"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

Saturday, November 27, 2010

The Next Largest Nuclear Powers, China and Russia, Openly Challenge US Economic Supremacy

Two very recent developments have transpired that I think warrant mention. I will be incorporating these developments in my Part III of my Fiat Evolution series. But as this blog has always emphasized: it is geopolitics that in the end, will determine the next monetary system. Will it be through geopolitical cooperation or conflict?  That's the question.

We have all seen the many photo ops at the recent G20 Summits, the empty promises, the fake smiles, the multitude of pronouncements of "lofty goals" etc.. But now that the most recent G20 Summit is but a couple weeks behind us, China and Russia are openly challenging US Economic, and by association, US Military, might. Keep in mind that the US has the world's reserve currency. It prints money with a lot less inflationary impact that other countries would normally face. Why? Because the US Dollar by far, is the most used international currency in global trade. This actually REQUIRES that the US print excess money to keep the global economy growing. But it also creates the Triffin Dilemma: the US needs to also consistently run trade deficits in order to "export" its dollars. That is not a sustainable model, as trade deficits cannot mathematically run forever.

But back to the open challenges to US Supremacy, first, from Bloomberg:

PBOC Researcher Calls on U.S. to Sell Gold Reserves, People's Daily Says
The U.S. should cut its government spending and sell some gold reserves to balance its budget and fund its recovery, the People’s Daily overseas edition reported, citing Xia Bin, an adviser to the People’s Bank of China.
The U.S. has to resolve its “twin deficits” in the government budget and the current account, Xia was quoted as saying. Three ways that may help the U.S. achieve that target include reducing military expenses, selling part of its gold reserves and relaxing some export limits on technology, he said.
“The U.S. has more than 8,000 tons of gold reserves; why can’t it sell some of it since the country wants to raise funds for economic recovery but doesn’t want to add more burden to the fiscal deficit,” Xia told the newspaper. He didn’t mention whether China would be willing to purchase any gold from the U.S.
So let's translate this.  China is basically telling the US to 1) sell its gold reserves, 2) reduce its military, and 3) give China more access to its technologies.  Now I know that this comes from an advisor to the People's Bank of China, but to me, it is not some last minute random trial balloon.  This is real.  China is openly questioning the US's role in the world, and by association, questioning the US Dollar's role.  China is speaking to the US the way Germany lectured Greece earlier this year.

This is cause for concern.  We are speaking about a rising power challenging the current (let's face it) Imperial Power.  Rome was just told to step down!  This amidst the recent North/South Korean confrontation, the yet to be fully explained "missile launch" off the coast of California, and the Russian/Chinese deal to omit the US Dollar from their trading.

To me, these events are all tied together (with the possible exception of the recent "missile launch" that has yet to be officially explained).  There will be no global cooperation in a transition to a new monetary order.  Sarkozy will lead the G20 next year as France assumes the G20 presidency.  But it will be pointless, he is no de Gaulle, and the world is becoming increasingly fractured.

And now, this from Russia:

Vladimir Putin said it is "quite possible" that Russia will one day join the eurozone and create a currency that would eclipse the US dollar as the global reserve standard.
Speaking at a conference in Germany the Russian prime minister, who is in the country for talks with Chancellor Angela Merkel, said he was convinced the euro would stabilise and strengthen despite the current sovereign debt crisis.
He said: "Yes, there are problems. But the economic policy of the European Central Bank and of the governments of leading European economies ... convinces me that the stability of the euro will be ensured."
He added: "We know there are problems in Portugal, Greece, Ireland and the euro is wobbling a bit. On the whole it is a solid, good currency and it should take its place, its role as a reserve currency."
Speaking at the same event, Josef Ackermann, chief executive of Deutsche Bank, echoed Mr Putin and said he could imagine Russia joining a common European currency.
Now this is a little more complicated.  What is the goal of this pronouncement?  Is Russia trying to jab at the US Dollar, and the US's role in having the world's reserve currency?  Is Russia giving an open vote of confidence to the flailing Euro because it has so much at stake in the Euro?  Does Russia want to someday merge economically with Germany - one is rich in natural resources, the other in manufacturing know-how?  I say it's all of the above.
And so, we are facing a world that seems to me to be lacking order.  These are the times that history shows are watershed events.  There are only two outcomes here in classical geopolitical theory:  1) Either the existing  hegemon reasserts its power or 2) a new hegemon assumes leadership.  Neither scenarios occur peacefully.  I am not saying that a major war is at hand.  But I believe that we will be witnessing proxy wars in the near future.  Look to Iran, North Korea, and Venezuela.  They seem to be the next battle grounds.
And what does this mean to the current monetary order?  As conflict escalates, and the US Dollar is used less in foreign trade or is continually openly challenged or avoided, the US will be faced with a decision: to deploy its guns or gold, or both.  Nations store gold and weapons for a reason.  Historically, the nation with the most guns and gold wins.  But Russia is the one that can tip the balance here, as it has increased its ties to both China and the EU.  In my view, a gold backed dollar is not out of the question.  The US is becoming increasingly alone, and its paper money is being questioned.  Once one country goes the way of gold, all else are forced to follow, as all fiat money immediately collapses with the reintroduction of gold.
Which will the US deploy?  


Nick said...

... As far as the Euro is concerned, I can only see the following scenarios playing out:
1) split into Northern/Southern Euro (high probability, especially after Putin's statements)
2) print 2 trillion just to start with…
3) move to a closer fiscal union (unlikely, given the "diverging" behaviour of EU leaders)

I cannot see the Euro disappearing altogether though (it would if Germany left, but I think such a move would also bankrupt their own banks, so it's a no no). As I can't see some countries leaving, since the fear that others would follow would leave everyone with the same problem that they started off with. Outright defaults (e.g. Greece seems certain to me) will only take place if the ECB decides to print enough so as to keep the major European banks alive, so that leads to number 2 above again - I can't see any other way for defaults to occur, which is why Germany's stance confuses me lately.

Regarding the dollar, I think it's a matter of perception: it might strengthen in the near future, but the economic situation is as dire as it is in Europe, and trust to that currency has taken a severe hit already.

If Asia manages to stay on its feet, I think that something like the 70s, but more severe, is going to take place. I am trying to be an optimist in my pessimism :) But I sense that this could drag for another 5 years, if they so choose.

I would appreciate your thoughts on the "lights out" vs 70's style (hyper?) inflation scenario.

Keep up the good work,

Nick said...

Hi Misthos,

sorry for the weird post above, but Blogger seems to have "eaten" the first half of my post twice... Lost it now, so can't submit it again

Anyway, just wanted to tell you that I really enjoy your blog,


Misthos said...


I will be covering many of the points you brought up in Part III of Fiat Evolution earlier this week.

I still believe the Euro as we know it today is doomed. There are just too many factors working against it: geopolitical infighting, increasing social unrest, divergent domestic politics, effectively insolvent banks, effectively insolvent nations, huge, and I mean really huge trade imbalances, etc...

I fear that there are some problems that have no solutions. Think of it this way: It's 2005, and you're the Governor of Louisiana and Hurricane Katrina is heading right your way. Is there a solution? Can you stop a Hurricane? Hell no. What can you do? Prepare for the
storm. That's all you can do.

Sometimes the only thing we can do is react as things enter a sort of entropy phase.

No one wants to admit this or face it. No one. I guess the human mind isn't programmed to think this way when it comes to the collapse of social, economic, and political structures and systems. We designed them, after all! How can we not be able to fix something we designed? I think policymakers are too arrogant to admit mistakes, so they react with temporary solutions. That's the political system we have today. But the truth is, sometimes there is no solution - not one in the sense that you can maintain control and decide the ultimate outcome. There are just too many variables that feed off each other.

But there may be one option that can give Europe more control and a fighting chance. I call it an option, not a "solution" because it is rather radical.

Systems that are destined to collapse need to be replaced. They cannot be altered or "patched up" anymore.

Either Europe changes politically- that is, it has a strong, centralized federal government - or EMU is dead. That's the ugly truth that policymakers can not speak about publicly. Europe needs a President, a Federal Treasury, and a Federal Taxing authority. They need a central authority that redistributes imbalances within Europe and centralizes and manages debt growth. The question is, do the people want this? Are they ready for it?

Asia minus Japan is a bubble right now. I think Jim Chanos is right.

Misthos said...


Regarding your lost comment - blogger has done this to me as well. No worries.

Thanks for visiting the blog and your words of support.


Nick said...

Thanks for your reply. What I was trying to say, and it was forever lost in the digital world, is that I totally agree with your perception of things - it's just that most people don't, and that's what's scaring me.

It's only recently that I discovered your blog, but from what I can see, we're hanging around at the same websites. I'm a Greek "trapped" in Britain (for the moment), trying to find a way to protect my family - and I'm really inspired by your profile and your decisions in life.

What I wanted to point out is that nobody that I talk to here seems to understand or care about the situation. It feels very lonely watching the whole thing unfold, and that's the main reason why I decided to post here. Everybody seems to live in their own localised bubble, unable (or, subconsciously, unwilling) to see the bigger picture.

What I meant to say by the "lights out" scenario before is, do you think there is going to be another Lehman instance, or do you think that they are going to print and print as Marc Faber and Jim Sinclair seem to suggest? Are the paper money system, stock markets, banks going to be functioning while (hyper)inflation takes hold, or are we going to witness the real deal of a collapse? Cause everything seems to hang from a very fine piece of thread at the moment...

Anyway, maybe I just wanted to communicate with someone who understands! I don't expect from you to have every answer - just interested in your opinion.

Looking forward to your next post

Misthos said...


I share your frustration. In early 2007 I was telling anyone that would listen that the economy was going to tank, and that our monetary system is ending as we know it - and with it, negative and unpredictable consequences would follow.

Very few believed me. And there's a reason for that. Most people have no concept on how our monetary system works. Most people think monetary systems last forever - they don't. And for many that do understand, there's a mental disconnect. They don't want to believe it. It's too depressing so they block it out.

My decision to move to Greece was based on several factors. I got tired of the corporate grind, over-consumption based lifestyle that focused on standard of living more than quality of life.

But to be honest, I also have access to family land and farmland here in Greece (I sometimes contemplate the worst case scenario, and that farmland with ample well water is reassuring) - and my expenses are minimal here as well. I am single with no children, so the decision was only mine to make.

I sold everything, and left. No regrets - well, one regret. I wish I did this sooner.

I'm not saying everyone should do what I did to be happy. It's a very personal decision. And it's not like I became one of those extreme survivalists that headed for the mountains to live in solitude. I live mostly in the island's capital city, but also have access to the village family home. I am truly fortunate to have the best of both worlds here.

I'll be writing my views on how this could play out for Europe and the US soon. I'm just gathering all the recent info on the EU's handling of Ireland, and how that sheds light on the future of Europe and the Euro.

During this crisis there are moments of stability, and then there are moments of accelerated mini-crises. We are witnessing one of those flare-ups right now.

Ultimately I believe there will be another Lehman Bros. type moment. In my view, the current monetary system will not end quietly with a soft landing. Seismic economic changes lay ahead.

Anonymous said...

I fully agree with both of you and I share your feelings. Who knows how many others do the same?

Misthos said...

Hi Fauvi - surprisingly, every once in a while I personally meet someone that "gets it." But most people that I have corresponded with that understand the situation we're in have been from the internet. We are definitely a minority.