We note the passage of the anniversary in our typical Whiskey way: pissing off everyone in the room. Depending on your take on the Japanese “sneak attack” on Pearl Harbor, you may never forgive us for the next handful of sentences.

In his 2007 review of the book The Pearl Harbor Myth: Rethinking the Unthinkable by George Victor, John V. Denson writes:

“The author, Victor, includes a chapter from the viewpoint of the Japanese. They were being pressured strongly by Germany to enter the war by attacking the Soviet Union, thereby creating a two-front war for the Communist nation. This strategy came within the actual interests of Japan since they, like Germany, saw communism as a great evil and a threat to their respective nations. Furthermore, Japan had substantial claims to parts of Manchuria as a result of defeating Russia in the war of 1905. Both Germany and Japan wanted to avoid a war with America at almost any cost.

“Roosevelt was well aware of this pressure on Japan by Germany but he felt that it was necessary to protect the Soviet Union as being the best weapon against the Germans, and therefore, he wanted to prevent Japan from attacking Russia. Roosevelt began extensive provocations to cause Japan to abandon its attack on Russia and instead attack America, which also served the purpose of giving Roosevelt the reason to enter the war.

“Roosevelt launched an eight-point provocation plan primarily through the cutting off of oil supplies to Japan so that by the time of the attack on Pearl Harbor Japan was virtually out of oil and on the verge of industrial and military collapse. The attack on Pearl Harbor and the Philippines also would provide Japan with the ability to attack the Dutch interests in the Pacific, thereby giving them a new supply of oil.”

Some of you Whiskey Shooters will be incensed at this recounting of events. World War II was the last good war in the minds of so many…and the Japanese unforgivable cowards who attacked a blameless nation whose leadership had no idea it was coming. We risk earning some ill will at suggesting otherwise in order to draw a disturbing parallel about U.S. actions in Asia today.

Whether it was a deliberate machination of the progressive Roosevelt or not, interrupting the flow of the lifeblood of industrial civilization to an Asian power resulted in the U.S. entering a world war.

Looks like much the same is set to happen again.

We read in this morning’s Financial Times:

“The U.S. has sought to reassure China that its recent diplomatic and military initiatives in Asia were not directed against Beijing.

“‘The U.S. does not seek to contain China, we do not view China as an adversary,’ said Michele Flournoy, U.S. undersecretary of defense, after bilateral military talks.”

Maj. Gen. Luo Yuan of China doesn’t seem to agree when he says, “The United States is making much of its ‘return to Asia’, has been positioning pieces and forces on China’s periphery, and the intent is very clear — this is aimed at China, to contain China.”

The U.S. government may be whispering soothing words, but those words can’t be heard over the screaming of its actions. And come to think of it, not all those words are the soothing sort, either.

We gently remind you, good patron, that President Obama recently announced 2,500 Marines will be based in northern Australia. The president also made some rumblings about China’s dispute with its neighbors in the resource-rich South China Sea.

And then, also from the Financial Times, there’s this…

“The U.S. has also adopted a new strategic concept, AirSea Battle, which involves closer integration of the operations of the Navy and Air Force. The concept is meant to make U.S. forces more capable of operating in an environment where enemy forces are trying to deny area access.

“Chinese analysts see AirSea Battle as an anti-China concept. ‘Even if you say it’s not completely aimed at China, it is still mainly aimed at China,’ said Li Yan, a researcher at the Chinese Institutes of Contemporary International Relations. ‘For the Americans have said very clearly that AirSea Battle is mainly directed at anti-access and area denial warfare, and [past U.S. assessments] al l show that they believe China is conducting anti-access and area denial warfare.’”

Michael T. Klare writes in his article “Playing With Fire: Obama’s Risky Oil Threat to China” (found on TomDispatch.com):

“President Obama said in Canberra, the U.S. is now in a position to begin to refocus its military capabilities elsewhere. ‘After a decade in which we fought two wars that cost us dearly,’ he declared, ‘the United States is turning our attention to the vast potential of the Asia-Pacific region.’

“For China, all this spells potential strategic impairment. Although some of China’s imported oil will travel overland through pipelines from Kazakhstan and Russia, the great majority of it will still come by tanker from the Middle East, Africa and Latin America over sea lanes policed by the U.S. Navy. Indeed, almost every tanker bringing oil to China travels across the South China Sea, a body of water the Obama administration is now seeking to place under effective naval control.

“By securing naval dominance of the South China Sea and adjacent waters, the Obama administration evidently aims to acquire the 21st-century energy equivalent of 20th-century nuclear blackmail. Push us too far, the policy implies, and we’ll bring your economy to its knees by blocking your flow of vital energy supplies. Of course, nothing like this will ever be said in public, but it is inconceivable that senior administration officials are not thinking along just these lines, and there is ample evidence that the Chinese are deeply worried about the risk — as indicated, for example, by their frantic efforts to build staggeringly expensive pipelines across the entire expanse of Asia to the Caspian Sea basin.

“As the underlying nature of the new Obama strategic blueprint becomes clearer, there can be no question that the Chinese leadership will, in response, take steps to ensure the safety of China’s energy lifelines. Some of these moves will undoubtedly be economic and diplomatic, including, for example, efforts to court regional players like Vietnam and Indonesia as well as major oil suppliers like Angola, Nigeria and Saudi Arabia. Make no mistake, however: Others will be of a military nature. A significant buildup of the Chinese navy — still small and backward when compared to the fleets of the United States and its principal allies — would seem all but inevitable. Likewise, closer military ties between China and Russia, as well as with the Central Asian member states of the Shanghai Cooperation Organization (Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan), are assured.

“In additon, Washington could now be sparking the beginnings of a genuine Cold-War-style arms race in Asia, which neither country can, in the long run, afford. All of this is likely to lead to greater tension and a heightened risk of inadvertent escalation arising out of future incidents involving U.S., Chinese, and allied vessels — like the one that occurred in March 2009 when a flotilla of Chinese naval vessels surrounded a U.S. anti-submarine warfare surveillance ship, the Impeccable, and almost precipitated a shooting incident. As more warships circulate through these waters in an increasingly provocative fashion, the risk that such an incident will result in something far more explosive can only grow.”

We feel we’d be remiss not to note where we find issue with Mr. Klare’s analysis. He spends a few sentences wringing his hands over this mess resulting in drive for greater domestic energy dependency. He worries that that could lead to another Deepwater Horizon-type oil spill…greater reliance on the “dirtiest” of energies — the tar sands — and an increase in greenhouse gas emmisions.

But those are point to take issue with on another day. Mr. Klare’s take otherwise appears to be spot on.

A new Cold War is in the making. We’d all be lucky if that were the worst of it. The last time the U.S. tried to starve an Asian power of energy, the U.S. president got the war he was looking for…and the U.S. was the only one with atomic fire.

Things are a little different this time around. Nuclear weapons are in the hands of the nations the U.S. is provoking. And the current president may not actually be looking to start a fight…though he will likely get one anyway.

Regards,

Gary Gibson

Is the U.S. Warming up for a Hot War With China? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The latest threats, and these are serious threats, are being directed at Iran. Regardless of the fact that the U.S. is still considered the world’s superpower, any aggressive war against Iran could come back to haunt even the most evil and powerful designers of U.S. foreign policy.

Iran is a country with 80 million people. Given the trouble the U.S. has had in dealing with places like Vietnam, Afghanistan and Iraq, what on earth do they think will happen if they wage war on Iran? Keep in mind that the U.S. is already involved in multiple wars of aggression, and now is attempting to take over Africa as well. This type of imperialism will, eventually, lead to the destruction of the empire, but if either Israel or the U.S. attacks Iran now, all hell could break loose!

Iran is the world’s fourth-largest oil producer, which makes it attractive to many hostile neighbors and to Big Oil companies. This is reason enough for concern, but Iran is also geographically important, at least in the eyes of American foreign policymakers. Iran is bordered by Pakistan, Afghanistan, Iraq, Turkey and Turkmenistan, and is just across the Persian Gulf from Saudi Arabia. Iran, literally, is the middle of the Middle East. Iran also borders the Caspian Sea, and the U.S. has long been after those huge stores of oil. Much of the reason for the war in Afghanistan was based on building and securing the north-south oil pipeline that would allow oil delivery from the Caspian through Turkmenistan, Afghanistan and into Pakistan. Securing Iran would take the U.S. a step closer to gaining access to the oil in the Caspian, but at what cost?

China and Russia, both nuclear powers, are very important trading partners with Iran. China now has very extensive oil and gas contracts with Iran. Iran currently supplies 12% of China’s oil, making Iran the third-largest supplier of crude to China. The Iran/China annual trade value is expected to increase to $50 billion just over the next few years. Russian and Iranian trade ties have expanded to include agriculture and telecommunications, as well as energy and other goods, and Iran exports many products to Russia. Will Russia and China sit back while aggressive attacks are taking place, or will they protect their interests in Iran?

This is only the tip of the iceberg, but it is obvious that any unleashing of force against Iran would probably come with many unintended consequences, very dangerous consequences at that. War with Iran would force the other Arab states to take sides. The entire Middle East would become a boiling pot of turmoil. The region is already a powder keg, and little agitation is necessary to turn this situation into total chaos.

In the past 100 years or so, Iran has not aggressively attacked any country, much less any Western country. During that same period, the U.S. and its complicit military have aggressively attacked, and in many cases, occupied country after country, nation after nation, and now are interfering with entire continents. The U.S. has become the leader in perpetual unholy wars of aggression against innocents, and most in this country still cling to the misguided notion that America is exceptional. It is only exceptional in its desire to gain total hegemony in its quest to conquer the world!

I fear that any attack of Iran by United States forces would bring cataclysmic results never before seen on this earth. Considering all the players involved, the entire Middle East, including Israel, China, Russia, the NATO countries and probably others, the ramifications would be deadly. This could easily turn into World War III, and with this many countries involved, it might only be a matter of time until nuclear weapons were used. If that happened, where would it stop, considering the nuclear capabilities of the U.S., China, Russia, Pakistan, India and, of course, Israel? It is evident that without the use of nuclear weapons by Israel or the U.S., Iran would be difficult, if not impossible, to defeat. This truth is not escapable.

The Pentagon is building and testing monstrous flying bombs that can travel anywhere on earth within an hour, killing all people in any given location. Killer-drone bases are being constructed everywhere. Our liberty at home has disappeared, and torture and rendition are commonplace. And while indefinite detention without trial is now accepted, and while the president — on his say-so alone — can assassinate Americans or anyone else he chooses, most are sitting in their living rooms waiting to see Dancing With the Stars or Monday Night Football. I have never seen or experienced anything more pathetic in my lifetime. This sickens me!

World War III might be just around the corner. The possibility of nuclear war is now a real threat, and that threat is too dangerous to consider. Do these loathsome politicians and war-makers know the real risks? Do they understand what consequences will befall us, should these wars continue? Do they even care? If they don’t know, then they are all fools playing a fool’s game, and that game does not have a happy ending!

Regards,

Gary D. Barnett

Targeting Iran Is a Fool’s Game was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The insidious method of this undercutting the competition? Underpricing of the currency. More accurately, however, the Chinese central bank is just matching the monetary inflation of the U.S. central bank. If China’s government underprices their currency, it’s only because they are trying to keep up with the U.S. government underpricing its currency.

Politicians are calling for China to knock it off. Or else. They want China to let their currency appreciate against the dollar, instead of losing value as quickly as the dollar.

In difficult times like these, it’s natural for people to look for someone to blame. The usual targets are being drug out before the crowds. The Occupiers around the world are blaming capitalism and the rich. The politicians in the U.S. are blaming China.

China’s undermined the might of U.S. manufacturing. They didn’t play fair. It’s not just a matter of outcompeting U.S. manufacturers on quality and price. They dealt from the bottom of the deck with currency manipulation.

That sort of thing ignores what policies and practices here in the U.S. might have done to make American business less competitive in the first place. It’s far easier to point the finger at foreigners.

Even if China’s currency is “unfairly” undervalued, politicians and lawmakers may be doing more harm than good by seeing to it that imports from China cost more.

This is where the unintended consequences come in. Unintended consequences are inevitable when politics interfere with individual preferences in the market. Tariffs or a rising renminbi would increase the price of Chinese imports in the U.S. This is supposed to lead to more jobs for Americans, as manufacturers would then find no benefit to set up in China.

But the goods produced here would be more expensive than they used to be coming out of China. More-expensive everyday goods are not exactly what Americans may need, with wages stagnant, falling and disappearing altogether.

The argument is that American jobs would be created, and the economy as a whole would be better off. But the true benefit would be for some exporting manufacturers, while the rest of society would pay for it in higher costs of goods.

Price inflation is currently written off as a nonissue because the “core” stuff of food and energy — which tends to rise plenty — are discounted. A rise in the renminbi would mean that all the other things Americans buy would no longer be cheap. Their prices would rise, too.

Further, a higher renminbi would mean that the Chinese themselves would have  more purchasing power per capita. Right now, China’s government would like for its purported economic might to benefit its people, whose purchasing power has been kept down in order to fuel the export market. These Chinese consumers would use that stronger renminbi to bid for the the same commodities that Americans wish to buy. We wonder how long it would take for American politicians to start blaming the Chinese for allowing their currency to rise, and causing higher food and gas prices in the U.S.

So a rapid rise in the strength of China’s currency could, easily, mean higher prices for everything in the U.S. There may be a rise in overall employment, but there is certainly no guarantee for a rise in overall wages to offset higher prices. In fact, it’s unlikely that the Federal Reserve would abandon its inflationary policies anytime soon. So Americans may end up in much the same situation the Chinese find themselves in now: with a strong export market but declining purchasing power.

Our stance is that it was government that caused the problems in the first place and government that will make the problem worse with more nonmarket solutions. The U.S. is going down the path of protectionism, continued currency debasement, trade wars that could end up being hot wars.

After a generation of accelerated debt expansion, thanks to central bank policy that resulted in wild malinvestments and bubbles in housing and education, Americans will have to contend with being poorer for a while. The scapegoating of China may score political points, but it will lead to bad economics that will make life even harder for Americans.

And there’s always the possibility that protectionism could lead to open hostility between the U.S. and Chinese governments. Wars cost both human misery and dollars. They’re paid for with higher taxes and currency debasement. But wars also tend to get a lot of popular support, if spun properly. So Americans may cheer as they find their standards of living declining even further, while their troops are shooting at yet another enemy.

Regards,

Gary Gibson

Protectionism Could Lead To American Poverty was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

“Economists blame China’s inflation on the dual pressures of consumer demand that is outstripping food supplies and a bank-lending boom they say Beijing allowed to run too long after it helped the country rebound quickly from the 2008 global crisis.”

The fact is that both the “lending boom” and “consumer demand” are simply the manifestations of monetary inflation, and originate solely from the PBOC’s expansion of the money supply.

Real consumer demand results in falling, not rising, prices. The only component of consumer demand that is pushing prices higher is artificial monetary demand in the form of more paper bills in consumers’ hands driving up prices, not in an increased desire to consume a greater physical quantity of goods.

As for a bank-lending boom, a boom in lending can occur only when an increase in money available to be lent is increased dramatically. So to say that inflation is caused by a lending boom is to say that inflation is caused by the printing of money (but without actually saying it). Though this cause and effect is obvious, reporters — and economists — choose to circumscribe the real explanation.

So what has the Chinese government done about the lending-boom and consumer-demand problems?

Concerning the lending boom, the article says:

“The government has clamped down on lending, but analysts say it will be months before the effects of that and other curbs are felt. They say inflation should climb further through at least midyear before easing.”

The government has “clamped down,” mainly by raising interest rates, as shown in Figure 2:

Mainstream economists believe this will do the trick, as they think that interest rates are the primary means of growing and slowing an economy. They ignore, or are not aware, that the money supply is what is driving inflation, “demand” and GDP growth. Manipulating the interest rate alone, without — as happens in most central-bank-run economies — simultaneously changing the money supply will usually have little effect.

Sure, with higher interest rates, borrowing costs are higher. But inflation also raises the rate of profit, which means business can profitably pay a much higher rate to borrow. But even when interest rates exceed the height of the rate of profit and cause businesses to quit borrowing and investing, all the money that has been pouring into the economy will still push prices higher. Economic activity might slow or stop, but prices will still rise. The only thing that will stop inflation is ceasing to expand the money supply. And even that will have a delayed effect.

Using Price Controls to Stop Inflation

As for the “consumer demand” component, the article says:

“Attempts at price controls, subsidies for the poor and orders to local leaders to guarantee adequate vegetable supplies have had mixed results. Beijing also has resorted to the blunt tool of freezing prices of electricity and some other basic goods, but that is starting to backfire.”

In other words, the government has tried to further manipulate the economy to compensate for the adverse effects of its printing of money. It should be no surprise the results are “mixed” and are “starting to backfire,” as shortages are the natural result of price controls.

Economic Growth as a Problem

The report also says that not only is inflation a problem, so is economic growth:

“Beijing also is struggling to control an overheated economy that expanded by a rapid 9.7% in the first quarter of this year, barely slowing from the previous quarter, despite Beijing’s efforts to steer growth to a sustainable level after 2010′s double-digit gains.”

Though the news report says “also,” in reality, this is the same monetary issue we’ve been discussing. There is no such thing as an overheated economy. “Overheating” is the Keynesian term for price inflation arising as a result of too much monetary pumping into the economy. It is the monetary pumping that has pushed China’s GDP into double-digit gains. As for sustainable growth, it is only monetary GDP growth that is unsustainable. Real, true economic growth is always sustainable and could never exceed what Keynesians call an economy’s “potential long-term growth rate.”

Speculative Money Flows

A different Associated Press article, referring to China’s artificially undervalued currency and the trade imbalances it causes, claimed that another problem could be speculative money flows:

“Many countries worry about speculative money flooding their economies and inflating assets like real estate or stocks.”

The notion of capital flows and money crossing borders is misunderstood by most people. Except for physical paper bills belonging to tourists, to drug dealers or to foreign workers sending cash earnings home to relatives, money does not cross borders. Money generally remains in the country to which it belongs — and merely changes ownership. As this section will show, “speculative” money “flowing across borders” really consists only of the domestic central bank trying to keep its currency artificially priced.

So-called “capital” or “hot money” does not “flow” from one country of origin into another country. However, money created in one country can be — and is to a limited degree — used to buy the currency of another country and direct it into the purchase of asset prices in that country (bidding asset prices higher in the process). If a disproportionate amount of local currency is channeled into asset prices in a country, less currency is being spent on goods and services in the economy, causing consumer prices to fall.

But in reality, consumer prices in countries with booming asset markets do not usually fall while asset prices rise; both usually rise in tandem. This is because the local money supply is increasing and pushing up both classes of prices (i.e., financial assets and consumer prices), even though one is rising faster than the other. It is therefore local money, not foreign money, inflating assets.

Also, in order for foreign demand to redirect purchasing power from local consumer prices to asset markets, there would need to be quite an overwhelming demand for domestic investment from abroad, resulting in a very large portion of local currency being purchased by foreigners. It seems fairly unrealistic that, in absence of already-rising foreign markets, such a strong desire for investment in a foreign country would exist on the part of these overseas investors.

Additionally, such a massive redirection of purchasing power would cause consumer goods to drop so low relative to their previous purchasing-power parity that foreign consumers, as opposed to foreign investors, would then purchase local consumer goods — because they would be so cheap in local-currency terms to those consumers — for the purposes of importing to their home country (i.e., being exported from the local country). This would increase the value of the local currency.

But again, we do not witness consumer prices falling or currencies rising (because they’re usually fixed) in the various countries experiencing asset-price booms. Therefore, the usual originating cause of booming asset prices in a country is that country’s central bank creating more money, pushing up both consumer prices as well as asset prices, not foreigners directing the local currency they purchase into asset prices.

What’s seldom noted is that when a country does not print money at rapid rates, it — almost categorically — does not experience “speculative money flows.” International investors and speculators usually take part in investing as a mass movement only in local asset markets that are already booming. The asset markets are booming because a large amount of the money being printed in that country is inserted into financial assets. Otherwise, if the money supply were not expanding, those same asset prices could not rise in price.

Also rarely explained is that “speculative money flows” usually occur between countries that have pegged or partially pegged currencies. Otherwise, as explained above, if the currencies of two different countries are freely floating, as one country expands its money supply, its currency will fall in price against its paired currency. Therefore, as a country’s asset markets rise in price, its currency would fall in price, largely in inverse proportion. This would cause the rising asset prices in the country to appear less appealing to foreign investors, as their gains would be offset — upon conversion back to their own currency — by a depreciating currency. Also, if investors just kept buying a currency whose supply was not expanding, its price would rise. This too would cause local asset prices to become less appealing. By contrast, speculators usually keep piling into currencies that are expanding and that are held artificially low, not ones floating freely.

Here is the real cause of so-called “money flows”: When a country keeps its currency artificially low relative to the opposing or “paired” currency, it does so, as we have seen, by its central bank buying the paired currency with newly created domestic currency. Thus, there is foreign currency “flowing into the country,” and the new domestic currency created for the purpose of purchasing the foreign currency is channeled into asset prices (and to a lesser extent, usually, consumer prices). It’s true that the domestic central bank takes ownership of foreign currency, but only the domestic currency circulates domestically. Thus, it is local currency, not foreign “speculative money,” that both causes and sustains local asset prices.

The Coming Bust

It has been shown that China is now letting its currency rise because it needs to stop printing money in order to tame inflation. Its currency has been artificially low (i.e., below the market price) for many years due to the fixing of its price to the U.S. dollar by way of printing the money that it uses for selling yuan (the printed money) and buying dollars. But such actions have resulted in price inflation.

Therefore, letting its currency rise will cause a recession, since reduced money supply and credit growth rates are the usual initiating factors that bring on recessions (reduced rates of spending alone can cause recessions, but they are usually preceded by prior reductions in money and credit). It has been rapid increases in money and credit that have driven the current boom in China, and it will be the reduction in the growth rate of those variables that causes the bust.

The economic boom in China has consisted of rapid increases in true economic growth accompanied by — but not driven by — an increase in monetary spending. The increase in monetary spending, in turn, has been driven by wild credit growth, and has resulted in massive overinvestment in particular industries. There has been no shortage of commentaries and videos highlighting building booms, mania-type herd-mentality home buying and the mass creation of buildings, shopping malls and even multiple entire cities in China that stand unoccupied — all dramatic, yet classic symptoms of credit bubbles.

The signs of bubbles are common, and date back to the 1600s. Even if we knew nothing about money and credit and their causing of financial bubbles, we should by now recognize the typical bubble-oriented characteristics — i.e., exponentially rising prices, investment and purchasing manias, exuberance over a new and unusual trend, etc. — and know that they are symptoms representing an actual bubble.

Given the lag effect of money and credit on the financial system and its transmission to the real economy, it is difficult to tell exactly when the rising interest rates and slowing money supply will result in reductions in the rate of spending and a reversal of the money multiplier, but when they do, a Chinese credit contraction, financial meltdown and economic malaise won’t be far behind.

Conclusion

Mainstream economists and the financial press are usually Keynesian. This means that they like to hide the true cause of economic problems. Their explanations, therefore, are ones that try to show how the tail can wag the dog. But these fallacious explanations have been around so long and are so widely taught that most people who do not know real economics — including most of these same Keynesians — easily believe these improbable explanations.

With respect to their explanations of the Chinese economy, it is not true that China imports inflation and that merely letting its currency rise will solve the problem. The real story is that the inflation is due to the printing of money that keeps its currency artificially low, and that the rising currency is a side effect of doing what’s necessary to stop inflation — stopping (or merely slowing) the printing presses. The rub is that a slower rate of money growth will also cause a reduction in spending and a credit contraction, which in turn will cause financial and economic problems.

Regards,

Kel Kelly

The China Bust: Tic Toc Part II was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

This article explains the real story behind the commonly espoused explanations regarding the taming of China’s inflation. It also breaks down many of the peripheral issues on the topic that are regularly discussed in the press, and exposes the false theories associated with these issues.

Currencies and Prices

In explaining how a rising currency will help tame inflation, most pundits relay that revaluing a currency to a higher price will cause import prices to be cheaper, thereby lowering domestic prices. For example, Credit Agricole CIB economist Dariusz Kowalczyk stated:

“Policymakers have sent a clear message that currency appreciation will be used as a tool to counter imported inflation [due to near-record global prices for oil and other commodities].”

Similarly, Bloomberg News reported…

“Chinese officials may also seek to speed up gains in the currency, also known as the renminbi, to fight inflation, lowering the cost of imported U.S. goods such as Boeing Co. aircraft and Microsoft Corp. software.”

The truth is that there is no such thing as importing or exporting inflation, because each country or currency area has its own individual currency, which is separate from another region’s currency. Prices within a particular currency area can rise only when that particular currency is inflated. (A rare exception is when other currencies also circulate within the same currency area, and an increase in the quantity of the other currencies causes prices to rise in that currency. But even in this case, the depreciating currency will likely soon stop circulating, as it will be shunned for the stronger currency.)

But currency changes can indeed affect prices by way of changes in the supply of goods. A country whose currency is artificially undervalued — such as China — will artificially export more and import less. If the currency is allowed to rise toward the market exchange rate, it will begin to export less and import more.

All else being equal, a higher-priced currency will indeed result in a lowered price of imported goods. When imported goods cost less, consumers have more money to spend on domestic goods; purchasing power increases. Or if the amount saved from spending less on imports is spent on acquiring greater amounts of the imported goods, there will be less demand for domestic goods, causing domestic prices to be lower. In either case, what has lowered prices is a stronger currency.

The previous explanation applies only to cases where “all else remains equal.” But a currency that rises with all else remaining equal is one that was previously artificially weak, for the purpose of exporting as much as possible and is, thus, being revalued by the marketplace to its true market price. Otherwise, excluding short-term fluctuations, one currency moves against another because of changes in the relative supply of currency units, and corresponding changes in relative consumer prices between the two currency regions in question. Currency movements absent these fundamental changes are due to government manipulation of the currencies.

The flip side of the rise in the price and purchasing power of a currency is that goods in that currency are then more expensive in terms of foreign currencies, resulting in fewer goods exported. Exporting less is economically beneficial, as it leaves more goods remaining inside the country, increasing the supply and lowering the price of domestic goods.

Therefore, it would seem that higher-priced currencies are better, since they result in cheaper imports and lower domestic prices. But if the currency is too expensive and artificially overvalued, fewer goods are exported, causing less foreign exchange to enter the country. An artificially high currency will, eventually, cause the country to run out of foreign exchange. This, and goods too expensive from the view of other countries, will cause trade to cease, resulting in lower standards of living.

The essence of the trade-off is that a country can have a weak currency and increase exports so as to obtain more foreign currency, or it can have a strong currency and increase imports so as to obtain more goods.

So what is the optimal level of a currency’s price? Does a country want a stronger currency or a weaker one? Does it want more cash or more goods? The fact is that a country is not an “it.” A country consists of millions or tens of millions of individuals, each having different goals and different valuations. Government bureaucrats cannot set an ideal currency price that is optimal for everyone. Thus, the only optimal currency price is that which is set by all market participants jointly, by way of their supplying and demanding both goods and currency based on their needs and desires.

And in reality, the optimal currency price they, the market, will settle on will be the price that, adjusting for transportation costs, causes domestic prices of internationally traded goods to approximate the price of those same goods in other countries. In other words, they will make relative prices equilibrate across countries, just as individuals do within a country. Otherwise, arbitrage opportunities would exist, and the result would be a leveling of relative prices and real currency valuations. That optimal currency price will also result in the country exporting about the same amount as it imports; the balance of payments will tend toward zero. Trade surpluses and deficits derive from mispriced currencies arising from government manipulation.

The Real Relation Between China’s Rising Currency and Inflation

A manipulated currency can cause domestic prices to be artificially higher or lower than they would otherwise be, but it cannot cause prices to rise on a sustained basis; it cannot cause price inflation. Aside from rising prices due to a continual reduction of goods produced and existing in a country, the only thing that can cause price inflation is that country’s expansion of the money supply, which results in increases in demand. Aggregate prices rise only with reduced supply or increased (monetary) demand. Thus, contrary to the popular perception displayed in the quotes above, China’s re-pricing of its currency — alone — will not reduce price inflation.

[Ed note: Our currency expert, Abe Kaufman, weighs in with his insight on the Chinese/U.S. currency war discussion.

"We need China to keep buying our bonds, so politically, it's really risky to escalate the tensions. Still, the uncertainty regarding China -- whether we have a trade war or not -- will cause sentiment swings in the markets. Then add China's real problem…not the trade war, but whether China's economic slowdown will be controlled or severe. As fears ebb and flow, we could see the effects in several currencies, such as the Australian dollar, the Brazilian real and more.

"Luckily, all that volatility is the perfect environment for the sphere I operate inside -- a relatively new way to play currency moves easily and inexpensively.

"Unlike the mainstream currency markets, this new market gives you a chance to turn 2% moves in currencies into potential 150% gains in less than a week. And as China worries continue, we could continue seeing those kinds of gains again and again."

Check out Abe's most recent report here.]

What will reduce China’s price inflation is ceasing the activity that is holding its currency artificially low: money printing. As Figure 1 shows, it is doing just that.

In general, China can keep its exchange rate even with the dollar only by creating new money at as fast of a rate as the Federal Reserve creates dollars. In addition to the rate of creation of one currency versus another, the amount of currency actually on the market available for exchange makes a difference as well. In this respect, China reinvests the dollar reserves it obtains from its trade surplus — which come about from an artificially low yuan and an artificially high dollar — into U.S. Treasuries, instead of selling them in the foreign exchange market, so as to prevent the dollar from falling (and yuan rising) from the increased supply.

But additionally, in order to keep the yuan artificially lower against the dollar than it would otherwise be — given the market supply and demand for each currency — the Chinese central bank, the Peoples Bank of China (PBOC), actively buys dollars and sells yuan in the marketplace. It pays for the dollars by creating yuan with which to buy them.

When the PBOC creates yuan, it expands the money supply. It is, therefore, this expansion in the money supply, not an artificially low currency per se, that is creating price inflation in China.

Exchange Rate vs. Money Supply as the True Cause of Inflation

When one has knowledge of the true nature of China’s currency and inflation situation, it can be very frustrating to hear mainstream economists focus on the currency as a cause and solution for inflation, instead of focusing on the originating cause of money creation. Even the World Bank misstates the problem:

“‘Strengthening the exchange rate can help reduce inflationary pressures and rebalance the economy,’ the World Bank said in its latest quarterly update on the world’s third-largest economy.”

But to its credit, it also separately said:

“Inflation expectations can be contained by a tighter monetary policy stance and a stronger exchange rate.”

While the comment is still vague in terms of giving the real link between monetary policy and the exchange rate, it at least notes the monetary-policy issue.

Regards,

Kel Kelly

The China Bust: Tic Toc Part I was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

“The tide of war is receding… It is time to focus on nation building here at home.”

– President Obama, June 22

Ideology makes people stupid. Employing ideology as the basis for policy is a recipe for disaster. Surviving in a complex, uncertain environment requires flexibility, pragmatism and, perhaps above all, self-awareness. That’s true if you’re in the business of making cars or selling doughnuts. It’s truer still for those whose business is statecraft.

When the Cold War ended 20 years ago, Americans chose to view the outcome through the lens of ideology. We congratulated ourselves on winning an unqualified victory, to which we attributed transcendent significance. The outcome had ostensibly rendered a great historical judgment, testifying to the manifest superiority of democratic capitalism — that is, to the American way of doing things. The universal embrace of liberal values, democratic politics and market economics seemed sure to follow, sealing our triumph and extending the American Century for centuries to come.

In Washington, such expectations qualified as advanced thinking, finding expression in the expansive claims that became a hallmark of the 1990s. “We stand tall. We see further into the future.” Thus did Madeleine Albright elaborate on the attributes accruing to the world’s “indispensable nation.” Meanwhile, her boss, Bill Clinton, was wagging his finger at China. Beijing needed to align itself with the “right side of history,” the president counseled, which meant that the Chinese should take their cues from America.

Expanding on or embroidering these themes got your books on best-seller lists, your columns in all the best newspapers and your smiling face on the Sunday talk shows. My favorite artifact of this era remains The New York Times Magazine dated March 28, 1999. The cover story excerpted The Lexus and the Olive Tree, Thomas L. Friedman’s just-released paean to globalization-as-Americanization. The cover itself purported to illustrate “What the World Needs Now.” Alongside a photograph of a clenched fist adorned with the Stars and Stripes in brilliant red, white and blue appeared this text: “For globalism to work, America can’t be afraid to act like the almighty superpower that it is.”

That globalization was transforming the world into a global village had become self-evident, with the United States serving as lord mayor, guidance counselor and purveyor of entertainments. More importantly still, America occupied the office of police chief. So we wished to believe.

A mere decade after the end of the Cold War had delivered history to a neat and satisfying conclusion, the Sept. 11 attacks occurred. Along with horror and heartbreak came humiliation. How could 19 thugs armed with nothing more than box cutters have caught the indispensable nation so completely off-guard?

Many factors contributed to the United States being surprised. Prominent among them was the self-congratulatory mind-set to which Washington had succumbed during the 1990s, manifesting itself in a sense of privilege and dominion appropriate to an almighty superpower. Like the song says, “You don’t tug on Superman’s cape.” Was not America history’s anointed Superman?

Remarkably, the events of Sept. 11, 2001, served not to overturn such thinking, but to affirm it. Dick Cheney and Donald Rumsfeld did not disagree with the claims of American prescience and prerogatives expressed by Clinton and Albright. Sharing in the view that the United States was, indeed, an almighty superpower, they merely wanted to assert that power more aggressively. After Sept. 11, they had little difficulty converting George W. Bush — hitherto proponent of a humble foreign policy — to their view.

If the results achieved from winning the Cold War had turned out to be less conclusive than first thought, then surely one more big push would deliver history to its intended destination. So the ideologues in power, now Republicans rather than Democrats, and those cheering from the sidelines, neoconservative voices now ascendant, determined to pull out all the stops. As Richard Perle and David Frum, co-authors of the agitprop classic An End to Evil, put it, “There is no middle way for Americans: It is victory or holocaust.”

Yet the crusade that Perle, Frum and their confreres so vigorously promoted did not unfold as expected. Launched with high expectations of victories won with Superman-style ease, the Global War on Terror turned out to be a long, hard slog and soon enough lost its luster. Over the course of his two terms as president, George W. Bush succeeded chiefly in running the United States military into the ground and the American economy off the rails. Along with victory or holocaust, there turned out to be a third possibility that Perle and Frum had overlooked: exhaustion resulting from our own folly and malfeasance.

With the meter still running, the enterprise launched by Bush a decade ago has taken the lives of over 6,000 U.S. troops, wounded many thousands more and consumed trillions of dollars, while undermining America’s standing around the world. (There is little point in citing the vastly larger number of Afghans, Iraqis and the like who have had their lives torn apart — in Washington, that number doesn’t count.) Rather than peering deep into the future, the United States is demonstrably unable to see even into next week, with major events — the Arab Spring being the most recent example — catching Washington asleep at the switch.

No longer instructing the Chinese on how to manage their affairs, we now routinely tap them for loans so that we can pay our bills. And needless to say, The New York Times no longer proclaims the United States to be an almighty superpower. Meanwhile, what was once advertised as a single coherent war has fragmented into several only vaguely related “overseas contingency operations” in locales as far afield as the Persian Gulf, Central Asia and the Horn of Africa. Were that not enough, we’re broke and stuck with an unemployment rate above 9%.

The years 1991 and 2001 are commonly treated as breakpoints, markers that inaugurate distinctive chapters of history, the first labeled “Post-Cold War,” the second “Post-Sept. 11.” Yet there is a strong case to be made for amalgamating the two decades into a single period: Call it the “era of ideological fantasy,” when U.S. self-regard and Washington’s confidence in its ability to remake the world in America’s image reached unprecedented heights.

To survey the past 20 years from our present, much reduced vantage point is to be struck above all by the once cherished, now discarded illusions littering the landscape. Prominent among those shattered illusions are the following:

1. The insistence that history has a discernible purpose, made manifest by the evolving American experiment that is destined to prevail universally.

2. The conviction that the United States is called upon to exercise “global leadership” and that our governing elites possess the capacity to do so effectively.

3. The assurance that U.S.-promoted globalization will produce unprecedented wealth while simultaneously contributing to global peace and harmony, with the American people thereby assured of both greater prosperity and greater security.

4. The notion that a self-regulated or minimally regulated market produces the greatest good for the greatest number of citizens.

5. The belief that America’s privileged place in the international order relieves the United States of any obligation to live within its means.

6. The expectation that in times of crisis, the American people and their leaders will selflessly unite, setting aside partisan differences to act in the common good.

7. The claim, for too long indulged by conservatives, that the Republican Party takes seriously the preservation of traditional values.

8. Perhaps above all, the belief that the United States, having mastered the art of war, can quickly and economically overcome any foe, high-tech precision weapons and superior professionalism, offering a surefire recipe for victory.

Not one of these is true. No amount of recalibration or reformulation or trying harder next time will make any of them true. To pretend otherwise serves no purpose. To escape from our era of ideological fantasy requires acknowledging this reality — facing the dismal consequences that 20 years of American arrogance and misjudgment have yielded. Seldom has a nation relinquished a position of advantage as quickly and recklessly as has the United States in just the past two decades.

What this means for the so-called conservative movement today is this: It’s time to face the music, assess the damage — much of it to be laid at the feet of the faux-conservative Republican Party — and begin the hard work of recovery and restoration.

The most urgent priority is to staunch the hemorrhaging of American power. In this regard, two facts stand out. The first is the federal deficit, hovering around $1.6 trillion for the current fiscal year. The United States government borrows 40 cents for every dollar it spends. The second is the war in Afghanistan, nearing its 10th anniversary. There the United States is spending $10 billion per month in hope of pacifying a country with a total annual gross domestic product of perhaps $27 billion.

Together the deficit and the Afghanistan war exemplify the chronic imbalances that, unless corrected, will accelerate American decline. But correction will occur not through pledges or posturing or citing the memory of Ronald Reagan, but by reviving a sense of modesty lost when the Soviet empire collapsed and a capacity for self-restraint flung away when terrorists brought down the World Trade Center.

A pox on ideology. Let’s try reality for a change.

Regards,

Andrew Bacevich

The American Conservative

An End to Empire was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The social and economic pathology of 19th century colonialism is well studied, but the monetary pathology of its successor, the neo-colonial reserve currency system of the dollar, is less transparent. In order to remedy this pathological defect, the United States must rid itself of its enormous Chinese financial colony, whose exports are subsidized by the undervalued yuan in return for Chinese financing of the U.S. twin deficits. Both China and the United States must also free themselves from the increasing malignancy of the dollar reserve currency system, the primary cause of inflation in both China and the United States.

In the end, only monetary reform, including an end to the reserve currency system, can permanently separate the dollar host from its yuan colony. Without monetary reform, the perverse effects of the dollar reserve currency system will surely metastasize into one financial and political crisis after another—even on the scale of the 2007–2009 crisis.

It is, of course, a counter intuitive fact that China has been financially colonized by the United States. But why is this a fact? Simply because China has chained itself to the world dollar standard at a pegged undervalued exchange rate, choosing therefore to hold the exchange value of its trade surplus—that is, its official national savings—in U.S. dollar securities. It is true that the dollar-yuan strategy of America’s Chinese colony has helped to finance a generation of extraordinary Chinese growth. But China now holds more than 3 trillion dollars of official reserves and more than a trillion dollars in U.S. government securities. These Chinese dollar reserves directly finance the deficits of the American colonial center. This arrangement clearly resembles the imperial system of the late 19th century. The value of a British colony’s reserves were often held in the currency of the imperial center, then invested in the London money market. Thus, the colony’s reserves were entirely dependent on the stability of the currency of the colonial center. While China is America’s largest financial colony, most other developing countries are also bound to neo-colonial status within the reserve currency hegemony of the dollarized world trading system.

China’s dollarized monetary system reminds us of nothing so much as the historic colonial financial arrangements imposed by the later British Empire on India before World War I—India actually remaining a financial colony of England long after its independence in 1947. How did the sterling financial empire work? The imperial colony of India, beginning in the late 19th century, held its official Indian currency reserves (savings) in British pounds deposited in the English money market; independent developed nations at that time, like France and Germany, held their reserves in gold. That is, France, Germany, and the United States settled their international payment imbalances in gold—a non-national, common, monetary standard—holding their official reserves, too, in gold. But the London-based reserves of colonial India were held not primarily in gold, but in British currency, helping to finance not only the imperial economic system, but also the imperial banking system, imperial debts, imperial wars, and British welfare programs. Eventually, as we know, both the debt-burdened British Empire and its official reserve currency system collapsed.

For more than a generation now, a similar process has been at work in China. China is America’s chief colonial appendage. The Chinese work hard and produce goods. Subsidized by an undervalued yuan, they export much of their surplus production to America. But, like the Indians who were paid in sterling, the exports of Chinese colonials are substantially paid in dollars, not yuan—because bilateral and world trade, and the world commodities market,

have been dollarized. And thus it may be said that the world financial system is today an unstable neocolonial appendage of the unstable dollar.

China, like its predecessor the British colony of India, has chosen to hold a significant fraction of what it is paid in the form of official dollar reserves (or savings). These dollars are promptly redeposited in the U.S. dollar market, where they are used to finance U.S. deficits. Every Thursday night, the Federal Reserve publishes its balance sheet, and there we now read that more than $2.5 trillion of U.S. government securities are held in custody for foreign monetary authorities, 40 percent of which is held for the account of America’s chief financial colony, Communist China. It is clear that without financial colonies to finance and sustain the immense U.S. balance of payments and budget deficits, the U.S. paper dollar standard and the growth of U.S. government spending would be unsustainable.

It is often overlooked that these enormous official dollar reserves held by China are a massive mortgage on the work and income of present and future American private citizens. This Chinese

mortgage on the American economy has grown rapidly since the suspension of dollar convertibility to gold in 1971. China—poor and undeveloped in 1971—was at that time very jealous of its sovereign independence, sufficiently so to reject its alliance with the Soviet Union—even earlier to attack U.S. armies on the Chinese border during the Korean War. In an

ironic twist of fate, China surrendered its former independence and, as a U.S. financial colony, joined the dollar-dominated world financial system. China’s monetary policy is anything but independent. It is determined primarily by the Federal Reserve Board in America, the pegged yuan-dollar exchange rate serving as the transmission mechanism of Fed-created excess dollars pouring into the Chinese economic system. Perennial U.S. balance of payments deficits

send the dollar flood not only into China but also into all emerging countries. The Chinese central bank buys up these excess dollars by issuing new yuan, thereby holding up the overvalued dollar, and holding down the undervalued yuan. Much of these Chinese official dollar purchases are then invested in U.S. government debt securities. So even though America exports excess dollars to China, China sends them back to finance the U.S. budget deficit—much like marionettes walking off one side of the stage, merely to reappear unchanged on the other side.

This is the little-understood arbitrage mechanism of the pegged exchange rate system by which Fed-created excess dollars are bought and held as reserves by the Chinese central bank, in exchange for which newly created yuan are issued, thereby supercharging inflation in China. The Chinese dollar reserves, which are reinvested in the United States, help to ignite inflation in the United States. It is clear that the workings of the official dollar reserve currency system cause purchasing power to be multiplied, or at least doubled, in both countries. But these central bank issues of new money are unassociated with the production of new goods and services during the same market period. Thus total spending, or purchasing power, exceeds the total value of goods and services at prevailing prices. When total demand exceeds total supply, the price level must rise.

But just as the subservient, colonial Indians were constrained not to sell their sterling reserves too quickly, so the Chinese are constrained—by politics, diplomacy, and self-interest—not to dump their depreciating American dollars. The Indians had to consult their imperial bankers, even though the English were debtors to their Indian colony, because the Indians did not wish to anger the colonial center, nor to precipitate a sterling crisis. From time immemorial, creditors with too large a stake in an over-sized debtor often beg leave of their debtor to get their money back.

China is frustrated by circumstances similar to those of a colony of imperial Britain. Hostility has arisen in the debtor—the United States. Fear of setting off a dollar slide haunts the hostile creditor, China. The difficulty of finding a suitable portfolio of alternatives for a trillion dollars in U.S. government debt annoys the outspoken Chinese financial colony, as it calls for a new world monetary system. But there seems to be no genuine alternative to the very liquid dollar market. De facto illiquidity of official Chinese dollar reserves is enforced by political sensitivities, not by market salability. The debtor, as the saying goes, is “too big to fail.” Thus arises an unstable stalemate, a yuan-dollar pegged exchange rate regime constantly on the edge of a crisis.

The “exorbitant privilege” of the dollar is matched by the insupportable burden of America’s overvalued reserve currency role, which has tended to deindustrialize the colonizer, gradually increasing social inequality by reducing the standard of living of lower- and middle-income American families. The reserve currency country then feels compelled, as the Fed does today, to depreciate the dollar in the vain hope of eliminating the trade deficit and the balance of payments deficit—by becoming more competitive abroad as it becomes poorer at home.

The perversity of the official reserve currency system is endless as China now endures high inflation engendered by its colonial status in the world dollar system.

The floating, pegged exchange rate system based on the dollar has been slowly decaying since the end of World War II. But the dollar-based reserve currency system, because of the unmatched scale and liquidity of the dollar markets, could last another generation. When it will collapse cannot be predicted. That it will collapse, without systemic reform, I think inevitable. Few predicted the timing of the collapse of the pegged dollar system of Bretton Woods. But it did collapse in August of 1971, followed by America’s worst decade since the Great Depression.

Ultimately America, the leader of the unstable world financial system, must choose bet ween two options.

1. The United States can wait for the eventual demise of the world dollar standard under chaotic

conditions, similar to the final sterling collapse and the subsequent collapse of Bretton Woods in 1971. This option is analogous to the intrepid daredevil who leaps from his 10th floor window, secure in the fact that he is still unhurt two floors from the street level.

2. Or, America could take the lead in reforming the official reserve currency system based on the dollar. Such a monetary reform program would entail a careful windup, by agreement, of the world dollar standard. At the same time America would reestablish by statute a dollar convertible to gold, i.e., a dollar defined in law as a weight unit of gold. Gold would replace the dollar as the world’s reserve currency.

The reform would, first and foremost, establish a tested, non-national, neutral monetary standard as the basis of a stable dollar—one which reasonable sovereign trading partners could accept. Gold would become the international settlements currency and thus would replace the dollar as the basis of world trade and finance. Inasmuch as monetary history shows that no unstable national currency can permanently serve as the crucial world reserve currency, it follows that neither can an unstable basket of national currencies, nor can a fiction such as the SDR—the reserve asset created by the International Monetary Fund to supplement member countries’reserves.

But we are left with the question: what does the evidence of American history suggest as the basis for a stable dollar?

The stability of the U.S. dollar has varied widely in its history. This variation is explained by two factors: the monetary standard chosen for the dollar, and whether other countries have simultaneously used cash and securities payable in dollars as their own reserves, even as their monetary standard itself (i.e., official reserve currencies in place of gold).

The United States has alternated between two kinds of standard money: inconvertible paper money and some precious metal (first silver, then gold). The dollar was an inconvertible paper money during and after the Revolutionary War (1776–92), the War of 1812 (1812–17), the Civil War and Reconstruction (1862–79), and again from 1971 to present. The dollar was effectively defined as a weight of silver (and gold) in 1792–1812 and 1817–34, and as a weight of gold in 1834–61 and 1879–1971. The minted gold eagle, set equal to 10 dollars, and subsidiaries thereof, was provided for in the Coinage Act of 1792. The dollar was not used by foreign monetary authorities as an official monetary reserve asset before 1913, but the dollar has been an official “reserve currency” for many countries since World War I (along with the pound sterling). The dollar has been the primary official reserve currency for most countries since 1944.

Applying two criteria divides the monetary history of the United States into distinct phases. We

can compare the stability of these monetary regimes by examining the variation in the Consumer Price Index (as reconstructed back to 1800) by two simple measures: long-term CPI stability (measured by the annual average change from beginning to end of the period of each monetary standard) and short-term CPI volatility (measured by the standard deviation of annual CPI changes during the period).

Weighting these criteria equally, the classical gold standard from 1879–1914 was the most stable of all U.S. monetary regimes (as the table shows).

After the failures of several generations of unhinged paper currencies, pegged and floating exchange rates, America should embrace a stable monetary system tested in the laboratory of human history—the cornerstone of which the elites have rejected for a century. It is now time to restore that cornerstone—the true gold standard, shorn of the economic pathology of official reserve currencies. Now is the time to restore the American monetary standard authorized by the Founders in the Constitution—Article I, Sections 8 and 10. Now is the historical moment for America to take the lead and again give the world a real money, the Founders’ gold dollar of the Coinage Act of 1792. What the Founders learned from the paper money inflation of the Revolution, the recent past has taught us again. America and the world need a monetary standard which, unlike the paper-credit dollar, cannot be created at zero marginal cost with which to dispossess the  prudent and to subsidize the U.S. government and insolvent financial institutions at near zero interest rates.

For America to establish the gold standard would provide the least imperfect monetary solution to the problems of a century of financial disorder—engendered over and over by central bank-manipulated paper money, official reserve currencies, and floating pegged exchange rates. Only a stable dollar, a dollar defined by statute as a weight unit of gold, can pin down the long-term price level, restoring the incentive to save and ruling out extreme inflation and deflation. Such a dollar convertible to gold would reopen the road to confidence in the long-term value of the U.S. monetary standard. This is the durable road to economic growth and prosperity—financed by increased long-term savings, increased long-term investment, and rising demand for labor at rising real wages.

China: American Financial Colony or Mercantilist Predator? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

As a long-time follower of the world oil industry, I was immediately struck by how one key target of the rioters and protesters was France’s petroleum distribution system. Clearly, the protesters understand the ideas of the 19th Century military theorist Karl von Clausewitz, who advanced the concept of finding the opponent’s “center of gravity,” and then bringing force to bear on that point.

The protesters were going for the jugular of modern societies, which is the energy supply. In France this week, over 3,000 — out of 13,000 — gas stations ran out of fuel after panic-buying by motorists. Also, eleven out of France’s 12 oil refineries remain on strike. Add to this that “flying pickets” are moving around, blocking fuel distribution depots. Thus has lack of fuel shut down major sectors of the French economy.

Indeed, the Charles de Gaulle Airport in Paris — a key transportation hub for the world, and not just France — suffered from a severe shortage of fuel for arriving aircraft. French authorities advised air carriers to land with enough fuel to take off, and fly somewhere else to gas up.

Pres. Sarkozy sent riot police to confront the blockades of refineries and fuel terminals. He knows that his response to the energy-based tactics of the opposition will make or break his political power. The jury is still out, but my hunch is not to bet against the power of the French state on this one.

What’s the Real Issue?

On the surface, the French rioting seemed like a political squabble over a high-visibility social entitlement. Considering the passion of the protesters, it’s like the current retirement age in France — 60 years — is some sort of sacred number. The protesters make it sound like Pres. Sarkozy wants to destroy a deep-rooted individual right that dates back to time immemorial of which, to use an old phrase, “the memory of man runneth not to the contrary.”

But the age-60 retirement number is not exactly some icon of bloody struggle, hewn out of the rock of revolution and war. No, the age-60 retirement eligibility dates only back to 1983 when the Socialist Party, under then-president François Mitterrand, reduced the former age of retirement from 65.

That is, the age-reduction for retirement was just a vote-buying political move during a time of relative peace and prosperity in France. Which gets us closer to identifying the real core issue behind the social unrest in France. It’s a lesson for all of us, in fact.

Times Have Changed — An Earthquake Across History

Neither France, nor the Western world generally, is living in a time of relative prosperity. Not anymore. Maybe not ever again.

Things have changed in this world, probably forever. The economic rise of China has caused an earthquake across history. That, coupled with the self-inflicted collapse of much of the Western way of running capital markets and managing economic growth over the long haul.

In just the past 15 years or so, China has evolved into a nation of immense demand. China has become the key player in a world of fierce resource competition. Look around. Things like energy, minerals, water and food are scarce, and getting scarcer. China is driving a long-term bull market in resources of every sort, from oil to iron, copper to cotton, cement to soybeans.

No “Value” in Value-Creation

On the other side of the coin, China is a land of mind-boggling, low-cost productivity. In almost every industrial arena and sector, the overall competition from Chinese firms has driven costs for many things. How low? Well, often down to right around the intrinsic value of the inputs — the plastic, the copper, the steel. As for the labor input? It’s not too much to say that Chinese competition has removed much of the “value” from value-creation.

Indeed, one of the major global economic issues today is that when Western businesses go head-to-head against Chinese competition, in almost any industry, nobody makes much money anymore.

So if this is the world in which we live, how can France remain a wealthy country? How can the West retain its status and historical standards of living? Tough questions, eh? But well worth asking.

What Can Nations Afford?

It takes us back to those French retirement riots. In France — and in the U.S. as well — government has promised far more than it’ll ever be able to deliver.

Retire at age 60? Who can afford that? Who’ll pick up that bill? Where’s the money? The government will collect taxes from who, exactly?

Really, when it comes to the French riots, it’s NOT just that the age-60 retirement idea lacks any sort of serious historical pedigree. Not at all. The problem is that the days of an entire nation retiring early are over.

Age-60 retirement is an idea that’s ridiculous and unsustainable in a world of Peak Oil — and Peak “Everything Else,” for that matter. We in the U.S. — and Canada, U.K, Australia, and so many other places across the world — need to take heed.

Until we meet again,
Byron King
Whiskey & Gunpowder

November 15, 2010

Riots in France a Symptom of Declining Western Wealth was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

And why should they be? They’re sitting on the sidelines holding US treasuries worth $797 billion. That’s quite a chunk of change.

Of course I’m talking about China.

The Chinese have been the biggest foreign creditor to the United States and in recent statements they’ve made it clear that Washington needs to maintain the value of the dollar.

“We have made a huge amount of loans to the United States. Of course we are concerned about the safety of our assets. To be honest, I’m a little bit worried,” said Chinese Premier Wen Jiabao.

It’s estimated that around 50% of China’s total reserves are held in US treasuries. And they know that the reserve currency they hold is depreciated with each passing day.

With so much riding on the price of the dollar you can bet that Beijing has been keep a close tally on America’s spending — and the results can’t be pleasing.

To say the least, Chinese faith in the dollar is feigning.

And I’ll give you one guess as to where they are going to spend their $797 billion nest egg… Gold!

Right now China is 6th on the list of world gold holdings with around 1,000 tonnes of gold reserves. Not bad right?

Wrong.

When you look closer at the statistics you can see that China has a mere 1.9% of its total reserve holdings in gold. Compare that to the U.S. with 77% and you’ll start to see China’s future motivation.

China is in the market for a reserve currency that’s stable. And when it comes to stability nothing glitters like gold.

Need proof? Look no further than another developing world powerhouse… India.

Recently India made a bold move to start protecting itself from the U.S. dollar and fiat currencies in general…

News broke that India made a huge gold purchase from the IMF — somewhere in the neighborhood of 200 tonnes.

Previously, the government of India held 350 tonnes of gold reserves. This 200 tonne purchase is a 57% increase in India’s reserves. Now that’s what I call a stand against paper currency!

The Indian transaction may be the largest single central bank purchase of gold ever. The only comparable event was the U.S. government seizure of gold from circulation within the nation back in 1933, along with steady U.S. government purchases in the 1930s and 1940s.

I spoke with an acquaintance of mine who works in the “financial” side of the U.S. government — I cannot say what Cabinet department, but his office has a view of the White House. I asked why the IMF sold the gold to India, and not China.

My acquaintance replied, “It’s all about balance. India holds a lot of U.S. Treasuries and needs gold to diversify its assets. We can’t let all the IMF gold go to China and leave India in the dust. China is already building up its gold reserves due to being the No. 1 gold producer in the world and still a net importer. Besides, if the news hit the wires that China just bought all the IMF gold, it would crush the dollar. So the deal was that India could buy 200 tonnes.”

Put it all together and the global outlook for the U.S. dollar is dreadful. As time passes more countries will try to escape the depreciation of the dollar — and that leads them to one option for wealth preservation: gold.

Okay, so no one wants paper dollars and instead they want gold — that’s easy right?

Not so fast…

Approaching “Peak Gold”

Just like the “peak oil” phenomenon, we’re headed for “peak gold.” It’s all about how much gold is left unprocessed underground. The more we take out, the harder it is to find more. And the harder it is to get to.

For instance, miners used to pan for gold in streams. Today, just to get enough gold for a wedding band, you need to crush up to 20 tons of rock.

And remember, gold isn’t just for jewelry, coins, or bars of bullion. Gold goes into computers, cell phones, and satellites. It’s used in medical lasers, industrial lasers, and in spacecrafts. It plays a major role in medical research. It’s even used for treating some diseases.

According to the World Gold Council, the world mined 2,414 tonnes of gold in 2008 — 64 tonnes less than the year prior. It was even less gold than mined in 2006.

Meanwhile, the amount of gold used in jewelry and industry alone topped 2,186 tonnes — add that to demand for bars and coins (which has really been ramping up lately) and you’ll see that, by necessity, at least 425 tonnes had to come into the market — most likely by central banks out of their dwindling hoards, a practice that cannot continue indefinitely.

And that’s not even including industrial use or the demand from vastly popular gold investment holdings like ETFs!

In fact, when you get down to brass tacks, the supply outlook for gold is down right dismal.

Over the past 10 years large gold discoveries have been inexistent. The discoveries that are being made tend to be in more remote and less geopolitically attractive areas.

Tough new environmental laws and 20 years of low mining investment don’t help. But it’s really geology that’s conspiring against the miners most. Nobody can find the big gold deposits anymore. It looks like they’re all tapped out.

With gold prices up, they’re looking. More holes open up in the ground. More tons of rock go through the mills. But so far, the average quality of the gold they’re finding has gone down.

The low hanging fruit of the gold mining universe — the easy deposits and rich mines — have started to disappear. Gold’s already rare. But it’s getting more rare by the day.

This rarity is running into increasing demand. There isn’t a more fundamental argument for rising prices. And if the U.S. dollar continues to plummet there’ll be no stopping the yellow metal’s upward charge. Again, it’s economics at work. Gold is priced in dollars, so as the currency becomes less valuable, the metal naturally becomes more valuable.

You want to accumulate gold investments now, while prices are still relatively low. Sure, gold prices are at all-time highs, but they still have a long way to go…over $2,000…maybe as high as $3,000…or even $5,000!

Until we meet again,
Byron King
Whiskey & Gunpowder

October 1, 2010

More Reasons Gold Is Going to $2,000 was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The Chinese government isn’t adding to its U.S. bond position. Nor is it rolling over its previous purchases. Instead, between September 2009–June 2010, Chinese holdings of U.S. bonds fell from $938.1 billion to $843.7. That’s a drop of over $94 billion over nine months.

The Chinese are backing away from U.S. debt. They’re reducing their exposure to the U.S. dollar, and by extension their vulnerability to a declining U.S. economy.

What’s going on? Is the decline in Chinese holdings of U.S. bonds strictly an economic assessment? Or is there something else afoot? What factions are driving this decision? And what does all of this mean for precious metals?

China’s Growing Confidence, and U.S. Decline

First let’s note how, in recent years, China has exhibited a newfound measure of international confidence, if not swagger. It’s easy to understand why.

China’s leaders see that the U.S. suffers from a weak economy, hampered by chronic overspending on consumption and underinvestment in new capital. In the wake of the global financial crisis of the past few years, Chinese leaders have concluded that U.S.-style democracy and Wall Street-style capitalism are discredited.

In other words, to use a Chinese term, the U.S. is a “sunset power.” China, on the other hand, sees itself as a “sunrise power.” The Chinese are going places in this world. The Chinese have developed a different approach to development than other nations, and they have the economic statistics to back it up.

The Chinese are not afraid to trumpet their success, either. Recently, for example, the German magazine Der Spiegel noted, “All around the world, from Africa to Asia to South America, Beijing is trying to tout its model of authoritarian state capitalism as the better alternative.”

The Chinese Military Influence

One way to look at things is that we’re watching historical waves unfold. China is on the rise, while U.S. power and influence wanes. But in a nation and culture as complex as that of China, it’s also useful to take a close look at how and why things happen.

One key source of influence within China is a hard-core military faction. The Chinese military offers a viewpoint that almost always holds sway on issues of supreme national importance. Such issues definitely include areas of so-called “core Chinese interests” that cover Taiwan and Tibet, as well as the South China Sea and the Yellow Sea.

It’s common knowledge, for example, that Chinese military advisers are incensed over U.S. arms sales to Taiwan. No amount of U.S. diplomacy ever is enough to smooth the troubled waters that divide mainland China from Taiwan. Indeed, the Chinese view their relations with Taiwan as an “internal matter” and consider most U.S. activities that touch on that relationship as “officious meddling.”

In a new development this summer, the Chinese military expressed outrage over joint U.S.-South Korean military maneuvers in the Yellow Sea.

That is, the U.S. and South Korea announced plans to conduct military exercises in the waters west of South Korea where a South Korean warship was sunk — apparently by a North Korean torpedo — in March of this year. The Chinese military, in turn, went ballistic (so to speak).

“Not in the Fundamental Interest”

One recent article on the state-run Xinhua news website warned the U.S. not to move the aircraft carrier U.S.S. George Washington into the Yellow Sea. The author of the article took care in his choice of words, but left no room for doubt about the Chinese position:

“Offending Chinese people is not in the fundamental interest of the U.S. Any activity aimed at pushing a country with a 1.3-billion populace with enormous potential would be inadvisable.”

On another news site, People’s Liberation Army Daily, Rear Admiral Yang Yi, former head of strategic studies at the Peoples’ Liberation Army’s National Defense University, was no less forceful, stating:

“On the one hand, [the U.S.] wants China to play a role in regional security issues. On the other hand, it is engaging in an increasingly tight encirclement of China and constantly challenging China’s core interests.”

Adm. Yang believes that the U.S. threatens China. Earlier this year, he said:

“The U.S. is the only country capable of threatening China’s national security interests in an all-round way… Japan has no such ability, while Russia has no such motivation and India is more worried about China.”

“Pay a Costly Price”

In a recent editorial, Adm. Yang expressed dismay over U.S. policies, stating, “Rarely has there been such wavering and chaos in U.S. policy toward China.” Adm. Yang expanded the point in another article in China Daily, China’s main English-language newspaper: “Washington will inevitably pay a costly price for its muddled decision.”

Not to be outdone — or perhaps simply to offer a consistent message — Maj. Gen. Luo Yuan, deputy secretary-general of the People’s Liberation Army Academy of Military Sciences, added his authority to the discussion. In a scathing editorial in the Chinese newspaper Global Times, Gen. Luo said that moving the U.S.S. George Washington into the Yellow Sea was a “deliberate provocation” toward China and that the U.S. should “think twice about the maneuver.”

When the Debtor Challenges the Creditor

Gen. Luo followed up with this comment: “Imagine what the consequences will be if China’s biggest debtor nation challenges its creditor nation.” China is the “world’s largest market,” and “offending China means losing, or at least decreasing, market share.”

I don’t think we have to “imagine” the consequences at all. I believe we just have to look at the decline in Chinese holdings of U.S. bonds — or “decreasing market share,” like the man said.

Thus, I believe that in addition to the Chinese economic concerns about the future of the U.S. economy and U.S. dollar, the Chinese military is also pushing its leadership to back away from holding U.S. dollars. There’s a component of military strategy to the decline in Chinese bond holdings.

What Are the Implications?

Then next question is if the Chinese are NOT buying U.S. bonds, then who IS buying the bonds?

My hunch is that it’s the U.S. Federal Reserve. That is, the Fed is covering China’s retreat from the dollar. For reasons both economic and military, China is gradually exiting its dollar position. The Fed is allowing this to happen quietly, without causing a dollar panic.

Meanwhile, the consequence is that the Fed is monetizing the U.S. national debt. Over the long term, this can only lead to the further decline of the U.S currency. Looking out over the medium and long terms, it can only mean higher prices for precious metals.

Until we meet again,
Byron King
Whiskey & Gunpowder

September 15, 2010

China’s War Uses U.S. Debt Against U.S. Dollar was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.