Posts Tagged ‘bretton woods’


August 12, 2010

Post added to on August 13, 2010 – last few paragraphs

The latest reason people are getting their knickers in a twist is Laurence J. Kotlikoff’s ruminations on the de facto bankruptcy of the USA. Professor of economics at Boston University, Mr Kotlikoff bases his comments on an IMF report that sets forth some indisputable arithmetic whereby current and projected US GDP falls short of satisfying current and projected state spending to the tune of over $150Trillion over the next twenty years or so. That’s Trillion with a “T”.

Kotlifoff’s Bloomberg article is being pored over and dissected by some of the brightest minds in the world as well as some of the less bright bulbs in government and everyone has something to say about it whether for or against the arguments set forth.

Rather than adding to the analytical cacophony, I prefer to whittle down the argument to simpler  terms and it goes something like this.

Short of returning to barter, we have no choice but to make use of some type of money. In actual terms, money is just like barter but since it allowes us to break down the value of an item in small fractions of value, it allows people to interact more easily than, for example, exchanging 20150 shovels to buy a car. Instead, you sell your shovels for bits of value that you then can deposit or carry around in order to exchange for other items and services you require.

So, money is necessary and is a fantastic concept.

What remains to be chosen now, is how the monetary system is to be managed.

In our life time, since 1913 to be precise, nations have gradually moved to a fiat monetary system. The USA were the first to adopt fiat money but then since 1971 gradually all other countries world wide have followed suit.

Fiat money is a rather ingenious concept to be fair or, at least, it could be. But the variety of fiat money first adopted by the USA and then imposed on the rest of the world is inherently self destructive as has been proven several times since the advent of modern finance in the 1500s. The variety of fiat money adopted by the USA in 1913 is the type that is predicated on the perpetual expansion of the monetary base ergo inflation.

At this point we can debate whether the choice was deliberate or forced and whether or not it was born of ignorance or intent. But that is not the point I wish to make. The point is that this is the monetary system we have to contend with.

The historical logic of fiat money has manifested itself several times since 1913. As the sole users of fiat money from 1913 to 1970, the USA first flirted with bankruptcy in 1929 only a short 16 years from adopting the system. In fact, the depression engendered then lasted up till WWII when the USA emerged as the only standing industrial power. As the only manufacturer to the world, the USA were then once again free to expand the monetary base in leaps and bounds without immediately suffering the effects of inflation. But by 1970 the cows were, once again, coming home and the USA were de facto bankrupt … yet again.

In 1971 salvation came in the form of the abrogation of Bretton Woods so that the then industrialized world moved onto a system of US$ based floating exchange rates. Thus since 1971 first Europe and then gradually all other countries have moved onto a fiat monetary system based on the US Dollar. Thus, regardless of when a country has adopted fiat money, due to the magic of floating exchange rates, today we all must contend with an inflationary dynamic that is just shy of 100 years old.

That is a lot of inflation.

Now; economists can calculate, extrapolate, study and dissect data but the logic of fiat money is well known. The only variable is time but the conclusion is inevitable and has been evidenced several times since the Renaissance. To be fair, history is replete with examples of catastrophe brought about by monetary debasement whether fiat or otherwise. It is just that fiat money is that much easier to debase masked as it is by government’s ostensible fiduciary duty.

So government makes the arbitrary and unilateral decision to adopt fiat money. Fiat money is predicated on inflation ergo it is predicated on the debasement of the currency.

So what’cha gonna do!!

Government is an entity. As an entity, government has made a choice that it thinks will allow it to achieve its ambitions. This choice was made 100 years ago and then imposed on all other governments. For governments and politicians today to come out and express doubt regarding a decision taken 100 years ago and that, in fairness, appears to have worked rather well, is unconscionable. Of course, we will never know what an alternative monetary system may have brought about but what we got for the past 100 years is not so bad. So why stop now. Quite the contrary. Government thinking at this point goes something like this. If 100 years of debasement have brought us this amount of development (and profit), then why not just do more of the same.

Of course, few ever stop to consider that debasement cannot be and is not infinite. If it were infinite, then the majority would not need to work at all. All we would need is to employ a handful of geezers to operate the money printing press and everyone else could safely kick their feet up and Bob would be your uncle right?

But debasement cannot be infinite because perpetual motion has not as yet been discovered and because Achille and the Tortoise argument is demonstrably false too come to that.

But… but… but… as the initial instigators to adopt fiat money and as the only and most vocal proponents of the system, the banks are perceived as the one and only pillar of life as we know it. At least, that is how government thinks evidenced by how all Western governments have responded to this crisis. And banks are now once again profitable. In actual fact, banks are making money hand over fist. So much so in fact, that never in the modern history of banking bonuses of this size have ever been paid out.

So that, if banks are making money, it means that we truly are in a recovery. How could banks turn a profit otherwise? Tim Geithner’s latest ramblings evidence such sanguine view of the world as viewed by bureaucrats.

And since in a fiat monetary system banks are the linchpin of the entire construct, if the banks are doing well then let the good times roll. That’s because, it is thought (or it is pretended), that if the banks are making money, this money will translate into loans which in turn will translate into economic activity and thus in expansion of the economy thus, eventually, in more money for the banks. And everyone should be happy.

The question of course is: are you happy?

Overlooked by almost all, is the fact that banks, in fact, are making money. But a significant chunk of the money they are making is due to government largesse and overtly and blatant preferential accounting treatment. Banks today cannot lose. Granted it is not all banks that cannot lose but certainly the banks members of the Federal Reserve cannot lose.

But, to return to Kotlikoff. As most pundits, analysts or economists, we’re all wringing our hands about something that in fact is following a logical evolution that is inherent in the system and the driver of which is the monetary system. Fiat money eventually obliterates itself. Fiat money in a democratic context eventually brings about the demise of government. The only variable is time and, certainly, government aggressive and continued intervention can stretch out the time line. But the longer you push back the natural tendency of the system to reset the more force you accumulate for the eventual unraveling.

What now remains to be seen is how the unraveling will come about.

As I never tire to repeat in these pages, modern government (whether democratic or autocratic) cannot contemplate any monetary system other than fiat. Fiat money is a brilliant construct. It is flexible and it is adaptable if easily manipulated. So that once we’ll come out of this crisis, I have to believe we will once again institute a fiat monetary system.

But from now till we emerge from this crisis, what are the likely events that will shape our lives? Since the viability of fiat money is predicated on inflation it follows that the system must constantly be fed at the bottom by assimilating new currencies and new markets. In the 30s monetary or political unions were unthinkable so that the crisis eventually was resolved by war. In the 70s, the monetary system absorbed a whole bunch of currencies so that then excessive US$ inflation could be released into European markets. Then came the Euro. Then globalization. Today, the US$ monetary system has assimilated all markets and all currencies. And guess what. We are today where the USA were in 1929 and 1970. That is we are now bankrupt. So what now? Bankruptcy is only deleterious to the extent that government cannot meet the social promises it has made. As social expenditure is curtailed, social unrest follows. As these two dynamics reinforce each other, the risk of revolution becomes real. But the West cannot allow revolution within its “civilized” borders. Revolution is something that happens in banana republics, not in the developed civilized West. So, watchyagonna do?

In my opinion the only thing that can now allow us to unwind the amount of inflation we have accumulated since 1913 is a war. A global war that is. And I’ll go out on a limb too on this one.

Regardless of where the war starts and why which cannot be predicted (we are neither short of excuses or triggers presently), if I am right and we are about to be plunged into a world war, I can predict where the war has to be taken to and that would be to a band of land that snakes from India through China to South Korea.


Some interesting articles this morning…

January 28, 2010

… but not necessarily for what they appear to be about.

Let’s start with Bloomberg and Stiglitz:

This is an ambiguous article that deals with the economics of happiness. Stiglitz sets off with this comment: “Bankers created “negative value” with innovations such as mortgages that homeowners couldn’t afford, said Nobel laureate Joseph E. Stiglitz, who is speaking today at the World Economic Forum in Davos, Switzerland, on the economics of happiness.

Setting aside for the moment that the article is about the economics of happiness in an attempt at finding a better way of gauging the wealth and well being of a country, what strikes me as typical is the fact that even Stiglitz, Nobel Laureate that he is, perpetuates the perception that the problem that has befallen us was due to bad mortgages. Glaringly absent in Stiglitz’s comments now or in the past, is any indication as to why the banks should have been allowed and even encouraged to do what they did; and, by the way, banks are still now aggressively encouraged to do more of the same. My peeve with the whole charade is the unwillingness to have a proper discussion on the utility and desirability of a fiat monetary system. Because if banks did what they did, it is only because the presumed guardians of the system allowed them to do so despite the various laws that, if applied, would have clearly and immediately put a stop to such aberrant (criminal?) practices.

But then, Stiglitz goes on and at least partly redeems himself when he says:

Stiglitz, who advocates a broader measure of gross domestic product that takes social well-being into account, studied the issue last year for French President Nicolas Sarkozy, who has said that relying on GDP to gauge the state of an economy helped trigger the financial crisis.

Right there, Stiglitz actually hits the nail on the head. As I have already written in previous posts, the GDP figure is at the heart of most social, economic and financial metrics. But GDP is a flawed figure and, by itself, says nothing of the direction or the quality of development. As a flawed figure, GDP becomes the proverbial end that justifies the means. Specifically, since GDP is the begin all and end all of politics and economics, the natural tendency of government officials is to boost GDP by any means possible. Hence the appeal of a fiat monetary system which allows government to push credit and money creation in excess of GDP progression. The rationale for doing that is that by stimulating credit and money creation government can induce inflation, thus a rise in prices thus a rise in GDP.

That right there is the elephant in the room that few can intellectually countenance and, of those that can, fewer still are willing or ready to discuss. Because I assure you there are some officials that understand that.

Moving on from Stiglitz, Mr. Sarkozy of France too has a beef and it happens to be globalization.

Once again, Mr. Sarkozy’s peeve is justified but fails to address the reasons why globalization came about. Anyone that in talking about globalization does not mention that it is the logical ramification of the use of fiat money, is wide of the mark.

Fiat money has a logic. Fiat money is predicated on the expansion of credit and money supply. If that were not the case, then we could make do with either a fixed amount of money or with a value based monetary system. It is as simple as that. No need for arcane mathematical formulas. The choice of a monetary system is deliberate even if it is unilateral thus not submitted to the people for ratification. As a deliberate choice, fiat money implies two things: first, fiat money must not contemplate intrinsic value – second, fiat money can only exist in an inflationary environment.

The above being so, then it is clear that globalization is an inherent and inevitable consequence of a fiat monetary system. Few will remember for example that in the 1960s, the United States were exactly in the same jam we find ourselves in today globally. That’s right. In the 60s, the USA were confronting bankruptcy brought about by profligate spending that pushed credit and money creation far in excess of GDP since 1913. (Just a related observation here to note that the causes of the first inflationary crisis of 1929 were never really tackled. What happened instead is that as a consequence of WWII nobody anywhere had any industrial capacity left standing so that the USA were finally able to utilize their excess capacity to supply the rest of the world). Curiously enough,  in the late 1960s events were precipitated by none other than France who, smelling smoke in the wind, asked to redeem their US$ currency reserves for the gold they thought they were entitled to.

Surprise!! The gold wasn’t there. At least not enough of it because if the USA acquiesced to redeemed France’s foreign currency reserves, then everyone else would have wanted to redeem their reserves too and at that point, obviously, there wasn’t enough gold anywhere in the world to satisfy sovereign demand.


Abrogate Bretton Woods.

The USA gathered the leaders of the then developed world and essentially made them an offer they could not refuse. I mean; heck! The gold wasn’t there anyway so they had nothing to lose by at least listening to what the USA had to say.

The deal the USA put to the Europeans was to adopt a new monetary system based on the US$ as reserve currency.

To the question: “Why should we do that?”

The answer was twofold. The first part of the answer is what counted and what ultimately would have clinched the deal anyway; that is, the USA told the Europeans that by adopting the US$ as reserve currency they could themselves go on a fiat monetary system, hence they could print as much money as they pleased. The shrewd politicians that the European heads of states were, they needed no other reason to go along with the scam. The second part of the answer and which was then and still is today a moot point is that if the Europeans did not go along with the scam, the USA would have annihilated them (WWII was still rather fresh in Europeans’ minds and the Russian bogey man was looming large). A hard sell it was not.

And so it was that the US$ got a new lease on life. Essentially, inflation had saturated the US market hence the looming bankruptcy. By assimilating new markets, US$ inflation could now be pushed into a whole bunch of new currencies.

Incidentally, the introduction of the Euro served the same purpose. In one fell swoop, European currencies were devalued by anywhere between 20 and 50% thus boosting inflation.

Globalization is just more of the same. New markets to expand inflation into. Hence the US$ is today the official reserve currency of all countries and, thanks to the magic of “floating exchange rates”, inflation is guaranteed.

The problem of course is that inflation is a dynamic that is exponential in character and conforms to the law of diminishing returns. It could not be otherwise. If that were not the case, then there would be a direct correlation between the amount of credit and money creation and GDP progression. But as shown here, that is clearly not the case.

Moving on.

Here is an interesting blog post that puts forth an interesting observation. Essentially, our nations have surrendered sovereignty to the financial elite.

Fact is, the United States of America had no one in power to stop the Fed. The Fed did what it wanted to do. No one was a there to protect the taxpayer. America abdicated sovereignty. The country was actually too weak to fight the banks.

Though astute the observation is, once again the author cannot or does not want to make the connection with fiat money.

Fiat money has a logic. Fiat money must follow a cycle. Inherent in fiat monetary logic are a number of ramifications and outcomes. Chief amongst the ramifications of fiat money is that each additional unit of currency created has a diminishing effect on the overall economy thus a diminishing effect on GDP. The diminishing effect of fiat money is illustrated by what is known as the “Money Multiplier”. This is what the multiplier looks like:

Graph: M1 Money Multiplier

Now, here is the interesting part of this graph. Let’s zoom in on the period of time going from 2000 to present day:

FRED Graph
Now look at this:
FRED Graph
Since hockey stick shaped graphs seem to be the topic du jour albeit in different discussions, how’s that for a hockey stick?
The hockey stick shape representing the acceleration of debt at government level (not included in this graph is corporate and household debt which must be added for full effect) is matched by a multiplier that literally sank like a lead balloon.
That, dear reader, in my opinion represents the limit of the “beneficial” effect of a fiat monetary system. That, in my opinion, is the end of the inflationary cycle and the end of what can be done to keep GDP on an expansionary trajectory. That, in my opinion, is the end of this iteration of this monetary system. As a by the by, there have been so far 3 iterations to this monetary system: 1913 – 1929, 1929 – 1970, 1970 – today. The first iteration was saved by WWII, the second iteration was saved by bringing in new markets and currencies in on the US$ fiat monetary system. How will we solve this iteration of the monetary system…??? (For those of you that are mumbling that a new reserve currency will solve our problems you get a goose egg. A new currency will buy us some time; think Euro. Ultimately, the problem remains excess debt, excess industrial capacity, overbearing government and insufficient revenue to service debt.)
But more importantly, if any of my contentions as outlined above are true, that is the reason our “leaders” are about to throw us into a conflict of global proportions.
But let me be clear about something here. Most of you reading this post have been indoctrinated by the facile cliche that wars are profitable. As a matter of fact, wars are profitable. Not only are wars profitable, but they also keep research and development alive and a large number of military applications then make their way into civilian life too. So limited back water wars are inevitable if for no other reason that when you build weapons you cannot stock them unused forever.
But this next war is not going to be an inventory management war. This next war has a well defined economic and social focus. This next war serves to reset the fiat monetary system and create the conditions that allow us to re-start inflation. This next war will be a world war complete with civilians called up and packed off to the front and energy and food rationing at home. This next war must deal with one of the inevitable outcomes of fiat money; this next war needs to address industrial and infrastructure overcapacity.
Since I can virtually guarantee that no main stream politician today could contemplate any other monetary system than fiat, then the present system must be reset. Thus a world war is inevitable.
Got bullion?
PS – The war is inevitable and must involve civilians packed-off to the front for the simple reason that currency seems to have lost its multiplier role. If that is true, it means that unemployment will increase significantly. The trouble is that if the currency no longer has a multiplier effect on the overall economy, then revenues will necessarily dwindle at individual and corporate level thus at government level. As revenues dwindle, government must curtail public spending. And that’s the flash point. Rising unemployment must now confront lower social expenditure if not discontinuation of certain social services. Thus, unless someone somewhere can find a way to restore to the currency its multiplying powers as contemplated by Keynesian economics (the prevalent economic model of the past century), then we are looking at horrendous levels of unemployment (by taking the broadest measure in the US, unemployment is already well in the 20% according to labor statistics measure U6 as opposed to U3 which is the figure government uses for its official calculations). Thus it looks to me that the next war not only has to address infrastructure and industrial overcapacity but also a pernicious problem of unemployment because the unemployed poor have a nasty but historic tradition of rising up against the power elites and hang them.