging countries. But there’s an issue here. Which European country will give up its seat? Who makes the decision? This reminds me of a quote attributed to Henry Kissinger, US Secretary of State under Nixon: If you want to speak to Europe, who do you call?” Ultimately, the decision will take a year or two, and some of the countries in the crosshairs, so to speak, are Belgium, The Netherlands, Denmark, and Switzerland. Switzerland, apparently, has some concerns here. From Swissinfo.ch:

A spokesman at the Swiss finance ministry, Roland Meier, said it was for the time being too early to say what impact the IMF reform would have. Switzerland is aiming to maintain its seat on the board because of its importance as a financial centre.

Two weeks ago, Swiss Finance Minister Hans-Rudolf Merz, said he was confident that Switzerland would be able to keep its seat on the IMF board as a result of its economy, the role of the Swiss franc and its financial contribution to the IMF. Source.
I’m sure Europe will ultimately decide who loses what. Right? Here is the full article on this “historic reform” by the IMF. Source.

The ongoing currency war

The IMF feels that a currency war is a possible threat that is unlikely to occur, but needs to be addressed. Yes that’s exactly how IMF Managing Director Dominique Strauss-Khan has characterized it in the past. My take is that the currency war is ongoing; it is not a possibility. The only issue that remains is how much longer will it take to intensify. It’s important to note that senior representatives from Brazil did not participate in this G20 meeting of finance ministers. Brazil’s finance minister, Guido Mantega, who recently proclaimed that a currency war was underway, decided he needed to stay in Brazil to fight this currency war. From Brazzilmag.com:

"All the world is aware that there's a currency war on and that we need G20 to discuss the issue and find a solution," said Lula speaking to journalists in Brazilian capital Brasília. The Brazilian leader is scheduled to travel to Seoul, South Korea November 11/12 for the G20 summit.

"We are going to do whatever is necessary to ensure that our Real does not keep appreciating against the so called 'strong' currencies thus impacting on our exports. I've given clear instructions to Finance minister Guido Mantega and Central bank president Henrique Meirelles to be alert the 24 hours and adopt all the necessary measures needed" to prevent the depreciation of the US dollar. Source.
Nonetheless, the G20 felt that the meetings on currency reform were a success. According to the communiqué that was issued:

“move towards more market determined exchange rate systems that reflect underlying economic fundamentals and refrain from competitive devaluation of currencies. Advanced economies, including those with reserve currencies, will be vigilant against excess volatility and disorderly movements in exchange rates. These actions will help mitigate the risk of excessive volatility in capital flows facing some emerging countries. Together, we will reinvigorate our efforts to promote a stable and well-functioning international monetary system and call on the IMF to deepen its work in these areas. We welcome the IMF’s work to conduct spillover assessments of the wider impact of systemic economies’ policies;”
Sounds like cooperation, right? But what about the US’s need to devalue in order to increase exports and service existing unbearably high debtloads? And what of the US’s ability to continue to deficit spend to stimulate the economy? Does anyone really believe Tim Geithner when he expresses a “strong dollar” policy? And what of China and Japan?

Well, here are some recent developments after the G20 meeting of the finance ministers:


Japan immediately broke ranks to declare that, contrary to the spirit of the communique, it would continue to devalue the yen if it saw fit.

Yoshihiko Noda, Japan’s finance minister, said: "A prolonged appreciation in the yen is not good for Japan’s economy. Our stance, that we will take appropriate, bold action if needed, is unchanged.” SOURCE.

The Federal Reserve’s push toward easier monetary policy is the “wrong way” to stimulate growth and may amount to a manipulation of the dollar, German Economy Minister Rainer Bruederle said…

“It’s the wrong way to try to prevent or solve problems by adding more liquidity,” Bruederle told reporters yesterday, saying that emerging-market officials were among the critics. Bruederle, a member of the Free Democratic Party, the junior partner in Chancellor Angela Merkel’s government, stepped in for hospitalized Finance Minister Wolfgang Schaeuble at the meeting.

“Excessive, permanent money creation in my opinion is an indirect manipulation of an exchange rate,” Bruederle said. The minister has taken a pro-market stance in his first year in office, criticizing state intervention in cases such as providing aid for General Motor Co.’s German Opel unit. SOURCE.
In a follow up post, I will address the final topic that was covered by the G20, the US’s push for a cap on current account surpluses. In my view, this is just another currency war weapon. Remember Kyoto and Copenhagen? Remember Cap and Trade and Climate Change? That too was an economic weapon pointed towards the currencies and economies of emerging countries. And just as that failed, so too will this push for capping trade surpluses. Don’t get me wrong, I agree that consistent and growing trade imbalances pose a danger, but only a new monetary system can address this.

Saturday, October 23, 2010

Cultural Clashes and Time Perception

This video can be useful in understanding why certain generations and cultures think and act differently from others.  I don't think it's the only answer, but it is definitely an answer that is often overlooked.  One will immediately think why children act different today from other generations, and why the EU's combination of North and South countries may be a hindrance. 

An argument can be made that the US has similar differences in different geographic regions.  However, there is still a national common thread, and you don't hear New Yorkers for example complain about southern states getting a disproportionate benefit of federal spending.  Unlike the EU, the US has a Treasury that taxes everyone, and a Congress that spends money often times, with no rhyme or reason.  Can the EU pull off something like that? To me, that would be unfair, as the EU is really a federation of different countries, not states with a common federal government, a single army, etc...

Anyway, here's the video, enjoy!

Wednesday, October 20, 2010

The Franco-German-Russian summit in Deauville

I have been following this summit closely.  Obviously absent in this "security" meeting was the US.  And one would also think:  How can France and Germany discuss issues of "security" without other EU nations' involvement?  What is really going on here?  I have mentioned this unusual meeting since September 27th in my post: Pre - G20 Meeting between France, Germany, and Russia - What's Cooking?

Well, looks like Russia's Medvedev let the cat out of the bag, so to speak.  As I speculated, it had to do with more than just "security" issues.  It was really a sidebar of sorts to the upcoming G20 meeting in Seoul this November.  Looks like cliques of nations need to meet without US participation before the G20 meeting.  Is this an organized ganging-up of smaller economic powers against the US?

From IBN Live:

Time ripe for G20 to reform world currency structure- Medvedev

Deauville, Oct 20 (Itar-Tass) Russian President Dmitry Medvedev believes that for the G20 time is ripe to move forward in reforming the monetary and financial structure of the world. He made a statement to this effect at a press conference following the Franco-German-Russian summit in Deauville, France.

"When the G20 began its activities, I realized that we would be unable to avoid answering this question - what will our monetary system be like in the coming years," the Russian president said. "Yes, objectively there are states that believe the Bretton-Woods institutions have not exhausted themselves, that there is nothing else to offer, and that everything will be OK. But nobody is claiming that the Bretton Woods institutions should not be destroyed." "The question is what sort of financial and monetary system there will be for the next 20-30 years," said Medvedev."Is what we agreed on in the mid-20th century will be enough? No, it is not enough. We need to agree on this issue." "And in general, for the G20 twenty time is ripe to do something definite. I mean, unconditional basic agreements," said the Russian president. "And for the G20 it must be a question of the structure of the monetary and financial system." "Yes, we have begun to reform the IMF and the World Bank, we have moved forward," admitted Medvedev, adding that the G20 was a good format, which brought many useful things, especially in crisis times. "But now we need to achieve a final result," he says."During the French presidency of the G20 this could be one of the most significant themes, as well as the topics of more reserve currencies and, perhaps, creation of a global reserve currency," Medvedev said.

Federal Chancellor Angela Merkel pledged that "Germany will support France during its presidency of the G20 in terms of constructing a monetary architecture. "In the discussions we see that the issue of currencies and exchange rates is one of the main threats of protectionism, and we will do everything to achieve greater transparency at the international level," said Merkel.(Itar-Tass)

I want to mention that I could not find this article on Russia's Itar-Tass News Agency.  I also split the article into paragraphs for easier reading - here is the original article.

Obviously, these leaders are challenging the current US Dollar-based system.  There was a reason they did not invite the US.  The question is, can they really pull it off without US engagement?  What will the US response be?  And what of China?  I believe that the recent era of accelerated globalization was a process that may have peaked.  And we may be witnessing fractures develop that may, to an extent, reverse the process of globalization.  There are too many competing interests for any one nation to sacrifice for the benefit of the global system.  They will all fight hard for their self interest, in my opinion. 

I don't believe the US will give up on dollar hegemony that easily.  That's why I believe the system will change through crisis, and not coordination.  And that's why gold, which is free of sovereign creation, could be the defacto system in the event of a severe currency crisis.

Will the Real Rogue Superpower Please Stand Up?

I pose this question in jest.  All nations act in their self interest, and the tools they use to act in their self interest are only limited by the power and wealth such nations posses.   Thus, I find it interesting that both China and the US are enagaged in a struggle to paint each other as threats to the rest of the world.

The article below was written by Li Hong, a Chinese journalist that also once resided and went to school in the US.  It is published by the People's Daily Online, yet a disclaimer as to the views of the writer follow the article.  Noentheless, I believe this article reflects an important viewpoint in China.  Whether you agree with the views or not, I think it's important to know the public relations "tools" that China will employ.

The US Dollar's reserve status will be challenged not only by the wrongful actions of the Federal Reserve, or the Forex market or the Treasury Market, but in Public Relations campaigns as well.  At the end of the day, a currency is judged along with the nation that creates it.  This not just be a currency battle between economic giants, but a battle for the hearts and minds of the rest of the world.

Who will win this public relations campaign?  Keep in mind that China's hands are not clean.  But no one's hands are clean when it comes to geopolitics.

Here's the article (yes, the English is not exactly perfect, but the purpose of the message is obvious)  Expect more as the currency and trade wars intensify:

Rogue superpower, you or me?

By Li Hong

China, following 30-odd years of spirited and painstaking efforts, is now materially better-off, and so, has rising leverages in the hands. But, the country, a new leader in global economy, isn't indulging in the newfound prominence and using economic muscles threatening to punish others, especially, the small and weak.

The Confucius has ingrained in Chinese descendants to always keep low-profile and refrain from posing noses in others' faces. The Teaching is: peace is most precious.

Only when China feels itself being bullied by the wealthier and mightier powers, or their proxies and pawns, it will be forced to use the leverages and fight back, till the bully feels the pain.

The allegation by some that China is becoming "a rogue economic superpower, unwilling to play by the rules" is not only ludicrous but also malicious. That the accusation comes from a pundit in the United States -- a country having bred and made the most out of the infamous "carrot and club" foreign policy, sounds sarcastic to many.

With no strings attached, China has for many years spelt out considerable aids, in keeping to its financial capability, to poverty-ridden countries in the Third World, mostly in Africa. Sure, China is not playing by the Western rules that catalogue governments on political grounds. But, because of China's aids and investments, the livelihood of tens of millions of people there has therefore improved.

In return, China has gained more friends, despite their remaining relatively poor today. In the eyes of these people, China's rise does not come that "rogue".

Titled "Rare and Foolish", Professor Paul Krugman wrote for The New York Times this week, taking case with China's reportedly restriction of rare earth minerals to Japan, in the aftermath of Tokyo's Coast Guard's arresting last month the captain of a Chinese fishing trawler operating in China's territorial waters. Japan only let go the captain after the strife seemed to boil over, dealing a potentially heavy blow to bilateral relations, including trade.

Mr. Krugman scolded the fecklessness of U.S. policy-makers because it did nothing "while an unreliable regime acquired a stranglehold on key materials". He went on to claim that the Beijing-Tokyo brawl showed "a Chinese government that is dangerously trigger-happy, willing to wage economic warfare on the slightest provocation". The accusations just went too far.

In the end, the Nobel laureate stated that "major economic powers, realizing that they have an important stake in the international system, are normally hesitant about resorting to economic warfare, even in the face of severe provocation." That sounds too self-righteous.

Just list an American reader's online comment which got the most approval hits: "Uh... like we're not waging economic warfare on a little island off the Florid coast that's no threat (to the United States) at all … " This commentator speaks it all.

And, didn't the ‘most reliable regime' in Washington invent the "Monroe Doctrine", readily to wield clubs to coerce whoever of the unruly it determines according to its own game rules? Aren't the small and powerless in the world shuddering after seeing the regimes from Yugoslavia to Iraq violently changed?

Need to count economic warfare launched by the United States? In addition to Cuba, how many countries remain unscathed in Uncle Sam's ‘omnipotent' trade embargo and financial black-listing? Even more than 20 years have passed since 1989, it has refused to scrap major technology embargo on China. A global currency war, as many are now seriously worried about, who is actually causing it? I bet Beijing will try its best to keep its currency stable, for the good of the world, though the dollar keeps tumbling.

China should continue to export rare earth minerals that are crucial to the production of many modern products, including greener cars that help the environment. But, if someone intentionally chooses to pick up a nuisance and forces China to swallow it, Beijing is poised to dispel it, with whatever leverages in the hands.

The articles in this column represent the author's views only. They do not represent opinions of People's Daily or People's Daily Online.

Source HERE.

Sunday, October 17, 2010

A Gold Standard, of Sorts, In the Making?

It is no secret that France, soon to have the upcoming chief role of chair/presidency of the G20, wants to facilitate tremendous change within the current global monetary system.

It is also no secret that France, Germany, and Russia, will meet in French town of Deauville tomorrow.  The US, was noticeably not invited, as I discussed in my post Pre - G20 Meeting between France, Germany, and Russia - What's Cooking?   And also, the US response to this meeting from a New York Times article was not receptive to this new clique of countries:

“Since when, I wonder, is European security no longer an issue of American concern, but something for Europe and Russia to resolve?” asked a senior American official, who spoke on condition of anonymity. “After being at the center of European security for 70 years, it’s strange to hear that it is no longer a matter of U.S. concern.”   (link)
That said, there was a recent article from Ambrose Evans-Pritchard in the Telegraph.  The article dealt with currency wars, and the US's position as well as the East-West conflict in global trade.  But what really caught my eye, was something Evans-Pritchard wrote about Christine Lagarde, France's Finance Minister.  Here is the relevant portion, emphasis mine:

And while the French deny that they are in talks with China over the creation of a new currency regime, I heard French finance minister Christine Lagarde say in person at a meeting in Italy that France would use its G20 presidency to push for an alternative to the dollar. She specifically cited the “Bancor”, the idea floated by Keynes in the 1940s for a commodity currency priced off a basket of metals. The US risks gambling away the “exorbitant privilege” it has enjoyed for two thirds of a century as currency hegemon.
The "exorbitant privilege" Evans-Pritchard writes of is regarding the US's unique position of hosting the world's reserve currency.  By having the reserve currency, the US must constantly print dollars as the global economy grows.  But there are by-products to this printing.  One is that the US gets to export its inflation, due to the global demand for US dollars.  The other involves what economists call the "Triffin Dilemma"  that is, the US must constantly run a trade deficit, i.e. the US gets to consume a disproportionate amount of the world's resources and economic output as a result of having the world reserve currency.  Yes, the US gets to print, at will, the currency that is used to buy oil and other commodities.  That truly is an "exorbitant privilege."

But as the world get smaller from global trade, and economic power becomes more dispersed, this "exorbitant privilege" is coming under increased scrutiny.  The Triffin Dilemma I wrote about above also describes the dilemma the US faces.  As I mentioned, because it has the world reserve currency, it must constantly run trade deficits.  If it does not, and dollars (along with inflation) were not "exported" fast enough, global trade would contract.  That's the dilemma - no nation can keep running trade deficits forever.  It's not sustainable.

The world needs a common currency for global trade.  Yet it also demands a system that is sustainable and equitable.

Will it be the SDR, which so far, has been described as a basket of currencies?  Will it be this bancor tied to metals, including, I would assume, gold?  Or will the dollar continue until it, along with the global financial system, crashes?  Will a new system emerge through cooperation and before a new crisis erupts?  Or will a new system be born out of conflict and crisis - a defacto, and by default system?

That's the real dilemma the world faces today.

A Genius Leaves Our World

Benoit Mandelbrot passed away today.  For those not familiar with him, here is today's write up by the AFP:

WASHINGTON — Benoit Mandelbrot, a French-American mathematician who explored a new class of mathematical shapes known as "fractals," has died at age 85 in Cambridge, Massachusetts, his family said.
The cause of death was cancer, his family said in a statement.

His seminal book, "The Fractal Geometry of Nature," published in 1982, argued that irregular mathematical objects once dismissed as "pathological" were a reflection of nature.

The fractal geometry he developed would be used to measure natural phenomena like clouds or coastlines that once were believed to be unmeasurable.

He applied the theory to physics, biology, finance and many other fields of study.

"Fractals are easy to explain, it's like a romanesco cauliflower, which is to say that each small part of it is exactly the same as the entire cauliflower itself," Catherine Hill, a statistician at the Gustave Roussy Institute, told AFP.

"It's a curve that reproduces itself to infinity. Every time you zoom in further, you find the same curve," she said.

French President Nicolas Sarkozy paid tribute to Mandelbrot, saying he had "a powerful, original mind that never shied away from innovation and battering preconceived ideas," according to a statement published by his office.

"His work, which was entirely developed outside the main research channels, led to a modern information theory," Sarkozy added.

Mandelbrot had been "very critical of the prevailing banking models," adding that his "warnings were not heeded," Sarkozy said.

"France is proud to have received Benoit Mandelbrot and to have allowed him to benefit from the best education."

A professor emeritus at Yale University, Mandelbrot was born in Poland but as a child moved with his family to France where he was educated.

In the United States and around the world, his work attracted the attention of academics, but also pop culture because the fractals he uncovered could be illustrated in stunningly beautiful, multi-colored representations.

"Mandelbrot spent most of his professional life working at IBM?s main research laboratory at Yorktown Heights, New York," the family statement said.

"He also taught mathematics for many years at Yale University; he was Sterling Professor Emeritus of Mathematical Sciences."

He was awarded the Wolf Prize for Physics in 1993, and the 2003 Japan Prize for Science and Technology.
David Mumford, a professor of mathematics at Brown University, told the New York Times that Mandelbrot revolutionized his field.

"Applied mathematics had been concentrating for a century on phenomena which were smooth, but many things were not like that: the more you blew them up with a microscope the more complexity you found," the Times quoted him as saying.

"He was one of the primary people who realized these were legitimate objects," Mumford added.
Mathematicians and economists were among those who reacted swiftly to Mandelbrot's death on the Internet.

Nassim Nicholas Taleb, the statistician and philosopher best known for the book "The Black Swan," turned over his website to mourn Mandelbrot's passing.

The page featured only the words: "Benoit Mandelbrot, 1924-2010, A Greek among Romans."
Chris Anderson, the organizer of the TED conferences that feature addresses from prominent thinkers drawn from a variety of fields, also offered his condolences.

He described Mandelbrot, who addressed the Technology, Entertainment, Design conference earlier this year, as "an icon who changed how we see the world" on the TED blog.

Mandelbrot leaves behind his wife, Aliette, two sons and three grandchildren.
Source HERE.

And here are two videos, one an FT interview on Efficient Markets, and another, a joint interview with Nassim Taleb:

Thursday, October 14, 2010

Krugman Says We Need 8 to 10 TRILLION in QE!!!!!!!!!!!!

Sorry for the recent brief posts.  I still intend to write a detailed post on the current monetary system's inevitable, mathematical collapse.  But I am on the road with limited acces and now in Athens, not far from the Acropolis.  Turns out that Ministry of Culture workers had barricaded themselves at the Acropolis, and were just dispersed by the police using tear gas.

But here at the Cafe, just blocks away, life goes on.  Funny how some things change, yet life continues.

But back to this post.  Paul Krugman, of neo-Keynesian times 1,000 claim to fame, has just made a more incredulous suggestion - the size of QE that is needed:  8 to 10 TRILLION of bond purchases!

But you know what?  He's right in a perverse way.  The system we have right now, debt based money, REQUIRES more debt to "solve" this recession.  This is a balance sheet recession, and the only way to solve the debt issue is either through debt destruction, i.e. debts are written down, or more "printing of new debt/money, i.e. enlarge the Ponzi system's base once again.

The contraction of money that follows debt destruction makes it that much more difficult to pay off debts.  That is, it becomes a vicious cycle of debt deflation, which will likely overshoot leading to a severe depression.  So in way, I think Krugman is not far off.  But does he realize that his "solution" merely delays the inevitable?  That instead of avoiding a depression, we destroy the currency instead?

Here he is, with some unkind (though I agree somewhat) words regarding China:

Trial Balloon, Market Manipulation, or Misguided Economics?

Edwin Truman, a Senior Fellow at the extremely influential Peterson Institute for International Economics in Washington, wrote an editorial yesterday for the Financial Times (link).  In it, he exhorts the US to open its vaults and sell its gold.

So what is this really about?  Does he really believe that the US's massive debt load can be handled by the current price of gold?  That's laughable.  There's more to it.  On King World News' blog, James Rickards writes an excellent analysis.  If anything, please read his conclusion in the last paragraph (emphasis mine):
A Message to Garcia
October 13 (King World News) - One of the most famous and widely published essays of all time was A Message to Garcia by E. Hubbard.  Written in 1899, it recounts the effort of the President of the United States to reach out to a foreign insurgent who was incommunicado.  For this mission impossible, the President relied on U.S. Army Lieutenant Andrew S. Rowan who delivered the message against enormous odds but without hesitation and with complete loyalty and devotion to duty.
Lt. Rowan, meet Ted Truman.
Today’s FT carries a column entitled “America should open its vaults and sell gold” by Edwin “Ted” Truman of the Peterson Institute.  Truman’s thesis, in a nutshell, is that the gold price is a bubble and the U.S. Treasury should take advantage of this by selling “high” and using the proceeds to reduce the national debt by about 2.25% of GDP.  Furthermore, the interest savings on the debt reduction would amount to about $15 billion annually thus helping reduce our deficit even more.  And the appeal of Truman’s idea goes even further because the gold sales would give anxious citizens, “…something to hang around their necks…”  How thoughtful.
The intellectual flaws in Truman’s piece are too numerous to review in detail but here are a few highlights: He says that the price action in gold is driven by the “…hype of the bullion dealers (holding large inventories)…”  Really? My wholesale bullion dealer constantly complains about shortages and occasionally puts his best customers on allocation because he’s short of supply.  Truman also says that the market is accompanied by “…the normal amount of fraud and misinformation accompanying asset price bubbles…”.  Apart from a few sleazy coin dealers, the only fraud and misinformation I’ve seen comes from the Treasury and the Fed who refuse to allow a proper audit of official holdings and who cover-up and deny their gold discussions held at BIS and other nearly impenetrable venues.  More to the point, the price action does not reveal a bubble in gold, it shows the collapse of the paper dollar.  The issue here is understanding the importance of thenumerarie or unit of account.  If you make the dollar the numerarie, and think in terms of “dollars per ounce” then the price action may look to some like a bubble.  But if you make gold the numerarie and think about how many ounces your get for a single dollar (now about 0.00075; was 0.00400 in 1999) you can see that the real problem is the dollar is rapidly shrinking to a vanishing point.
Truman’s idea that gold sales and debt reduction would reduce U.S. interest expense by $15 billion per year is the kind of nonsense one gets from static, linear analysis.  In dynamic, nonlinear analysis, such gold sales would so undermine confidence in the dollar as to cause a skyrocketing of interest rates and an explosion of the U.S. deficit easily submerging the savings that Truman posits.  Truman says that the gold standard was associated with “…unstable, prices, output and employment…”.  If by unstable, he means cyclical, yes that’s true (and necessary) but gold was also associated with some of the longest and strongest periods of sustained real growth in U.S. history from 1865 to 1912 until gold’s function was derailed by the creation of the Fed in 1913.  Truman says the U.S. “…has been sitting on [gold] since the Great Depression, receiving no return…”  Actually, gold went from $20.67 per ounce to $1,350 per ounce in that time period; seems like a 6,500% return to me.
Truman says that the gold standard “…has not existed for a century…”.    This is highly revealing. In fact, the U.S. went off domestic gold convertibility 76 years ago, within living memory to many, and only went off international gold convertibility 39 years ago.  But if Truman dates the end of the gold standard not from 1971 or 1933 but from the creation of the Fed in 1913 then he’s right; it has been a century.  That tells you something about how establishment intellectuals like Truman view the real purpose of the Fed regardless of the existence of any formal systemic role for gold.  Nevertheless, gold is not quite the musty relic Truman would like it to be although it is true that an entire generation of finance scholars have come of age since 1971 with no formal analytic training in gold.
We could go on but you get the point.  No amount of analysis will reach the right conclusion if you get the paradigm wrong.  Truman’s paradigm is anchored in a perpetually sound fiat dollar and he is intellectually unable to see the world any other way.  Sadly, he’s not alone.
This leads me to Truman’s most revealing remark of all.  He writes, “Official discussions of the reform of the international monetary system do not include any advocates of a return to gold…” (emphasis added).  The problem with this observation is that he is almost certainly right.  And this is scary.  I have maintained for some time that the return to gold is inevitable and the only issue is whether it would happen through a rigorous and studied process led by the United States or by a chaotic process in which the United States is caught off guard to its disadvantage.  Learning from an insider like Truman that none of the power elite are thinking seriously about gold increases the odds that the dollar dénouement will be chaotic not orderly. 
The reaction of the gold community and various bloggers to Truman’s op-ed was swift and predictable.  He was ridiculed as espousing the “dumbest idea we have ever heard” by zerohedge.com.  Others were simply incredulous and assumed that Truman must have wandered onto the FT op-ed pages after decades alone on a deserted island.  While I might not disagree with zerohedge, there is one problem with this response.  Ted Truman is not a nobody.  He’s one of the most seasoned, experienced and highly respected international monetary experts in the world. His academic, government, scholarly and think-tank credentials are nonpareil.  He speaks to finance ministers, sovereign wealth funds, IMF officials, and Wall Street CEO’s on a daily basis.  Importantly, he was a staff economist to the FOMC.  I have personally worked with many of his colleagues at the Peterson Institute on matters relating to international finance and national security and they are uniformly of the highest intellectual calibre and operate with a truly warm and collegial demeanor.
And that is the point.  Ted Truman is not a fringe figure or a minor intellectual; he is a giant in the field.  He is not just close to the establishment.  He is the establishment.  An op-ed by Truman appearing one day after the IMF semi-annual meeting ended with no effective solutions on the currency wars is no coincidence.  It is a metaphorical Message to Garcia, to the gold insurgents, from the President and the powers that be.  It is price suppression without having to engage in actual sales.  It is a warning to gold bugs that they may get crushed.  It is meant to induce fear into those newly interested in gold that it’s a rough game with no holds barred.  It is a show of bravado by the fiat money crowd.  But it is also a sign of desperation; the last gasp of the ancien régime of fiat money.  If a smart guy like Ted Truman is reduced to the old canard about gold being good only for hanging around your neck, then what else is there to say? The intellectual opponents of gold are now as exhausted as the mines.
Misthos here.  So what did gold do today?  Looks like another record.  It seems to me that gold is a steamroller that not even Sovereigns can stop.  And if this can't stop gold, can a paper debt backed SDR become the next world reserve currency?  I don't think so.

Tuesday, October 12, 2010

Follow Up on Banking Armageddon Part II Post

On September 24th, I posted a summary of a King World News interview that involved Christopher Whalen.  During that interview, Whalen discussed a potential upcoming banking crisis involving the spread of foreclosures, which could be magnified byt he improper recordation of mortgages and subasequent improper filing of foreclosure.

Many Blogs have since covered this story, and thus, I have hesitated to write about it, as there was already plenty of info on it in the blogosphere.  Well, time to resurrect this, as Lori Ann Larocco of CNBC just interviewed Christopher Whalen and James Rickards - both analysts that were well ahead of the curve in predicting this mess.

I take a lot of stock in that.  It's not enough to agree with an analyst, but to also look back evry once in awhile and judge their track record.  Rickards and Whalen, are two of my favorite analysts, and although I disagree on ideology occasionally with them, their predictions are usually compelling and accurate.

Here is the full interview:

But for Jim Rickards and Chris Whalen none of this is very surprising. Rickards and Whalen, the Senior Managing Director of Market Intelligence at Omnis, and Co-Founder and Managing Director of Institutional Risk Analystics respectively, sounded the alarm about the foreclosure crisis in this very column on September 29th.

I tossed out the question that an economic tusunami warning was being sounded and if bank investors were listening. I guess I should have added Congress and State Attorney Generals.

Since I last spoke with them, there is movement to halt all foreclosures. But is this a knee jerk over-reaction lead to more harm than good to the ailing real estate market? I decided to ask both Rickards and Whalen.

LL: This foreclosure fight is a very sticky situation. Not all banks are bad. Will this create more investor uncertainity?

CW: Yes. The uncertainty regarding forward earnings, revenues and particularly expenses is growing. The combinations of still record default rates and rising servicing costs related to foreclosures is making banks hyper cautious about credit. The muddle along policy of Obama and Geithner equals no net credit growth.
We need to understand that government intervention in the mortgage market, not the banks, caused this mess. Goes back to WWII and the New Deal. So really if you want to blame anyone, start with FDR and the Democratic Congress of the 1930s and work forward.

The U.S. banking industry is entering a new period of crisis where operating costs are rising dramatically due to foreclosures and defaults. We are less than one-fourth of the way through the foreclosure process. Laurie Goodman of Amherst Securities predicts that 1 in 5 mortgages could go into foreclosure without radical action.

JR: This will definitely create uncertainty to go along with all of the uncertainty we have already about taxes, financial rule making, cap-and-trade, currency policy and the rest. That's important because while monetary policy may have caused the Great Depression, regime uncertainty is what kept it going so long and we're in that mode again.

Home buyers looking to buy out of foreclosures will step back from the market. Mortgagors considering strategic default will see less risk in doing so, thus leading to more defaults. Potential buyers of servicing rights will back off. Ditto for bulk purchasers of non-performing residential portfolios. Forecasting bank earnings and therefore stock prices and the market as a whole just got much more difficult. Throw in the lawyers and the politicians and it's a perfect storm of uncertainty, gridlock and wealth destruction. Just what we don't need right now.

LL: Should there be a national foreclosure moretorium?

CW: No. Moratoriums do not change the reality facing the banks, only makes it worse via delay. Banks should be aggressively refinancing performing borrowers and short-selling or renting to marginal borrowers. The President needs to start to make this a priority.

JR: No. The situation is definitely a mess, but one way to make it more of a mess is to impose top down government solutions which will just be one more step on the ideological road to redefining housing as a human rights entitlement and nationalizing the entire process from origination to servicing to foreclosure. The banks made this mess but they also have the strongest incentive to fix it so let them do so without government intervention. We have enough government interference already.

LL: This is halting the foreclosure market. Buyers are on hold, how will this effect the housing recovery?

CW: The Obama Administration is making the problem worse. If you were a title insurer, would you be writing new risk on mortgages today? In this environment? No. But the irony is that before we are done, the states will be enacting mortgage moratoria and the federal government will be powerless to stop it — as in the 1930s.

JR: What recovery? We are nowhere near the bottom. We will not hit bottom until markets clear. That will not happen until we reimpose some mark-to-market discipline and shut down more banks and let private buyers price the portfolios at market levels. None of that is happening and a moratorium on foreclosure just delays the process further and therefore prolongs the Depression.

LL: You both called the Tsunami two weeks ago in this column. Is it arriving faster or right on schedule?

JR: Good question. It's a slow-mo Tsunami. That's scarier because instead of sudden damage and a quick recovery you get to stare at the coming cataclysm for a long time and, like deer frozen in the headlights, the politicians and bankers don't know how to react.

Maybe volcano is a better metaphor; it builds pressure over long periods of time and sends off signals but still erupts suddenly and violently causing massive damage and catching many unaware. The point is, we are nowhere near the bottom on home prices, commercial real estate prices, currency collapses, etc. and the worst is yet to come over the course of 2011 and 2012.

CW: No, like all tsunami, it builds slowly and with terrible predictability.

LL: How much more damage could a moratorium have on the economy?

JR: Plenty. To put it differently, the principal losses on the mortgages are already baked in the pie and have been since 2006 because the entire structure was overleveraged, nonsustainable and bound to fall. Once that devleveraging process begins, there's no stopping it until every misallocated dollar of malinvestment has been destroyed.

The issue is how long does this take and are there collateral costs? Policy, in general, can prolong the process but at very high cost. Some of the unnecessary (as opposed to necessary) costs of the mortgage foreclosure moratorium are (a) encourage and subsidize more defaults, (b) bleed the mortgage servicers dry, (c) impose damage claims from class action lawyers on top of the base costs of foreclosure.

LL: How much more damage could a moratorium have on the banks?

CW: In a way the moratorium is good because it will accelerate the problems at Bank of America , Wells Fargo , JP Morgan and the GSEs. It will force the government to embrace restructuring, which will probably involve a good bank/bad bank model a la the RTC in the 1980s. Bond holders will be haircut and equity will be wiped out. But this is the start of a true solution. There is no free lunch Lori.

JR: In general, negative cash flow in servicers, greater loan losses (foreclosures do not get better with age) and more strategic defaults (because this will seem like a progressively more attractive option to borrowers on the knife edge).

LL: Could this create a double dip?

CW: Already has.

JR: Well, in my view everything since 2007 has been one continuous Depression so I don't really think about double-dips. Market rallies in 2009 were to be expected after you print $1Trillion and hand it out on street corners. But what's your second act? Another $1Trillion hot off the press? I don't think so.

LL: The whole housing contract system looks like it has broken down. Are the tentaciles reaching further out now?

CW: Well, not the housing contract system is fine for borrowers and lenders. The concept of a “good sale” of a mortgage is in shambles, this the private MBS market is probably going to be dead for a generation. This is bad for Wall Street, but good for America because the model of community banks funding mortgages is far more stable. We are going back to a model where lenders finance mortgages where they can see the collateral. This will turn houses back into a form of forced savings and not speculative vehicles.

JR: As Dick Cheney would say, Big Time. From the immediate impact on bank earnings, this will spread out to effect home builders, construction jobs, non-durable goods, municipal finance (because of eroding grand lists), etc. etc.

Link HERE.

Ayn Rand, Capitalism, Gold, and False Prophets

"Whenever destroyers appear among men, they start by destroying money, for money is men's protection and the base of a moral existence. Destroyers seize gold and leave to its owners a counterfeit pile of paper. This kills all objective standards and delivers men into the arbitrary power of an arbitrary setter of values. Gold was an objective value, an equivalent of wealth produced. Paper is a mortgage on wealth that does not exist, backed by a gun aimed at those who are expected to produce it. Paper is a check drawn by legal looters upon an account which is not theirs: upon the virtue of the victims. Watch for the day when it bounces, marked, 'Account overdrawn.'

- Ayn Rand, from Atlas Shrugged (emphasis mine)

I first started reading Ayn Rand when I was in high school in the late 1980s.  Being young and impressionable, her writings had a tremendous effect on me.  But as I got older, and maybe wiser, I began to understand that there are shades of grey in life.  That no one can apply one philosophy 100% to their lives.  Society does need its altruists and greed isn't everything.

But the quote above (emphasis mine) has a lot of truth to it.  It is part of a speech called "The Money Speech" given by a character named Fransisco d'Anconia in the novel Atlas Shrugged.  The speech's purpose is to address and challenge the saying "money is the root of all evil."  But I want to focus on this one paragraph.  It tells us a lot about many of those that "follow" Ayn Rand's philosophy.

I have said before that many economists, businesspeople, and politicians pick and choose the parts of economic philososphies that best serve their needs.  Or oftentimes, they purposefully misrepresent those philosophies for their own gain or just because 100% adherence to that philosophy, as I said, is impractical.

But what really annoys me is when Financial Oligarchs claim to be adherents to Capitalism, or Ayn Rand's philosophy.  One thing they conveniently neglect, is that to Ayn Rand, GOLD is money, not easily inflatable paper.  These financial lords also love to keep their profits, yet socialize their losses.  Now that's hypocrisy.  I have no problem with someone keeping their profits, if they are vulnerable to the risk of their actions.

Anyway, I saw this article recently:

Bankers Trying to Pay Colleges to Teach About Ayn Rand

Did any of these Bankers really read Atlas Shrugged?   I know that Ayn Rand considered government to be the threat to liberty.  And that's understandable; she was Russian and witnessed the birth of the Soviet Union.  But take a look at my post below with the Damon Vrabel videos, particularly the second one.  Who is the US governemnt?  It's the financial oligarchs.  One only needs to see how the US government responded to the financial crisis  of 2008 to understand this.  And these Banksters had record bonuses at a time when their very existence was perilous!

Now back to gold, and Ayn Rand's view of it.  She rightly saw the replacement of gold with paper as a threat to liberty.  And she was right, government has become more invasive with giant budgets easily financed with fiat paper.  But you know who else grew enormous with the steroids of paper money? 

The Banking Sector.  I wonder what Ayn Rand, were she alive today, say about these False Prophets, these Bankers and their "love of paper money and bailouts?"

Monday, October 11, 2010

Debt Based Money and Democracy... Can They Co-Exist?

Two important videos that summarize many of my concerns: Debt based money, its influence on government, and sustainability issues. Damon Vrabel discusses money and power in the first video, describing money creation and balance sheet dynamics. In the second video, he accurately questions if the US is still a Constitutional Republic, and if not, what is it?

Sunday, October 10, 2010

Currency Wars likely to continue, IMF Fails to Resolve Currency Conflict

It has been a point of this blog, and please bear with me if you heard it before, that the future of the current global monetary system lies in the hands of influential global governance institutions such as the World Bank, the IMF, and the G20.

The IMF, led currently by Managing Dorector Dominique Strauss-Khan (DSK), has spearheaded the effort to resolve the ongoing "currency wars," as I call them.  (See my prior posts:  China - US Currency conflict escalates... former adviser to the PBoC says US Dollar "One Step Closer" to a Crisis , Currency War On! The first finance official to state the obvious: "a trade war and an exchange rate war" , Who "Wins" a Currency War? , and Dominique Strauss-Khan and the "Unlikely" Currency War He Feels the Need to Prevent .

Well, this weekend's IMF meeting is over and what has transpired?


From the Wall Street Journal, emphasis mine:

IMF Fails to Resolve Conflict Over Currencies

WASHINGTON— The International Monetary Fund's annual meeting this weekend failed to ease currency battles roiling markets, pushing the dispute off to a summit next month of leaders of Group of 20 countries, with no clear resolution in sight.

The meeting Saturday might have been more significant for possible solutions ruled out. Chinese central bank officials rejected calls for an international or regional currency accord, and the World Trade Organization's chief said his institution didn't want to get involved in exchange-rate fights.
But there's more:

IMF members also scotched an effort by the U.S. to link a bigger Chinese role in the IMF to changes in Beijing's currency policies. "Nobody is linking this," said Egyptian Finance Minister Youssef Boutros-Ghali, who chairs the IMF's policy-making committee.
Amd China's Central Bank governor sounded rather confident:

China's central bank governor, Zhou Xiaochuan, said he figures U.S. and European pressure will diminish once unemployment there begins to decline. He also dismissed the possibility, suggested by some Chinese academics, that Beijing should offer to limit exports to the U.S temporarily as a way to defuse tensions, in the same way that Japan limited exports of automobiles to the U.S. in the 1980s.

"That's an opinion of a small group of economists," Mr. Zhou said. "It's not seriously considered."
And as for the issue of EU "over-representation:"

The IMF meeting did produce progress in continuing efforts to reorganize how the institution is governed. Mr. Boutros-Ghali said he expects a deal by the G-20 summit in which Europe will, in effect, cede two of its eight seats on the IMF's 24-member executive committee.
And it looks like Belgium has made a sacrifice:

For instance, Belgium represents a constituency that includes Turkey, which has come to have a more significant role in global economy than Belgium now has. "They'll rotate seats," Mr. Boutros-Ghali said. The board members " won't have a European face" as frequently as before.
Misthos here.  I'm not at all surprised that the issue of currency manipulation by all major economies was not addressed or eased by the IMF.  The IMF has no real teeth when it comes to such matters.  It barks, and it advises the G20 - where the real power lies.  But even the G20 needs cooperation and coordination to be relevant.  And don't get me wrong, I support such forums for international dispute resolution.  The alternative is a world that falls all too easily into conflict.  But nonetheless, I remain negative in my forecast.

We will see what transpires this November in South Korea when the G20 meets.

Saturday, October 9, 2010

George Soros Warns China of Global Economic Collapse

The imbalances caused by the current global economic system, exasperated by fiat currency that is easily manipulated and expanded, have caused a new economic power to rise.  China has a lot more power than most understand.

From the UK Telegraph:

George Soros warns China of 'Global Currency War', (emphasis mine)

George Soros has warned that a global “currency war” pitting China versus the rest of the world could lead to the collapse of the world economy.

Mr Soros told BBC Radio 4’s Today programme that China had a “huge advantage” over international competitors because it can control the value of its currency.

He said China could also influence the value of other world currencies because they have a “chronic trade surplus”, which means the Chinese have a lot of foreign currencies. “They control not only their own currency but actually the entire global currency system,” he said.

Writing in the Financial Times, Mr Soros added: “Whether it realizes it or not, China has emerged as a leader of the world. If it fails to live up to the responsibilities of leadership, the global currency system is liable to break down and take the global economy with it.”

China’s central bank governor Zhou Xiaochuan defended the world’s second largest economy, however.
“We’ve already started to have exchange rates reform for quite long time...[but] it is gradual... it is good for a large economy otherwise it may be dangerous,” he told the BBC on the sidelines of this weekend’s International Monetary Fund meeting in Washington.
Misthos Here.  Here's another way of looking at the issue:  Extreme imblances in global trade and the historic accumulation of sovereign debts has created the need for many nations to devalue their currencies.  I'm going to set aside the argument that fiat money is at the heart of the matter - and just analyze the current system as is - assuming it is sustainable.

Debtor and trade deficit nations need to devalue their currencies to 1) increase exports and 2) better manage the servicing  (paying of interest) of their current debts.  Historically, nations would devalue against the existing world power's currency.  But that is not the case today because the current world power, the US, needs to desperately devalue as well.

So who has the next largest economy, and therefore currency to devalue against?  It's China.  And they don't want to play that game.  They want to hoard their surplus, and crush the competition.  But you know what?

We live in a fiat debt-backed paper world.  If you want to export your economic output, without trying to allow world trade to be somewhat fair - you too will lose in the end.  You are exporting your economic output for pieces of debt backed paper that will collapse in the end.  And you, a great exporting power - are accelerating that collapse, and with it, your own economic demise.

I'm targeting this to China - but I'll also say this:  Germany, are you listening?

Thursday, October 7, 2010

US Treasury Secretary Geithner preparing to take on China

In the ongoing saga between the US and China over currency manipulation (and let's be honest, BOTH countries are doing it, it's the method that differs), Timothy Geithner hinted that the IMF has a mechanism for addressing a nation that allows persistent surpluses to accrue through currency manipulation.  From the Business Insider, quoting Timothy Geithner in a speech given Oct 6th at the Brookings Institute(emphasis theirs):

...we believe it is very important to see more progress by the major emerging economies to more flexible, more market-oriented exchange rate systems.  This is particularly important for those countries whose currencies are significantly undervalued.

This is a problem because when large economies with undervalued exchange rates act to keep the currency from appreciating, that encourages other countries to do the same.

This sets off a damaging dynamic, described first by my former colleague Ted Truman, as "competitive non appreciation." Over time, more and more countries face stronger pressure to lean against the market forces pushing up the value of their currencies. The collective impact of this behavior risks either causing inflation and asset bubbles in emerging economies, or else depressing consumption growth and intensifying short-term distortions in favor of exports.

It is unfair to countries that were already running more flexible regimes and let their currencies appreciate.  And it requires a cooperative approach to solve, because emerging economies individually will be less likely to move, unless they are confident other countries would move with them.

This problem exposes once again the need for an effective multilateral mechanism to encourage economies running current account surpluses to abandon export-oriented policies, let their currencies appreciate, and strengthen domestic demand.  This is a necessary complement to the adjustments being undertaken by countries running current account deficits.  A cooperative rebalancing of policy in this direction would be better for overall growth.

This issue was well-known to the group of economists who gathered in Bretton Woods, New Hampshire, to refashion the war-ravaged global financial system in 1944. The Articles of Agreement of the IMF, drafted at that conference, contain a now-obscure paragraph calling on the Fund to issue reports on countries with "scarce currencies"--what today we would call countries running persistent surpluses--"setting forth the causes of the scarcity and containing recommendations designed to bring it to an end. That clause now reads like a relic of a bygone monetary era; But the problem it was drafted to address--the threat to global financial stability posed by persistent, large surpluses--is as salient today as it was then.

Full article HERE.

Now it's getting interesting. Does this sound like cooperation, or an escalation of words, that leads to something else?  But there's more.

The US is also concerned about China's recent muscle flexing regarding rare earths.  From the AFP:

The United States called Wednesday for the world's major economies to look at ways to ensure a free flow of rare minerals used in gadgets after Japan said China cut off shipments for political reasons.

US Commerce Secretary Gary Locke praised the Asia's two largest economies for agreeing to talks next week and hoped "there will continue to be a free flow" of rare earths.

"That's something that I think all the countries perhaps will have to address in the upcoming G20," Locke said, referring to the November summit in South Korea of 20 major economies.

But just recently, Chinese Premier Wen Jiabao spoke directly to Europe, imploring them:

"I say to Europe's leaders: Don't join the chorus pressing [China] to revalue the yuan," he said during a speech in Brussels Wednesday. (source)

So it looks like a trilateral world is forming here.  The US, the EU, and China.  But what about Russia?  Well, my post Pre - G20 Meeting between France, Germany, and Russia - What's Cooking?  speculates where Russia feels it belongs, or at least what Europe believes.  Russia is basically being courted by both China and the EU.  And it looks to be the one to tip the balance.  And what's really at stake here?  The US paper dollar standard.

Wednesday, October 6, 2010

Dan Norcini Summarizes the Real Estate-CDO-Foreclosure Nightmare

From King World News, a summary of an upcoming interview with Dan Norcini and Jim Sinclair of Jim Sinclair's Mineset blog emphasis mine:

Dan Norcini:

“Where we are at on the charts with regards to the precious metals is that they are blowing through resistance levels like they are not even there.  If we can clear $23 on silver, there isn’t much resistance until $25 and if silver plows through $25, then you have a realistic possibility of it running up to $35.”

Because we are at new highs in nominal terms on gold, we can’t go back and reference charts so we are projecting levels.  The next technical resistance is at $1,380 with light selling possible at $1,350.

The primary drivers in gold and silver today had to do with concerns over currency devaluation as well as securitized debt problems and the implications associated with it.  Here is what Jim Sinclair had to say:

Jim Sinclair:  “Each time that happens an item of collateral on the securitized debt publicly dies. That is why this is dynamite that people will realize very soon. This is one reason gold is up hard today.”

Norcini continues:

“That collateralized debt obligation is now effectively worthless because the collateral behind the debt can no longer be collected.  The banks cannot go and get it. 

Let’s say you have 10 mortgages at $1 million a piece, the sum total of those mortgages are $10 million.  So, the banks took the 10 mortgages and bundled them together into a collateralized debt obligation or CDO with a face value of $10 million.  

They then sold that new entity that they created to an investment group of some sort, a pension fund, hedge fund, etc. promising them a yield of let’s say 7%.  The sales pitch would emphasize the fact that this CDO was backed by real collateral.  In the event of loan defaults by the borrowers, the banks would tell the buyer of the CDO that the collateral behind the loan could be sold to recapture any potential losses on the part of the purchaser.  

Everything seemed to work fine until the defaults began and the foreclosure process kicked into high gear.  The foreclosure process has exposed fatal flaws in the system and the flaw is that the banks cannot prove clear ownership of the mortgage.  

Consequently, they are then barred from foreclosing on the property.  Because they can no longer foreclose on the properties, the CDO is now effectively worthless. 

The hedge funds and the pension funds cannot now sell these CDO’s on the open market, so how are they going to recover their original investment?  Perhaps you may say that won’t be a problem because these instruments were insured.  The problem is now the credit default swap or the insurance policy that was purchased to protect against default assumes that the insurer has the financial wherewithal or resources to make good on the claim.

If there were only a small number of these problem CDO’s this would not be an issue.  But as the number of the foreclosures continue to skyrocket, and more and more banks are prohibited from seizing the collateral behind the property, the sheer magnitude of the number of claims presented to the insurer will overwhelm their balance sheet.

In effect what you have is an insurance company which doesn’t have enough money to pay off the claims.  Compounding the problem is the fact that the CDO’s and credit default swaps related to these claims form a mass network of interdependence.  This then ripples through the entire system and creates a domino effect which can cause the failure of entities creating the next financial crisis.

Ultimately the Federal Reserve will be asked to step in and buy up the now worthless CDO’s and put those on its balance sheet.  In order to do this the Federal Reserve will have to engage in massive quantitative easing, taking onto its balance sheet the worthless CDO’s in exchange for  newly issued treasuries.

This of course will have a horrific effect on the US Dollar which is why gold and silver are heading much higher.

But keep in mind, this is just one threat of many the current financial system faces.  We have an ongoing currency war, Pension Fund shortfalls, sovereign and local government insolvencies, and high levels of unemployment that depress aggregate demand, but for government deficit spending.  It's extremely complicated and no one knows how all of these factors play against each other, and which will be the tipping point.  Or it could also drag out for years, with increasing "bandages" of debt monetization being "applied" by the Central Banks of the world.  So we have two issues here - weak economies, and weak currencies.  Keynesianism and Monetarism being applied to the extreme to ward off collapse, and in the end it will be Austrianism that will prevail, not because governments like gold, they HATE gold.  But because no government will trust another with anything else but the REAL thing after the system falls apart.  That's why Central Banks keep gold.

Unless of course, there is a global coordinated effort by the world powers to bring into the system the SDR and create through the IMF a global "bad bank" so to speak to sop up all the excess garbage in the system.  And even that seems like a stretch.  What surplus nation will go with a plan that gives the free rider deficit nations a way out?  And in a world of scarce resources no less?  And can all nations agree on the composition of a new currency - when they can't even agree to stop an existing currency war?

This blog will continue to closely follow IMF and G20 developments.  Because in the end, it is through those global institutions that a new system will emerge - whether through conflict or cooperation.  That is the big question.  Understanding history, and watching how nations interact today will give us a clue into the future.