Weâ??ve all gone down the rabbit hole.
World Bank President Robert Zoellick has lent a certain Alice in Wonderland quality to the financial landscape by saying that the world should consider a return to a modified gold standard of international exchange.
If youâ??d asked me in 2007 how likely it was that a consummate insider like Zoellick would propose such a thing Iâ??d have said it was only slightly more credible then the head of the National Cattlemenâ??s Beef Association coming out in favor of giving cows the vote.
The idea that we would move away from or curb a fiat money system â?? in which the value of money is tied only to faith in a government, buttressed by its policies â?? was, and probably is, unsupportable, not so much impossible to implement as impossible to agree.
The takeaway from this is not that we will go back to currencies tied to gold but rather that the existing order is dying. When old religions die â?? and that pretty much is what any monetary system is â?? fantastic new ones spring up to contend to fill the void.
Zoellick is acknowledging what investors have already figured out â?? real assets are the place to be when the solvency of the banking system is threatened and the authorities refuse to deal directly with this.
With trillions in bank collateral worth less than where it is marked and with an economy mired in a balance sheet recession, the temptation to magic away issues by creating more backed-by-nothing money is too great. This is exactly what the Federal Reserve is doing in its latest $600 billion round of quantitative easing.
This in turn is an invitation to the rest of the world to print right back. There is no brake on this system other than the ability of nations to cooperate, and right now cooperation is not in everyoneâ??s individual interest.
Gold then can serve as a sort of adult in the global kindergarten dispute because it is finite, sort of. You simply cannot go and print your way out of trouble because we have adopted an arbitrary limit. No gold, no new dollars, or yen, or yuan.
You could argue that where we are now was a likely outcome of the current system. A global reserve currency in a fiat system creates tremendous incentives to take on too much debt. China helped the U.S. along by feeding it capital and keeping its own currency low, but there were many other ways in which this could have happened.
UNLIKELY PROPOSALS
So, the strange thing is not that a fiat system tends towards debasement of the currency â?? that is always the risk, but rather that someone from inside the system is grappling with that possibility openly.
Of course, you have to understand that Zoellick, who was writing in the Financial Times, made his call for debate over the role of gold at the end of a very long list of proposals, few of which are likely to ever come to fruition: here#axzz14iI6H1gW
That is the job of the head of the World Bank during a currency war that may morph into a trade war â?? advocate the unlikely until your head disappears beneath the waves.
Zoellick argues first that China and the U.S. should agree on a course of yuan appreciation, as well as committing not to engage in trade retaliations. This happy fantasy having been broached, he goes on to propose that the rest of the major economies join in by agreeing not to intervene in currency markets except when approved by others.
This isnâ??t going to happen and neither is a new monetary system that uses gold as an â??international reference point of market expectations about inflation, deflation and future currency values,â? as Zoellick wrote.
There are, of course, huge problems with this. Matching current supply of gold to current supply of money implies a huge appreciation in the metal or huge deflationary pressure. The gold is also not now in the hands it would need to be in to make such a system possible. Further, world trade can only grow as fast as money in supply to make possible the exchanges, so tying to a currency regime to gold means putting what could turn out to be an arbitrary brake on trade growth.
So, the lesson here is not a return to the ancient store of value, but instead that things are so volatile and risky that people in authority might even suggest it.
Runaway inflation is not inevitable, but avoiding it is not a sure thing either. Investors will continue to look for ways to hedge that risk, and that will drive not just gold but the prices of things that can be eaten, combusted, or manufactured with higher.
(Editing by James Dalgleish)
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund)
Oh, highly unlikely weâ??ll jettison the fiat system, after all, why does gold and other metals have value? Because it is perceived to be worth something. Despite the recent mess, the fiat currencies are still a medium for trade, nothing more. Hell, we could be using shells and have the same problem that we have now-those people from the north shore with the green ones found a bunch on a sand bar, and the chief gave them all 5 a household. I want two of those instead of the 1 to buy this coconut yesterday. Itâ??s not fair, after all.
Mr. Saft is correct, the confidence is really low. That does not mean that the end is nigh.
Weâ??ve entered a new era in global financial markets: the U.S. is intentionally devaluing the dollar.
For the U.S., which has long espoused a strong dollar but in reality had a policy of benign neglect, this is the equivalent of pushing the big red eject button in the jet cockpit: something big is going to happen and we will have to see how it will work out. The Federal Reserve on Wednesday moved to open a second round of quantitative easing, pledging to purchase a total of $600 billion of longer-dated Treasuries between now and the end of the second quarter of next year. As well, the Fed will reinvest $250-300 billion in the same period, meaning that the central bank will be buying up $110 billion a month in Treasuries and creating a like amount of new money out of the ether.
Perhaps the principal way QE will boost the economy, the Fed hopes, is by lowering effective interest rates, enticing investors to move into riskier assets, some of which may generate inflation and jobs. As well there is the wealth effect; the old canard of spending more because your retirement account and house have gone up in nominal terms.
The bald fact, though, is that by turning on the printing presses the Fed will drive down the value of the dollar absent a similar move in another currency. Much of the new investment created by QE will be made not in the U.S. but will be money borrowed in the U.S., exchanged into a foreign currency, probably an emerging markets one, and invested overseas. That will drive the dollar down, which will help to make U.S. industry more competitive.
There you have it; competitive devaluation, a beggar-thy-neighbor policy. It is not much of a lever, but it is one of the few which the Fed has left to pull.
Donâ??t expect anyone from the Fed or the Treasury to tell you this in simple declarative sentences, but itâ??s true nonetheless.
â??Devaluation is the intention, and devaluation is what is going to happen,â? Avinash Persaud, Chairman of Elara Capital told the Forex Forum conference in New York on Tuesday.
We can surely expect the U.S. to deny this, as Treasury Secretary Timothy Geithner did in October, but the truth will be seen in the foreign exchange markets, where the dollar has been falling and will fall further as the year winds down.
GETTING THE GENIE BACK INTO THE BOTTLE
It is most certainly in the power of the U.S. to begin a period of competitive devaluation. The U.S. dollar is a global reserve currency and the marginal cost to Bernanke of printing more is very low indeed. Less certain are the reactions of the rest of the world.
While the U.S. will surely have prepared the way for QE2 with its major trading partners (and in fact may be deliberately ticking off the Chinese) there remains a strong chance that a falling dollar sets off a range of tit-for-tat reactions. Already Korea and Brazil are moving to stem the appreciation of their own currency. Look too for the possibility of other countries joining in to QE, in part so that the Japanese yen, to name just one, does not rise too much against the dollar.
A currency war blossoming into a trade war has to be one of the outside but significant risks of 2011. If global growth can recover significantly this may be averted, but this is far from promised.
The second and maybe more important risk is that the U.S., having lost control over its own monetary policy many years ago due to recycling of capital by the Chinese, now loses control of its currency. Like going broke, this can happen little by little and then all of a sudden.
On the Fedâ??s reckoning it will go like this; QE2 and very low rates go on for an extended period, but almost as a matter of mechanics, when the Fed begins to tighten, the dollar recovers. The Fed has used the dollar lever to ease and then uses it to help to tighten. The dollar remains the principal global reserve currency and investors respond to the Fedâ??s incentives.
The alternative is that QE is not terribly successful in improving U.S. growth but does touch off a round of speculative investment elsewhere, investments that make returns in a shrinking dollar look worse day by day. When the time comes that the Fed, perhaps hurrying to prove its control, decides to stop QE2, bond investors want compensation for holding U.S. debt â?? a lot of compensation. U.S. equities, which have been held aloft by QE, duly fall sharply, as does the dollar, while yields spike. This is not a central case, but it is a possibility, and as it would be a disaster, one that needs to be watched closely.
Extraordinary times surely call for extraordinary measures, but those measures sometimes bring extraordinary results, and not always the ones we hope for.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.
â??Extraordinary times surely call for extraordinary measures, but those measures sometimes bring extraordinary results, and not always the ones we hope for.â?
Yes, and the previous rounds of similar â??extraordinaryâ?? measures were ineffective to a point they resulted in the Democrats losing big time in the midterm elections.
NEW YORK (Reuters) â?? Weâ??ve entered a new era in global financial markets: the U.S. is intentionally devaluing the dollar.
For the U.S., which has long espoused a strong dollar but in reality had a policy of benign neglect, this is the equivalent of pushing the big red eject button in the jet cockpit: something big is going to happen and we will have to see how it will work out.
The Federal Reserve on Wednesday moved to open a second round of quantitative easing, pledging to purchase a total of $600 billion of longer-dated Treasuries between now and the end of the second quarter of next year. As well, the Fed will reinvest $250-300 billion in the same period, meaning that the central bank will be buying up $110 billion a month in Treasuries and creating a like amount of new money out of the ether.
Perhaps the principal way QE will boost the economy, the Fed hopes, is by lowering effective interest rates, enticing investors to move into riskier assets, some of which may generate inflation and jobs. As well there is the wealth effect; the old canard of spending more because your retirement account and house have gone up in nominal terms.
The bald fact, though, is that by turning on the printing presses the Fed will drive down the value of the dollar absent a similar move in another currency. Much of the new investment created by QE will be made not in the U.S. but will be money borrowed in the U.S., exchanged into a foreign currency, probably an emerging markets one, and invested overseas. That will drive the dollar down, which will help to make U.S. industry more competitive.
There you have it; competitive devaluation, a beggar-thy-neighbor policy. It is not much of a lever, but it is one of the few which the Fed has left to pull.
Donâ??t expect anyone from the Fed or the Treasury to tell you this in simple declarative sentences, but itâ??s true nonetheless.
â??Devaluation is the intention, and devaluation is what is going to happen,â? Avinash Persaud, Chairman of Elara Capital told the Forex Forum conference in New York on Tuesday.
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