"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

Wednesday, January 12, 2011

Moving Away from a Global Dollar Standard

Barron's Randall W. Forsyth has a great article out today that ties two recent developments:  Japan's recent support of the Euro, and China permitting trade of the renminbi in the US.  The author's conclusion?  The world is gradually moving away from a global dollar standard.

My only criticism with the article is that it does not address the underlying issue of debt backed money.  It is not just the dollar that is being challenged, in my opinion, but the debt backed dollar standard, that is, under the current system accumulated foreign reserves are exchanged for trading partner's debts, and not an asset, like gold in the pre 1971 era.

Nonetheless, the article makes some valid points that I also made in yesterday's post:
The new world monetary order continued to evolve with two separate developments Tuesday.
Japan said it would join China in buying debt securities to support beleaguered European sovereign creditors. In so doing, the world's No. 2 and No. 3 economies were acting to try to hold together the euro as a viable alternative to the world's reserve currency, the dollar, from the No. 1 economy, the U.S.
At the same time, China permitted trading of the renminbi in the U.S. for the first time -- a significant step in the RMB becoming a full-fledged international, convertible currency.
To be sure, steps taken by both Japan and China are being motivated by their own considerations. But they are both part of the loosening of the global monetary system away from its dollar-centric mooring.
..."Normally, it would be considered a pretty sick joke: Japan, the world's largest debtor by a mile, riding to the rescue of eurozone debt? C'mon now!" comments Uwe Parpart, Cantor Fitzgerald's Asia Strategist in his daily missive to clients. "But these are not normal times and if Japan has nothing better to do with its forex reserves than stuffing them into the European sinkhole, why should anyone object?"
Indeed, but Japan and China would prefer to have the euro survive than to be stuck with just the dollar as the sole viable currency for international transactions and as a reserve. What's more the economic impact of a break-up of the euro would hit Europe as a whole, a major trading partner for the export-dependent economies of Japan and China. Thus, the countries no doubt see themselves keeping Europe afloat rather than pouring reserves down a sinkhole. 
... In essence, Japan and China are buying time. Obviously, their hope is that Greece, Spain, et al, will have a chance to grow out of the debt deflation. Good luck to that. 
That also would provide time for an evolution of the monetary system, with the renminbi playing a greater role. The Bank of China, a state-controlled commercial bank, is expanding RMB trading in New York after it was permitted last year in Hong Kong, the Wall Street Journal reports. 
This also follows an expansion of RMB dealings directly in other currencies, such as the Russian ruble and Brazilian real. Traditionally, Such "cross trading" typically involved in the exchange of one currency, say RMB, for dollars. Then, those dollar would be exchanged for rubles. This intermediate step is starting to be eliminated, cutting out the middleman of dollar dealings. 
...According to the old Chinese saying, the thousand mile journey starts with a single step. These steps are part of the movement away from dollar hegemony, a journey already begun.


Misthos here.  Overall, I agree with the writer's view of these currency developmets.  However, should dollar hegemony come to an inflection point, that is, it reaches a more serious stage that also may affect US National Security, I think the US has something up its sleeve that most countries do not.  I have written about it HERE.


Dave Narby said...

Great points as usual Misthos, and your reference to your earlier excellent post has me thinking again... I think you're right, let me try and add to it if I can...

Rickards has stated that the world needed a 'hard' currency to inflate against, and the USD provided that for 40 years - But now we're running up against the debt wall. So since the USD will have to revalue, what is likely to happen next?

I think that if China attempts to expand into empire too aggressively, the US will repudiate the debt to them entirely, either directly or by inflation. It is also likely to seize the foreign gold as payment for (essentially) previous security services rendered (providing deterrent against the USSR and China).

However, this will precipitate a response from the various other countries. If I was a developing nation (e.g. Brazil) I'm not sure who I would want to accept either USD, Yuan or Rubles, given the inability of those countries to keep a promise for more than an election cycle.

Instead, I would demand that the unit of account be something no single country can control the production of, and we all know what that is... And the more people of the world choose to make that their store of value, the more likely that becomes (I believe it is inevitable, but unlike The Bernank, I am not 100% certain about such things).

So in the end, China & Japan get to keep their factories, Russia stays a basket case (until the Russians get sick of gangster government), we get to keep the cheap shit we piled into our landfills, everybody "wins"... After a fashion.

Once we're past that, I expect there to be a long stretch of PPP (Productivity, Prosperity and Peace) as finance and government will have been reduced in influence and size throughout the world (sort of a global Tanzimat revolution), but I'm an optimist.

BTW, where's those pictures you promised of around where you live? Show us snowed-in New Yorkers some sunny Mediterranean climate porn! ; )

Misthos said...

Haha... I have friends and family not far from you - in New Jersey - what's up with the snow this year?!!! I remember last winter and into spring we were hit bad. Here on the island it's pretty good. Went spearfishing just a couple days ago. Both water and air temps 60 F. The only snow I see is occasionally on the highest mountain on the island.

I too don't see any currency taking over a global role, and as you said the dollar could eventually be "forced" to seek some backing (shiny metal, anyone?)

I hope you're right about your optimistic predictions... I just hope a global war doesn't enter into the mix.

I also think China may have a hard landing this year due to their property bubble. Which will have extremely negative consequences for the world economy.

Jim Slip said...

Guys, excuse me for my ignorance, but if China wants to export to the US, won't it have to accept dollars as a means of payment (or any other local trade-deficit currency they want to export to)? And if they don't, well, good, cause we'll get a chance to actually start producing things again. But I'd like to see where will that leave all the multi-nationals that have shifted production in Asia. Surely relocating factories doesn't come cheap.

Dave Narby said...

We got a couple feet of snow a week ago, and about a foot again. Fortunately this last time was really fluffy, so it was easy to shovel.


"Here on the island it's pretty good. Went spearfishing just a couple days ago. Both water and air temps 60 F"

OK, I now officially hate you. XD

Dave Narby said...

Hi Jim,

China can choose to accept anything it wants in payment, but we can't force anybody to use dollars other than our own citizens, and then only for payments to government (you and I can agree to transact in chickens, seashells or whatever we want, but you have to pay your fees and taxes in legal tender).

If China says "sorry, no more dollars", we'd have to pay them in whatever they wanted payment in.

Naturally, that would be terminally bearish for the US dollar..!

Misthos said...


You bring up some good points. And as you and I have said before, this global crisis of lopsided debts and surpluses and imbalanced trade relationships will affect everyone - not just debtors.

China needs the US as a trading partner, but what good is it if they are constantly worried about the value of their US "assets?"

see: http://economicedge.blogspot.com/

And what are those "assets" other than US denominated debt that has become so unmanageable, that the US must devalue its dollar to manage those debts. And China pegs the Yuan to the dollar! China loses here too.

Look at Germany. It grew as an economic powerhouse with the introduction of the Euro, only to see a large part of its customers go broke... and the result? Sovereign "bailouts" that are really German Bank bailouts.

Back to China - I'm sure they are hedging their US Dollar exposure with investments in real "ASSETS" like mining, agricultural, petroleum, etc contracts and investments. I know people in resource rich Australia, and they tell me the Chinese presence there is strong. And so... we have global inflation seen in many commodities. The costs of Western debt are being socialized around the world in a round about way. And now we see food riots. (which are also driven by other factors)

As for US Multinationals - they will have problems too. But keep in mind, many like Nike contract out their work to Chinese owned companies. Many can easily re-contract their work, as many have done, to other countries like Vietnam, or they can even bring the work back to their own countries.

The rebalancing will not be smooth, in my opinion, but it is unavoidable. The question is, how will the rebalancing ultimately play out. Will it be managed and gradual? Or will a currency crisis propel force it? A currency crisis that may bring on the return of commodity backed/pegged money - gold.

I think China fears this, and so China, India, Russia, and others are scrambling to accumulate gold in the event of a chaotic monetary transition brought upon by a sudden breakdown - a currency or sovereign bond market crisis.

I don't see this happening overnight, we are still very early into the process. It's not unavoidable either. But given the current policies being implemented, I have my doubts the rebalancing will be anything but smooth.

Others are predicting a Chinese real estate collapse this year. In that event, anything goes. We could see a massive drop in commodities, much like the drop in oil in 2008 from a high of $147 to $30 a barrel. But that too, keep in mind, was short lived.

It's going to be a bumpy ride. The recent stock market bull runs around the world have given many people a false sense of business as usual... like the days in 2007 when "subprime was contained." Shortly after such calm periods is when the shit hits the fan. 2011, I think, is going to be very interesting.

Misthos said...

Jim, sorry, link above should reference: http://www.marketwatch.com/story/china-seeks-reassurance-ahead-of-us-visit-2011-01-13?reflink=MW_news_stmp

Jim Slip said...

Misthos, perhaps we are missing the point. Perhaps in a MMT world it doesn't matter whether governments save in assets of value (foreign currency reserves) in exchange for their trade surpluses. Governments after all always have means to purchase goods and services if they desire.

Maybe China wants to save in assets of value, but China is an anomaly in a MMT world, because it operates in a fixed-rate system. What would happen if China free-floated the Remnnibi? I believe this article from the FT's Alphaville blog sums it up nicely:


The point is that if anything, China wants to maintain a trade surplus with the USA, not an account surplus, because that is how it's economy functions. To the USA on the other hand, it didn't use to matter. But now with 10% unemployment, it matters very much.

That is why the situation in the Eurozone is so bad. Yes, debt deflation is a virtuous path. But having societies go through virtuous paths of punishment can have unintended consequences.

Misthos said...

And not everyone in the world lives in a true MMT world.

That's my biggest criticism of MMT, it mostly focuses on domestic matters and disregards the real world realities of dollar pegs, geopolitics, resource constraints, austerity by others, etc... In a way, there are several monetary systems that exist in the world, all impacting trade, but the one thing all these systems have in common is irredeemable fiat currency.

Redeemable currency, like the gold standard, was a "check" in the system. In the 1960s, when Charles de Gaulle saw that the US was printing more money than it had in gold, he sent battleships to NY to redeem France's excess dollars for gold. That was an inherent "check" in the system. Of course, that system collapsed in 1971 under Nixon when he closed the gold window. And the western world, still facing the threats of the Iron curtain, foolishly and with cowardice, went along with the new system the US created.

We don't have that "check" today, and I am not saying that gold is a better system, that's another argument. What I am pointing out are the deficiencies in MMT that are often overlooked.

If a government, any government, is not revenue constrained - especially the US government, the largest economy in the world, then watch out. It will undoubtedly and eventually overstep its bounds and will print until the system collapses and war is the final resolution. That's my most pessimistic, negative opinion of what can result. And I fear that may likely be the actual result.

On the other hand, debt deflation may be virtuous, but it is foolish in the world we live today. So long as the US and others like Japan can print at will, then that's the game you play. Playing a different game only ensures that you will be the first to lose and be amongst the first to suffer the sociopolitical consequences.