Posts Tagged ‘floating exchange rates’

Our monetary system is broken (more evidence)

June 7, 2011

As stated numerous times in these pages, the Western monetary system and the monetary system of the vast majority of countries the world over, is a US$ based Debt Based Fiat Monetary System. The whole thing is predicated on Floating Exchange Rates.

Don’t let the technical terms scare you. All the above, simply means that all countries that recognize the US$ as reserve currency pledge to prop the system by purchasing the sovereign debt of all the partners to the system (floating exchange rates).

Thus, for as long as the system is working as intended, then all sovereigns purchase sovereign debt from each other. This is what maintains the appearance of sovereign currencies when in fact each currency has been replaced by the US$.

So far so good.

But as the efficiency of the currency wanes, the diminishing marginal utility of debt means that at some point sovereigns may no longer desire or be able to purchase the sovereign debt of other countries. For as long as this situation pertains to one or two countries than the whole scheme can survive. For example, when Japan’s economy began to implode in the 90s, the economies of the rest of the world were by and large still expanding so that Japan engaging in Quantitative Easing didn’t really matter.

Things get interesting when gradually, most but then all parties to the Floating Exchange Rate mechanism are confronted with overwhelming debts. At that point, the rationale of the Floating Exchange Rate system must by necessity be thrown out of the window as each sovereign must desperately try to prop its own sovereign debt … by buying it from themselves…

That is the point the DBFM system is broken.

Banks bought 91pc of the £39.8bn of net issuance of new gilts with purchases totalling £36.1bn, compared to the £11.4bn of UK debt bought in the preceding six months. ”

Basically the auction was a massive success primarily due to the Primary Dealer participation, which took down 51.9% of the entire issue, or $16.6 billion of $32 billion. We predicted, accurately, that “Naturally, none of this due to actual demand, but merely due to Primary Dealer expectations of a prompt and profitable flip back to Brian Sack (the Federal Reserve).”

By the way. The Federal Reserve as of a few months ago is the largest holder of US sovereign debt paper having overtaken China.

Our monetary system is broken. Everything else is a dog and pony show.


Thoughts on Japan

March 13, 2011

The tragedy befalling Japan is likely to have much wider consequences for the global economy.

Japan is already the single most indebted country in the world as compared to GDP. As a consequence of this earthquake and the destruction that it has caused, Japan will need to sell billions more of sovereign debt into the market. As a result, sovereign funding needs for Japan, the USA and Europe in 2011 are going to be in the $10Trillion range.

Where is this money going to come out of?

Moreover, coming on the heels of already heightened volcanic and seismic activity globally, I should think that the likelihood of more events taking place globally is fairly high.

Too, we’ll have to monitor whether Japan’s rice growing capacity is intact or has been hindered and, if it has, to what degree.

So that’ll probably mean more sovereign debt come flooding onto the markets at a time that sovereigns are already attempting to compensate for lack of funds globally buy ‘buying’ their own sovereign debt.

This is the predicament brought about by a debt based fiat monetary system.


Debt ceiling (re-post)

January 17, 2011

A re-post from just over a year ago and here we are today at a very similar juncture. Today the USA are non only rolling over all previous debt but are also considering raising the ceiling once again whilst Europe is going to roll over and seek somewhere in the neighborhood of E1Trillion (1 trillion Euro). So, in the spirit of our floating exchange rate sovereign currencies, only in terms of roll over and new debt, Western economies are looking to use their pension, insurance and sundry institutional funds to absorb some $2 Trillion.

Now remember, this is only what must be absorbed by all global sovereigns so as to keep our current monetary system alive. By way of comparison, this sum does not take into account any spending on, for example, pensions, health, road maintenance nor, indeed, the military or any new bail out fund that must be set up shortly. Just debt.

Begin re-post from November 2009 – and, by the way, the Fed has confirmed it is the single largest buyer of its own debt issuance… well on its way to become the single and only buyer…

This is going to be interesting.

If you read this essay and this essay, you will know I contend that we have reached the limit of how far we can expand inflation and that as a consequence, our Dollar based fiat monetary system is now broken. The most immediate concern is that deflationary environments bring about the insolvency of government.

Some of you will retort that governments have always been bankrupt but that somehow we’ve always come out ok.

What you are missing is the logic of inflation in a fiat monetary system characterized by floating exchange rate.

For as long as a government is able to borrow progressively more money, then its unfunded liabilities can be kicked down the road. Think of the pension trust fund. The money has been paid in all right. But government has used that money. Physically the money is no longer there; it has been spent. What governments count upon is inflation. Essentially, government feels free to spend today what it thinks it can repay back tomorrow in devalued currency. That in a nutshell, is what Western governments have been doing.

The above works for as long as inflation can be maintained on a positive trajectory and for as long as sovereign participants to the monetary system can and want to purchase each other’s sovereign debt (that is the meaning of floating exchange rates – i.e. the value of a currency is predicated on a basked of other currencies thus relying on sovereigns buying each other’s sovereign debt)

But pushing inflation into a system artificially, aggressively, pervasively and relentlessly over decades necessarily results in distortions, aberrations and criminal behavior. Thus, towards the end of the inflationary cycle, nominal profits progressively show up in fewer and fewer sectors until at the very end they show up only in the financial sector as the entity that is first in line for the use of fiat money.

The point at which nominal profits disappear from most sectors, is the point at which unemployment and social costs soar and is also the point at which tax revenue declines. This is the typical environment in which the power elites are also shown to be willing and consenting participants in unlawful and criminal enterprise.

Here is the problem.

As tax revenue declines, the ability of sovereigns to expand debt is hampered. On one hand declining tax revenue puts a dent in the budget that leads to credit worthiness revisions. On the other hand, as governments apply more of the tactics they think have enabled them to induce inflation into the system till recently (i.e. more spending on public projects, bailouts, military) they worsen an already critical fiscal situation.

This is the point at which sovereigns are either unwilling and/or unable to purchase each other’s debt.

The USA today have opted to increase the debt ceiling by $1.8Trillion.

Even assuming other sovereigns were willing and able to buy US debt, 1.8Trillion is a gargantuan chunk that would be tough to palm off during good times let alone during a crisis when all sovereigns are busy bailing out their own industries and banks.

Considering that the Fed has already been the purchaser of last and only resort of US debt in the past 8 months, it will be interesting to see who will buy any of this 1.8Trillion and how much of it. If the Fed should once again be the largest buyer as it has been in the recent past, the balance sheet of the entity responsible for the global reserve currency (the Fed) is going to show that the international monetary system is totally and utterly broken.

Let’s hear it for consistency – hip, hip…

September 13, 2010

Though many things he may be, Willem Buiter is at least consistent. This is not a quality to be sneered at when you are in the employ of the public or have the fate of large numbers of citizens in your hand. If you are consistent, the public can feel a degree of confidence when deciding whether to follow you or not. Consistency is also related to integrity or the ability of someone to take criticism because of an ideal or a different interpretation of available information. Consistency is generally good because it allows others to plan accordingly.

I’ve already referred to Willem Buiter as one of the more strident supporters of fiat money and the preeminence of government when I wrote about currencies and gold in a previous post. Now, obviously uncertain as to whether he’s made himself clear, Mr. Buiter offers what can only be described as his revelation as to what is needed to bring salvation for humanity.

Ben Bernanke, chairman of the Federal Reserve Bank, has a lot more tools for supporting U.S. economic activity through expansionary monetary policy than he discussed in his Jackson Hole speech…“- he tells us confidently thus hinting that he, either personally or through a higher agent, holds the ultimate and exclusive secret for salvation.

Treasury Secretary Tim Geithner can always send a sufficiently large check to each U.S. resident to ensure that household spending rises.”

In normal times (i.e. in times that are not interesting), merely uttering the above should suffice to give pause to anyone with a modicum of real world experience and attachment to reality. But we live in times that are interesting (much to the delight of our Chinese friends as our governments would have you believe … but that’s another story) so that a publication like the Wall Street Journal feels it is fit to give Mr. Buiter space on its venerable pages.

But, it gets better:

As long as households are confident that these transfers will not be reversed later, “helicopter money drops” will, if pushed far enough, always boost consumption.”

And there you have it! All that is required to achieve permanent prosperity is for government to give a salary to every man, woman and child in the land and presto!! We can look forward to a life of fun and fulfillment with no need to ever bother to produce anything.

Seven thousand years of human history and development and Mr. Buiter is the only human to ever walk the earth that has the solution to contentment and prosperity.

Looks like we now can all sit back and relax tranquil in the knowledge that our travails are over. All we need is a good printing machine and a handful of volunteers to punch the required keys so that we can all be prosperous and rich. I wonder if the people hired to punch the keys like Tim Gaithner must be relieved of their duties on occasion so that they too may enjoy some rest and relaxation from the dreary and repetitive stress of punching keys… things that make you go hmmm!

Sarcasm aside. What Mr. Buiter proposes is nothing but more of the same. Just neutron-bomb more.

OK! To be fair, Mr. Buiter does go on to say that this should only be a “cyclical” remedy but that what is needed is: “… to raise the national saving rate, boost fixed investment in plant, equipment and infrastructure, achieve a trade surplus and shift resources from the non-tradable to the tradable sectors.

But exactly because the above paragraph makes arithmetical sense, I cannot reconcile it with what Buiter suggests just moments before it. Not in light of where we have been. As a reminder, without linking to any of the hundreds previous posts on this and other blogs, we have a history of government, commercial and private debt that, even if we only count the past 40 years, has progressed in the double digits yearly. This means that since 1980 for example, all manners of debt has progressed well in excess of 1000%. In the meantime, GDP only progressed by 100% – i.e. whereas we’ve experienced a ten fold increase in debt, GDP has barely doubled.

But what we did get is the almost total obliteration of our currencies –


Now, that may not look too bad if you are a European or a Japanese for example. What do you care about the destruction of the US Dollar right!? But let me tell you. Globally, our modern monetary system is based on what is known as “Floating Exchange Rates”. This is nothing but a fancy name that means that the value a currency is based on is related to the value of all other currencies. But since the US$ is the currency of reference, de facto all currency values around the world are based on the value of the US Dollar.

In any other field of human endeavor, “Floating Exchage Rates” would qualify as circular reasoning.

But circular reasoning is not the only fallacy afflicting our monetary system. We must also contend with “experts” that have no ability or desire to observe reality empirically. To wit:

To restore monetary policy effectiveness in a low interest rate environment when confronted with deflationary or contractionary shocks, it is necessary to get rid of the zlb [zero lower bound] completely. This can be done in three ways: abolishing currency, taxing currency and ending the fixed exchange rate between currency and bank reserves with the Fed.”

Setting aside for a moment the arcane explanations Mr. Buiter launches in, all I can say is that he would do well to go have a chat with people in Argentina or Zimbabwe just to mention two very recent examples of strategies based on devaluation. But, of course, Mr. Buiter will retort that the same rules do not apply to the reserve currency of the world. To which claim I can only refer Mr. Buiter to the graph above.


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.