Since my last post we have had the announcement that $600 billion new dollars will be printed over the next six months. A day later we heard from the ROW (the rest of the world):
China, Brazil and Germany on Thursday criticised the Fed’s action…
the Brazilian finance minister who was the first to warn of a “currency war”, said: “Everybody wants the US economy to recover, but it does no good at all to just throw dollars from a helicopter.”
… the Chinese central bank called unbridled printing of dollars the biggest risk to the global economy…
Backlash against Fed’s $600bn easing
So in keeping with the theme of Monday's post, "the network effect," I thought it would be interesting to explore what might happen to all those "homeless dollars" if "the effect's" feedback loop were to turn sharply negative. In looking at this I will let others do the writing for me, posting excerpts of my choosing with the credit and date at the bottom of each excerpt. This should keep the lively discussion going. Beginning here, it is no longer me writing...
The "Chartalists" (and their useful idiots everywhere) claim that the Federal Government simply spends money into existence, and thus they can do this all they want. Well, technically true - you can print all the money you want. However, you cannot control its value except through relative scarcity!
The Bond Market, rather than being a monetary tool as these people claim, is in fact a fiscal discipline enforcement device.
This is what The Fed with its QE and now QE2 has destroyed.
When Ben Bernanke said "we will not monetize the debt" what he was saying is that he would not permit that fiscal discipline device to be removed from the scales of financial balance. He lied - he not only removed it with QE1, he has now ratified that this discipline function will remain removed via QE2.
QE is effectively naked emission of currency into the economy by government spending.
Eventually The Fed ends up being, for all intents and purposes, the entire government bond market.
At that point the issuance of credit money is no longer backed by anything at all - it is simply emitted raw, and for every dollar emitted in this fashion you have both a 100% transmission into prices and a premium applied on your threat to do more of it.
That's Weimar Germany folks - it is exactly what happened there, and exactly what will happen here unless Bernanke stops this crap. Since he won't stop on his own volition it is up to Congress and the people to stop him.
How does the Fed print money? It’s easy; they simply buy bonds from the market and credit the seller’s bank account with electronic cash that comes out of thin air.
How risky is the Fed’s program of bond purchases? Very.
If inflation takes off, the Fed will have to choose between holding bonds and letting inflation get worse or selling bonds and going bankrupt in the process. Since no entity goes down without a fight, the Fed will naturally hold the bonds and let inflation take off.
Jim Rickards on King World News
His point being, only Americans and those in contracts governed by American law have to use dollars. The real deal is international trade and the settlement and clearing of trade flows among central banks. Right now most of that is done via the dollar.
Jim Rickards is suggesting that current policy (creating base reserves to pay over market price for crap and then burying said crap on the balance sheet at mark-to-fantasy valuation till term, or playing a game of hide the ball) may lead to that no longer being the case. Which isn't good for the FED, because they really just have dollars. If nobody wants what you have, you're broke.
People who worry about the dollar's international primacy are confused about how exactly currencies are used, as well as exaggerating by how much the US economy benefits from oil sales between, say, Kazakhstan and South Korea being denominated in dollars.
Yes, international oil trade is generally conducted in US dollars, as is much other trade in commodities and goods, and the dollar's use in international transactions is larger than the US economy's share of world trade. But, then, so is the Swiss franc's share. All that tells you is that most companies and countries prefer to do business in some currencies (dollars, Swiss francs, euros) than others.
Open any reputable economics textbook and you will find a chapter on the role of money. They pretty much all say the same thing: money is a unit of account, a store of value and a medium of exchange. The US dollar is regarded a reliable store of value - in the same way that gold, sterling or Swiss francs are - because of the strength of the US economy and the stability of its institutional support.
But the "medium of exchange" and "unit of account" elements are just functions of liquidity and convenience. If South Korea buys oil from Kazakhstan by converting Korean won into US dollars, then Kazakhstan can either keep the payment in dollars or convert it into Kazakh tenge for domestic use. In any case, all that happens is a transfer from one bank account outside the US to another one.
For all three reasons of value, exchange and account, the world's central banks tend to hold large proportions of their foreign exchange reserves in US dollars - in part because, as in the Kazakhstan example, that's what they receive a lot of in the first place.
So what does the US gain from the dollar's international role? In theory it means the US can borrow money more cheaply, receiving a lower interest rate for dollar-denominated loans or bonds than would otherwise be the case, because those dollars have to go somewhere. Unfortunately, there is no evidence that US interest rates would be higher if the dollar were not a widely held reserve currency - for many years Germany paid lower interest rates on its bonds than the US, despite the German mark not being internationally as popular.
The only tangible benefit comes from forgone interest that would have been paid on US currency - actual notes - held outside the US. According to the Federal Reserve, about $300bn in hard cash circulates outside the boundaries of the US, with much of it held by criminals and black-economy participants.
The US economy does gain a benefit from this, but it is only a tiny benefit. If this hoard were kept in interest-bearing assets, the US economy would be paying out about $10bn a year in one way or another. Instead, the US economy is subsidised to that extent. In an economy the size of the US, that is chicken-feed - the equivalent of £25 a year to an average full-time wage earner in Britain.
Let's be clear what this does not mean. Just because Kazakhstan has a US dollar-denominated bank account in London or Basle does not mean that it is in hock to the US, or that it is forced to buy American assets or exports. Nor is Kazakhstan subsidising the US economy, at least not to any appreciable extent.
It certainly does not mean the US somehow gets to import oil for "free" because it pays for it in dollars - it can't simply print money to pay for barrels of black stuff. Or, to be theoretically correct, it could do so but not for long - the value of the US dollar would sink on foreign exchange markets as a result, and cost the US economy far more.
A little dollars and sense
The Guardian (UK)
Why does this article by Richard Adams worry me? Has he got it right or wrong?
I thought that if oil was paid for in Euros, say, instead of dollars, then that would encourage most countries to divest themselves of an appropriate number of "dollar asset reserves" in favour of "Euro asset reserves", thereby reducing the demand for dollars and lowering its "value", and increasing the demand for the Euro and raising its value.
...and in his last paragraph, I thought that the US HAS been "simply printing money" - maybe not to "get oil for nothing" directly, but to support US asset prices…
Any other opinions out there?
Sundeck (5/5/03; 03:56:35MT - usagold.com msg#: 102354)
Dollars for oil - how important is it?
Like Sundeck, I was surprised at the Guardian author's blunt dismissal of the importance of the dollar's being a reserve currency. Don't get me wrong: I am not for a moment suggesting that preserving reserve status is the ONLY factor in deciding US foreign policy; but I do believe that losing reserve status would knock the US quantity of money wildly out of balance and that the US Treasury knows this.
His argument about the unimportance of oil's being priced in dollars is then expressed as: '... the "medium of exchange" and "unit of account" elements are just functions of liquidity and convenience. If South Korea buys oil from Kazakhstan by converting Korean won into US dollars, then Kazakhstan can either keep the payment in dollars or convert it into Kazakh tenge for domestic use.'
It's an argument I've seen before: if I have dollars, and oil is priced in euros, then this makes no difference -- I can "convert" my dollars to euros before I buy the oil. And to me, his use of the word "convert" seems to confuse the "medium of exchange" and "unit of account" uses of money.
Let me explain what I mean. There are some transactions which are much the same whether they are carried out by me or by the United States ... give or take an extra eight zeros on the numbers involved. But there are others where the large transaction is different in kind from the small.
If I want to buy an ounce of gold, I can go into any coin dealer in the High Street and buy a Krugerrand for a few per cent over the intrinsic metal value.
If I want to buy 200 times as much, 200 Krugerrands, I can telephone Centennial, where I'll pay a smaller percentage premium because of the quantity I am buying.
If I want to buy 200 times as much again, 40,000 ounces, then everything changes. "Economies of scale" become less important than "supply and demand." I am probably buying most of the available physical gold in the market and need to compete against other major buyers of physical gold. My purchase will take time and cost more.
If I want to buy 200 times as much again, 8,000,000 ounces, then probably nobody anywhere has that much on sale. This is 10% of the gold mined worldwide in a year.
Much the same holds for "converting" from one currency to another for the purposes of exchange. As a unit of account, I can just use multiplication: "Your account at present stands at 1,000 pounds sterling, John, which is the equivalent of 1,500 US dollars." But if I want to use those dollars as a medium of exchange -- to buy something with them -- I first have to use my pounds to buy the dollars.
If I want to buy 1,000 pounds-worth of dollars, then first I must come out of the coin dealer in the High Street -- or I shall wind up with 1,500 Sacagawea golden dollar coins -- and go into any bank, which will give me Federal Reserve notes in exchange for Bank of England notes, at the tourist rate. I can "convert" the currency easily.
If I want to buy a thousand times as much -- 1,000,000 pounds-worth of dollars -- then I can still convert the currency easily. In foreign exchange terms, a million pounds is a very modest amount, though large enough for me to get the forex (rather than the tourist) exchange rate. My own bank will have an account with USD 1,500,000 in it, which it can withdraw and pay into a dollar account in my name; at the same time deducting GBP 1,000,000 from my sterling account. (I should perhaps point out that I have never actually done this!)
If I want to buy a thousand times as much again -- 1,000,000,000 pounds-worth of dollars -- then it becomes clear that I am buying dollars, rather than converting pounds to dollars. The extra demand for dollars that I have created will increase the price of a dollar. My bank, however, will have no great difficulty finding that many dollars. The reason for this is that there is a huge quantity of dollars in the London foreign exchange market ... because the US dollar is the principal reserve currency. These are the dollars that European oil users buy so that they can buy oil, and which the oil producers later use to buy euros so that they can buy the things they need from the Eurozone. These dollars are, in practice, never taken back to the US and spent there.
It is this need to find dollars -- in practice, to find banks which have large dollar deposits which they are willing to sell to me -- that makes the big difference between a "medium of exchange" and a "unit of account". And it affects the monetary policy of the owner of the reserve currency. If there was no longer a demand in London for US dollars to buy oil, then the banks in London would no longer need large dollar deposits. Where can these dollars be spent if they cannot be spent on oil? In the United States.
This is what I meant when I wrote that losing reserve status would knock the US quantity of money wildly out of balance. The repatriation of the petrodollars would considerably increase the quantity of money available for spending in the US ... with an immediate inflationary effect.
How much of an effect, I don't know. Does any of the Folk of the Forum know?
John the Jute (05/05/03; 16:04:12MT - usagold.com msg#: 102381)
Enjoyed your post John the Jute - thanks for painting the circumstances surrounding "medium of exchange" so clearly. You've got me thinking about repatriation of dollars now.
From first principles, I suspect that the net global "float" of petrodollars is related to the cumulative total-dollar-expenditure on oil by all countries per unit time, and to the time-rate at which the dollars are recycled. On top of this will be the "oil-portion" of dollar-reserves set aside by all countries to buffer their balance of payments at any give time. Do away with the dollar-oil symbiosis and both the "whirlpool" of circulating dollars and the oil-portion of reserves will look for another home...back in the U.S of A.
Probably heaps been written about this here and elsewhere in the past, but how to find a definitive and succinct treatise???
Sundeck (5/6/03; 03:46:21MT - usagold.com msg#: 102414)
Good post, John the Jute! Very nice way of explaining the relativeness of scale.
Regarding your musings re: dollar repatriation, it can be a tough one to answer. The obvious take is of course as you express, that without use for dollars, they would simply find their way back to US shores, and help drive (hyper-)inflationary pressure. Yet, if you will permit me also to think out loud for a moment ;->, perhaps we can take a look at this currency as the derivative instrument it effectively is, and then try to figure out its ultimate fate. Let's view it specifically as a kind of call option; one that commands a premium as a price paid for its exercise-ability at any time for any of the goods or investment media that exchange in the currency's universe (or the settlement of debts). This amounts effectively to a liquidity premium.
This premium gives it a trade value in its own right, and as such, as long as there is a market that believes in the currency's stability, the currency itself trades on its own merits. Not unlike futures and options. And just as many of these contract instruments get exercised for whatever underlying asset they represent, most are simply exchanged among speculators and hedgers trying to benefit from movements in the contract price, never actually intending to exercise or take delivery. The paper remains viable so long as the holder is confident that the next guy believes the contract is generally good.
While many holders of a currency intend to "exercise" the currency for real things, especially those in the currency's principal use domain, most of these currency units are likewise exchanged among speculators and hedgers (including all those private individuals, who own dollar denominated savings and investment accounts overseas), who are only trying to profit (speculate) from the currency's movement, or preserve (hedge) their own currency's seemingly endless trek of depreciation vis-a-vis this US dollar. Most of these have no intention whatsoever of "taking delivery" of things with these currency instruments.
So, what happens to the dollars they sell? For these average citizen types, the banks that held their accounts buy them. They then either sell them to another institution or may enter the foreign exchange markets themselves (depending on how they are regulated). They also may hold some back, depending on how they wish to balance their own portfolio. So, now these dollars that have not ended up remaining in reserves at these banks have entered the foreign exchange markets putting upward pressure on the currency of the seller, and downward pressure on the dollar.
Historically, the paradigm was to do as little of this as was necessary in order to keep the seller's currency "competitively" weak (among other reasons). As the influence of export to the US wanes (tapped out US consumer + growing size and sophistication of other markets), the need to keep one's currency weak vs. the USD, so as to compete for this market also wanes. Instead the stabilizing and strengthening of one's currency becomes more important (thereby encouraging borrowing in the local capital markets), and allowing local workers to enjoy a bit more the fruit of their labors, instead of always helplessly watching the value of their labors get sucked into the vortex of a dollar-dominant currency paradigm.
So, do these orphaned dollars eventually come home to roost in the US domestic markets? We will be told that. The media will wring their hands over anecdotal wake-up stories like Arabs buying up vast tracts of property, and how "they" will soon "own" the country... (This has been going on for ages in the U.K., as you're aware... every other lovely English manor is seemingly owned by some Saudi mogul...) We experienced the same with the Japanese in the 80's (Rockefeller Center...). Hence part of the political response will be to enact capital flow restrictions. But anecdote amounts to chump change, in a purely financial evaluation.
The really big holders of dollars are the central banks. What they do with their reserves will make or break. Their influence over other banks and financial institutions will also largely dictate the destiny of these dollars. In the gold standard, the currency acted as something of a title deed for a specific good at a specific price. Central Banks could and did take these "receipts" and claim gold from each other. In this day, there is nothing for CBs to "claim," as these dollars are no longer "title deeds." Rather, they are like non-expiring calls for things on demand, at the variable and going price. CBs are likely to neither a) dump them on the forex markets, as this would simply devastate the currency, and risk dreaded instability globally -- something banks are NOT prone to do; or b) race to our markets to try and buy things (like gold), as this would also be fruitless, since a market revaluation for this action would instantly make gold unpriceable, and it would not even be offered. Again, why engender the instability?
Without a certain weapon in the arsenal of the euro's design, the foreign CBs would indeed be over a barrel. Previously they were forced to evermore be on a dollar standard, since they would realistically only opt for this as the lesser of two evils. The alternative of saying no to the dollar at that time, would only have meant a return to a gold standard, and the politically unacceptable bone-crushing depression that would follow (as well as instability). In 1979, the European CBs began marking their gold reserves to market. This one act demonstrated immense foresight, and would provide the escape valve from the rock-and-hard-place no-win choices between eternal dollar support, or global depression.
Quietly, the euro-system banks have been divesting themselves of dollars. Collectively they retain something like 211 bn. currently. (This is not a large amount relatively speaking, but consider fractional reserve lending, and quickly we perceive the immesity of euro-dollar infestation.) This decline in dollar holdings is desired to take place concurrently with a rise in the price of gold to offset this. Spoonfeeding dollars into the system won't crash it, as well a slow commensurate rise in gold. The discipline that they have thus far maintained is indicative of the tectonic movement of the geopolitical strata. Ideally there will be no rash or even discernible activity. The perfect result is to simply keep shifting these plates until we wake up one day and the world has been remapped. Reality of course is that there are points of friction that cause tremors of unpredictable frequency and proportion all along the way. At some point critical mass will be reached, and the dollar contract markets for gold will no longer be able to contain its price as market perception on a large enough scale discounts paper parity with the real metal accordingly. It is at this juncture that the gold reserves of the CBs will provide immense expansionary leeway, as they are for a season revalued constantly upward. This bona fide liabilityless reserve base will make the ECB member banks the premier lending institutions to fuel the economic growth of the euro zone, and those align themselves with it.
In this respect it is important to curry the cooperation of the more maverick dollar holders, like China and Russia, as their track record of unpredictablility, may lead them to use their dollars as weapons... (And don't think that their dollar debt is of much concern to them, as they know all too well that those totals can be reduced in real terms to pocket change, if such a hyper-inflation were to manifest.) Indeed as far as the books are concerned, this one use for these dollars overseas -- the repayment of dollar debts -- would actually provide a contractionary effect as these receivables are cleared from the balance sheet... One reason why Goldendome's sought after interest rate hikes can't happen... (gotta keep expanding..., and making it more expensive to borrow, isn't gonna help matters...) [Goldendome, there is much to this discussion, and I would like to provide my opinion in response to you -- as I used to think exactly the same... I likely won't have time, but the Trail provides some excellent discussion along these lines...]
The strategy of the level-headed is to slowly remap the globe financially. This involves as much as possible a SLOW transformation from one currency paradigm to Another. These dollars en masse will not return home. They were born in exile and will die in exile. We will hyperinflate ourselves, and won't need help from overseas...
Take care John the Jute,
USAGold Hall of Fame
Gosh, what a thorough response, miner! You've clearly thought about this matter in considerable detail. Thank you for sharing the results of your thoughts with me.
John the Jute (05/06/03; 11:25:50MT - usagold.com msg#: 102432)
miner49er @ 102429 -- Homeless Dollars
As I read your post I was held in rapt admiration. So many folks stubbornly live in the past, but when a few guys like you (y'all know who you are) can lay it out so clearly for general consumption, surely the future for everyone is brought forward by *at least* a few days.
Thanks for your contribution toward making the world, in aggregate, a more rational place one post at a time.
Gold. You know the drill. --- Ari
Aristotle (05/06/03; 13:54:06MT - usagold.com msg#: 102444)
Aristotle (05/07/03; 18:17:02MT - usagold.com msg#: 102497)
"*Money* in its purest form is a mental association of values in trade...a concept IN MEMORY...NOT A REAL ITEM!!! Understand money and you understand Gold!" --- Belgian
Amen. And further:
"The exhorbitant growing confetti-creation, policies... NEED TO BECOME DETERMINED BY WEALTH *OUTSIDE* THIS OFFICIAL MONEY REALM!" --- Belgian
Amen. Hence the primary universal function of global physical Gold comes into view -- an asset for savings that lets its owner know the true size and shape of his wealth.
True Wealth. Get you some. --- Ari
Aristotle (05/07/03; 20:44:46MT - usagold.com msg#: 102502)
omegaman -- money is also known as a time value judgment
The key point to recognize is that it's the multitude of goods prices that we're exposed to along with our various wage-level associations that we hold in our minds which gives money a functional *unit valueness* even though it's not a standard weight or measure of any single physical thing. Physicality be damned. As a *nominal* (mental value) measuring unit it serves perfectly as the lubricating *unit of account* in the ever-adjusting network of purchase orders, loan contracts and labor agreements which all form the backbone of our economy and monetary system.
To deny ourselves that pure nominal form for our monetary system is to deny that we are human with warts and all. Although Gold has no right place *IN* the monetary system, it is by natural selection the nearest neighbor living in the real *OUTSIDE* world that can act as a universal translator to judge and announce *without bias(!!)* the temporal values of the many monetary pricing units being wiggled and jiggled around *inside* the "gamey" system.
Only if and when *observed* by Gold like this can we begin to call it a *perfect* monetary System for our admittedly imperfect world. Don't worry, we'll get there from here on that vehicle -- even if only by default as every other sort of vehicle will break down during the journey.
Gold. Rolling rolling rolling along like a song. --- Ari
Aristotle (05/07/03; 21:10:04MT - usagold.com msg#: 102506)
steady -- it's VERY good to know the true size and shape of your wealth
I was deep in your vest pocket up until you offered this extreme:
"gold [...] is constant . [...] its value doesnt ever change all that is changing is the amount of fiat one gets for it."
Wellllllll,,,, I suppooooose we *could* accept Gold as the fixed-value center of the relative value universe. But what's wrong with accepting that its value in human affairs could in fact climb even higher than it is relative to other real things like butter and bread and eggs as we put it to this special modern (ancient!!) usage we're describing?
You went onward to ask and bemoan:
"isnt it unfair that some group of bankers can meet and make your life worthless by devaluing your capital? That simply is not fair, not honest, most importantly not cool."
Take heart! If we can finally rid ourselves of the paperGold games that are played in parallel with money games, they can then only make your life worthless if you let them. That is, if you hold your primary savings in the form of money instead of Gold.
It doesn't take much training to fall into the excellent rhythm of Gold savings as the harmony to accompany your monetary melody of earnings and spendings. Billions of little easterlings and southrons are in graceful step even as we westerners only begin to hearken to the distant hum.
Gold. Get you some. --- Aristotle