Thursday, September 26, 2013

The importance of the dollar as a reserve currency

We use the term "reserve currency" when referring to the common use of the dollar by other countries when settling their international trade accounts.  For example, if Canada buys goods from China, it may pay China in US dollars rather than Canadian dollars, and vice versa.  However, the foundation from which the term originated no longer exists, and today the dollar is called a "reserve currency" because foreign countries hold it in great quantity simply to facilitate trade.  The first reserve currency was the British Pound Sterling.  Because the Pound was "good as gold", many countries found it more convenient to hold Pounds rather than gold itself during the age of the gold standard.  The world's great trading nations settled their trade in gold, but they might hold Pounds rather than gold, with the confidence that the Bank of England would hand over the gold at a fixed exchange rate upon presentment.  Toward the end of World War II the US dollar was given this status by treaty following the Bretton Woods Agreement.  The International Monetary Fund (IMF) was formed with the express purpose of monitoring the Federal Reserve's commitment to Bretton Woods by ensuring that the Fed did not inflate the dollar and stood ready to exchange dollars for gold at $35 per ounce.  Thusly, countries had confidence that their dollars held for trading purposes were as "good as gold" as had been the Pound Sterling at one time.

However, the Fed did not maintain its commitment to the Bretton Woods Agreement and the IMF did not attempt to force it to hold enough gold to honor all its outstanding currency in gold at $35 per ounce.  The Fed was called to account in the late 1960s first by France and then by others until its gold reserves were so low that it had no choice by to revalue the dollar at some higher exchange rate or abrogate its responsibilities to honor dollars for gold entirely.  To it everlasting shame, the US chose the latter and "went off the gold standard" in September 1971.

Nevertheless, the dollar was still held by the great trading nations, because it still performed the useful function of settling international trading accounts.  There was no other currency that could match the dollar, despite the fact that it was "delinked" from gold.  There are two characteristics of a currency that make it useful in international trade: one, it is issued by a large trading nation itself, and, two, the currency holds its value vis a vis other commodities over time.  These two factors create a demand for holding a currency in reserve.  Although the dollar was being inflated by the Fed, thusly losing its value vis a vis other commodities over time, there was no real competition.  The German Deutschemark held its value better, but German trade was a fraction of US trade, meaning that holders of marks would find less to buy in Germany than holders of dollars would find in the US.  So demand for the mark was lower than demand for the dollar.  Of course, psychological factors entered the demand for dollars, too, since the US was the military protector of all the Western nations against the communist countries.

Today we are seeing the beginnings of a change.  The Fed has been inflating the dollar massively, reducing its purchasing power vis a vis other commodities, causing many of the world's great trading nations to use other monies upon occasion.  I have it on good authority that DuPont settles many of its international accounts in Chinese yuan and European euros.  There may be other currencies that are in demand for trade settlement by other international countries.  One factor that has helped the dollar retain its reserve currency demand is that the other currencies have been inflated, too.  For example, Japan has inflated the yen to a greater extent than the dollar in its foolish attempt to revive its stagnant economy by cheapening its currency.  So the monetary destruction disease is not limited to the US alone!

The dollar is very susceptible to losing its vaunted reserve currency position by the first major trading country that stops inflating its currency.  There is evidence that China understands what is at stake; it has increased its gold holdings and has instituted controls to prevent gold from leaving China.  Should the world's second largest economy and one of the world's greatest trading nations tie its currency to gold, demand for the yuan would increase and demand for the dollar would decrease.  In practical terms this means that the world's great trading nations would reduce their holdings of dollars, and dollars held overseas would flow back into the US economy, causing prices to increase.  How much would they increase?  It is hard to say, but keep in mind that there is an equal amount of dollars held outside the US as inside the US.
Perhaps only such non-coercive pressure form a sovereign country like China can wake up the Fed to the consequences of its actions and force it to end its Quantitative Easing policy.

No need for national conflict over Arctic resources

Arctic leaders talk in Russia about tapping riches without ruining environment
The nations of the world are right to discuss opening the Arctic to economic development without threats of national conflict. Austrian economic theory points the way. Previously untapped resources become the sole property of the first to bring them to market. In his Second Treatise on Government John Locke explained that man has the right to property ownership in any previously untapped resource via "mixing one's labor" with it. Austrian economists call this the homesteading principle. Therefore, the Arctic should become a free economic zone, and property rights should accrue to whichever individual, company, or country homesteads it. The benefits that will accrue to the citizens of the world are the same regardless of who brings the product to market. It is important that the new owners obtain complete ownership of the resource so that they will capitalize it for the long term rather than simply exploit it for temporary gain. Any homesteader may, of course, transfer his ownership rights to anyone else at any time. Plus, any owner loses his right to the property if he abandons it; then the property becomes available to the next homesteader. The homesteader may rightfully claim ownership only to the property that he can work. He may not claim the entire Arctic or even a large part of it without working it.

IMF calls for a socialist EU

The IMF--whose mandate for existence ceased when the US went off the gold standard in 1971...yet, like Dracula, it still walks the earth, sucking the lifeblood of more victimes--has recommended that the EU become one, big socialist union in order to fight the scourge of deflation. God forbid that deficit countries "suffer" deflation, whereby their costs of production fall and the nation becomes more competitive. Fighting deflation has become one of the world's greatest fallacies. Deflation is GOOD. Lower prices are GOOD. This is how an individual and an entire nation recovers. In his seminal book America's Great Depression Murray N. Rothbard explained how Presidents Hoover and FDR insisted on propping up prices during the Great Depression, which only prolonged the misery. Jorg Guido Hulsmann explains the economic theory involved in this short book Deflation and Liberty.

Wednesday, September 25, 2013

Failing to address the core problem

Draghi wants permanent eurozone bailout fund

ECB president Mario Draghi wants a 500 billion euro bank bailout fund, as if a one time bailout is all that is needed. However, the core problem has not been addressed. Fractional reserve banking means that the banks can pyramid multiple amounts of new lending (creating new money in the process) out of a small increase in reserves. This "something for nothing" credit expansion causes an unsustainable bubble, and that which cannot be sustained will not be sustained. The malinvestment must be liquidated, and Draghi assumes that his bailout fund is sufficient to save the banks...just this one time. But Draghi's proposed one time bailout will be repeated again and again until we realize that lending must be funded from real savings and not newly printed fiat money, created by the banks' privilege of fractional reserve lending. The template for an honest and noninflational banking system can be found in Murray N. Rothbard's The Mystery of Banking.

Sunday, September 22, 2013

Lowering the bar

From Open Europe news summary of September 20, 2013:

European Commission finance officials have tentatively reached an agreement to adjust the way the ‘structural deficit’ of eurozone countries is calculated. This could allow for an easing of austerity since more of the deficit could be seen as ‘cyclical’.WSJ
This would be hilarious if it were not so serious. Since the deficit countries lack the courage to balance their budgets and, furthermore, have no reason to do so in a union without real enforcement, the euro elite have decided to redefine success by lowering the bar! When will the rest of Europe wake up and realize that the EU and the EMU suffer from structural faults that cannot be avoided? The EU is a socialist organization, whereby success is punished and failure is rewarded. There is no way to avoid the inevitable consequences of such a structure. Europe's capital base and its world competitiveness is being undermined by its attempt to place entire countries on welfare.

Thursday, September 19, 2013

Once again, I'm Shocked! Shocked! (Not really)

From today's Open Europe news summary:
The ECB's Money Market Contact Group, a panel of industry members who advise the ECB, have called for the central bank to renew its three year long term refinancing operation (LTRO) next year due to fears over funding pressures as the current loans expire.
Once again, I'm (not really) Shocked!  Shocked! that politicians are prevailing upon a central bank to keep printing money.

Here is a short explanation of the LTRO.  It means that the European Central Bank can print money and funnel it to European banks so that THEY, and not the ECB itself, can monetize their own governments' debt.  This is just one of the many backdoor methods by which the ECB violates the Maastricht treaty, which specifically precludes it from buying sovereign debt.

No surprise that the Fed will continue Quantitative Easing

A friend asked me if I were surprised by Bernanke's statement that the Fed would not end or even slow down it $85 billion per month bond purchases.  Here is my reply:
Not at all.  Bernanke knows that he has a Hobson's Choice or, as Hayek said, a tiger by the tail.  If he keeps printing money, we risk hyperinflation. But if he slows down printing money, we get a recession.  The Fed will always choose to risk hyperinflation, because hyperinflation is not apparent until it is too late.  Thus, we get the inane statements that there is no sign of inflation.  Plus, there are no honorable central bankers anymore.  Paul Volcker was the last of a dying breed.

Here's my dictum: "If you can print money, you will print money."  The politicians will not appoint a central bank chairman that might do otherwise.  The political pressure to print money in order to buy the bonds of governments running massive deficits and keep the bubble economy inflated will always outweigh the political pressure to take our medicine and allow the recession to cleanse the economy of malinvestment.

My advice, prepare as best you can for hyperinflation.

Saturday, September 14, 2013

I'm Shocked! Shocked!

Greece not meeting Troika's agreement to cut civil service jobs

I'm shocked! Shocked! (Not really) that the Greeks are not living up to their promises to cut civil service jobs in order to get the latest round of bailout money. Wake up, Europe! There is no enforcement mechanism! The only real enforcement mechanism is to end the madness of the European Monetary Union. It is nothing more than a socialist construct that depletes the capital of responsible people without their consent.

Great Analogy!

From Charles Gave of Gavekal Research:
"Germans might as well load much of their auto exports headed to eurozone countries on to a boat and sink it outside of Hamburg. It would do as much good as selling Audis in exchange for IOUs issued by bankrupt countries."
Mr. Gave goes on to point out the the ECB's TARGET2 balances continue to increase. TARGET2 is an accounting fiction at the ECB whereby bank deposits in deficit countries do not have to fund deposits that their customers transferred to more responsible banks in more responsible countries. They simply get to carry a gigantic overdraft balance at the ECB. The responsible nations carry a credit balance that is unfunded. It is a backdoor bailout that few understand. As of the end of August the Bundesbank's (Germany's central bank) TARGET2 credit balance stood at 573 billion euros. That is money that is owed Germany by the ECB. It represents nothing substantial, not even mostly worthless Greek bonds. Yet Germany continues to deny that it is being robbed by the rest of Europe via the misconstructed European Monetary Union. It has better wake up before its economy is completely depleted of capital.

Thursday, September 12, 2013

Is war really the only alternative to a European super state?

From Open Europe news summary of September 11, 2013 (my highlights):

In his ‘state of the Union’ speech in Strasbourg this morning, European Commission President José Manuel Barroso said, “Not everything needs a solution at European level. Europe must focus on where it can add most value. Where this is not the case, it should not meddle.” However, he also said, “Let me say to all those…who rejoice in Europe's difficulties and who want to roll back our integration and go back to isolation: the pre-integrated Europe of the divisions, the war, the trenches, is not what people desire and deserve…I believe a political union needs to be our horizon.”
What is now called the European Union started as the European Coal and Steel Community in the early 1950's. Its purpose was simplicity itself: free trade in coal and steel, the foundation of the modern industrial state at the time, to remove the necessity of war to acquire these goods for the autarkic, warfare state. The Europeans had finally learned Frederic Bastiat's dictum that when goods do not cross borders armies will. Later the idea of free trade was expanded to include almost all goods plus services. Then it was expanded to allow the free flow of capital and people. None of this requires a European state. The people of Europe want freedom, not another layer of parasites taxing and regulating them into poverty. There is nothing that the European Union can offer that cannot be obtained from unilateral free trade. Barroso is disingenuous to equate the building a European super state as the only alternative to war.

Tuesday, September 10, 2013

Godfrey Bloom explains housing market realities to EU statist politicians

My good friend Godfrey Bloom, member of the European Parliament for Yorkshire and North Lincolnshire, explains housing market realities to statist politicians in the European Parliament. Perhaps the crime of which he speaks is so apparent and so widespread that none dare speak its name. What the politicians and central bankers on both sides of the Atlantic (and Pacific) do not understand is that THEY are the criminals, perhaps criminals by neglect and negligence, but criminals nonetheless.

Friday, September 6, 2013

Peru is NOT the dollar counterfeiting capital of the world

I disagree with this news article that Peru is the dollar counterfeiting capital of the world.

Here is its evidence: "Over the past decade, $103 million in fake U.S. dollars "made in Peru" have been seized..."

The Fed's QE3 program injects $85 billion into the economy each month; therefore, Peru's counterfeiting operations over the last ten years represents only 52 1/3 minutes of money printing by the Fed.

It is beyond a doubt that the Federal Reserve Bank is the largest counterfeiter of dollars in the world.