“In the current weak dollar situation,” said German economist Peter Bofinger to Der Spiegel last week, “[a treaty should be signed by the central banks of] China , South Korea, Japan, Russia, and other countries that have huge dollar reserves…so that they don’t dump massive amounts of dollar onto the market.

“A similar treaty already governs the gold market in Europe,” continued Bofinger, one of the German government’s ‘Five Wise Men’ advisers. “It is something that the World Monetary Fund could coordinate.”

Why smart people feel they need to spout such idiocy is, of course, all too clear. “As international investors wake up to the relative weakening of America’s economic power,” says The Economist, “they will surely question why they hold the bulk of their wealth in dollars.”

Indeed, “The dollar’s decline already amounts to the biggest default in history,” notes the venerable weekly, “having wiped far more off the value of foreigners’ assets than any emerging market has ever done.”

But the U.S. government pulled off a far greater debt default more than three decades ago — an absolute default that somehow, incredibly, allowed the bankrupt to continue growing his debts at an ever-quickening pace.

Whatever you think of gold as a measure of value or price today, Richard Nixon reneged on the terms of U.S. borrowing — as they then existed — when he shut the “gold window” at the New York Fed on Aug. 15, 1971. The U.S. dollar was no longer redeemable for gold, a crucial commitment under the Bretton Woods Agreement signed amid the rubble of World War II.

Foreign governments, not least in Europe, found the terms of their lending were void.

The immediate outcome — and the obvious aim — was to usurp gold as the world’s premier monetary asset. The dollar had secured Bretton Woods’ stability, but it was still just the chain, not the anchor. And it had faced trouble from gold as early as 1965, when French President Charles de Gaulle baulked at “America’s exorbitant privilege” of issuing paper that no one else could refuse.

Less than two decades after the Bretton Woods system began, de Gaulle started to demand gold bullion in exchange for the dollars sent eastward by U.S. business and travelers. What to do, wondered Washington’s finest?

“Hmmm…[stroke pointy beard, evil glint in eye] with gold out of the way — locked in a dungeon, say, like some metallic mad aunt — the dollar could reign supreme at last!”

Thus, the paper-made dollar has now measured all things, and paid for them too, for more than 36 years. The No.1 currency held in central bank reserves, it has been greeted by cheering crowds during most of its reign. And across much of its empire, the dollar still has client kings only too happy to applaud it in public.

Zhou Xiaochuan, head of the People’s Bank, told Henry Paulson at a meeting of G-20 economic leaders in Johannesburg last week that China supports a strong U.S. dollar. Chucking Paulson’s throwaway phrase right back in his face — the U.S. Treasury secretary again said, “A strong dollar is in our nation’s interest,” on Nov. 19 — must have raised a laugh from the other central bank delegates. Either that, or it gave them heartburn.

The U.S. Treasury loves a strong dollar; Beijing loves it too. So how come the damn thing now looks all puny and weak?

“We all know that the U.S. dollar has no economic value,” as the Iranian president, Mahmoud Ahmadinejad, put it last week.

“Buying currency is like buying a little bit of an economy,” agrees Germany’s Süddeutsche Zeitung newspaper. “That’s why the fall of the U.S. currency has political and economic implications far beyond the present financial market crisis.”

“They get our oil and give us a worthless piece of paper,” Ahmadinejad spat. But for now — and unless Iran really wants the USS Enterprise to divert its bomber flights from Afghanistan to Tehran — worthless paper is all the U.S. has to offer. That leaves America’s biggest creditors, like all big-time lenders, stuck with a quandary.

China, Saudi Arabia, South Korea and Japan all want it both ways. They’d like their debtor — the United States — to both settle up now…but also keep spending more money. If the dollar were to strengthen on the back of, say, higher U.S. interest rates, the resulting loss of U.S. consumer spending could destroy their economies. Just look at China.

The Chinese economy, set to grow by 11.5% in 2007, has been built on servicing the demands of foreigners, rather than domestic shoppers. It holds a whole heap of U.S. Treasury bonds as a result. But funnily enough, now that’s it’s grown so big so quickly, most of those foreigners today earn and spend euros, not dollars.

EU-China trade doubled between 2000-2005, making Europe China’s largest single export market.

“The slight depreciation of the dollar does not mean the currency is weak,” mused Mr. Zhou in Johannesburg this week. Clearly, he’s learning a lot from Hank Paulson, if not from George Orwell’s vision of a communist hell in 1984 . “Slight” now means “huge.” “Weak” means “destroyed.”

But in the European Union, this “slight” drop in the “strong” dollar is really starting to hurt — not least because the massively weaker dollar is weaker only in terms of the euro. That means exports from China are also cheaper thanks to the dollar-linked yuan.

That’s why the Chinese currency, the yuan, remains closely pegged to the U.S. dollar. Allowing it to float freely instead would just invite hedge fund speculators and investment funds to buy a piece of the Middle Kingdom’s future. They’d sell the current world No.1 to achieve it, long before China got a chance to spend its $1.43 trillion in foreign currency reserves.

Hence the unstoppable rise of the euro. “It could easily climb to $1.60,” reckons Peter Bofinger, “an appreciation of another 10%, which would eat into annual economic growth [in the eurozone] to the tune of half a percentage point.”

What to do? I don’t doubt that the U.S. subprime crisis will continue to go global. So central banks the world over will soon try to fend off recession by devaluing their currencies alongside the dollar.

“I think we’re now at the point where other central banks will join the U.S. Fed in cutting interest rates,” said Benedikt Germanier, currency strategist at UBS in Zurich, to Bloomberg on Nov. 20. “The Bank of England will join, and we also, in fact, expect by the second quarter of next year the ECB will join.

“So while it keeps the dollar weak for now, there’s scope for other central banks to cut rates too, and that could eventually put a floor under the dollar.”

Such a race to the bottom, however, might come too late for the eurocrats in Brussels. EU commissioner Peter Mandelson warned Beijing on Nov. 23 that China may face “anti-dumping” trade tariffs if it fails to address its ballooning trade surplus. Today the wonks will take their fight to China itself, when a commission led by Jean-Claude Trichet, head of the European Central Bank, lands in Beijing.

Trichet will officially request that the PBOC let the yuan float more freely against the basket of currencies that have already replaced its dollar peg, easing pressure on the euro as the world’s No.1 long for its growing short-dollar position.

Nicolas Sarkozy, president of France, will also be in town, as will the prime minister of Portugal — currently head of the European Union as part of its rotating presidency — and the European Commission president himself, Jose Manuel Barroso.

But what can the eurocrats offer Beijing in return for no longer pursuing its national interests on the currency markets? To soothe China’s fears of a rout of the dollar — and a rout denominated in yuan, rather than euros, at that — might they drop Bofinger’s crazy scheme into conversation, we wonder.

“It’s not just enemies of America like the presidents of Iran and Venezuela who are ridiculing the United States,” the Suddeutsche Zeitung tells its German readers. “In Europe too, some dream of the end of the superpower. They should remember that just seven years ago, the euro could buy only 82 American cents and there was speculation over the end of the EU’s currency. [Now] the dollar may well lose its role as the world’s unofficial currency. As long as the shift isn’t too abrupt, that could be good news for the global economy.”

Oh really? Just how could King Dollar abdicate his throne without unleashing open revolt?

“During the third quarter of 1999, European central banks had become increasingly concerned at the danger of an uncontrolled fall in the gold price that would reduce the value of their own holdings,” explained Philip Klapwijk, head of the GFMS consultancy in a 2003 paper for the London Bullion Market Association.

“This fear, coupled with the need to provide a framework for Swiss and British gold sales, plus other intended disposals, led to the deal announced in Washington [in September 1999] to limit sales to 2,000 tonnes over five years and to cap lending and derivatives activity at existing levels.”

You can guess why “Wise Men” like Peter Bofinger think the Central Bank Gold Agreement (CBGA) offers a model to Asian and Arab governments looking to move beyond the dollar standard. Since the CBGA began a little over eight years ago, the gold price has not only found its floor. It has soared nearly three times over against the U.S. dollar.

The CBGA, therefore, stands as a paragon of crossborder co-ordination. And if sales quotas and agreed ceilings could work for the gold market, why can’t they work for the dollar?

Hmmm…let’s see now:

• Is it because gold — even after it lost its official role in the world’s monetary system — still retained real intrinsic value?
• Is it because gold, used as a store of wealth for more than 5,000 years, appeals to jewelry consumers, as well as dentists, microchip fabricators and skyscraper designers?
• Might it be that even after the United States stopped backing its dollars with gold, the metal continued to be the world’s premier monetary asset — no one’s to print, inflate or peg?

Once the dollar loses its role as the supreme “reserve currency,” on the other hand, just what other uses might it be put to exactly — wallpapering the inside of central bank vaults? Rolled up for use in the People’s Bank restrooms?

Just who in the hell would want to buy yesterday’s fiat paper?

Regards,
Adrian Ash

November 27, 2007

Goldfinger? Bofinger! was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

— Ecclesiastes 10:8

THE FRENCH PRESIDENT, NICOLAS SARKOZY, was in Washington earlier this month, speaking to Congress en Français and telling the United States to stop dumping dollars and risking a global financial crisis.

Ooh la la! Sounds just like old times…

“The dollar cannot remain solely the problem of others,” said Sarkozy before a joint session of Congress on Nov. 7, riffing on the (infamous) joke made by John Connally, treasury secretary to Richard Nixon in the early ’70s.

Connally said the dollar was America’s currency, “but your problem.” Au contraire, replied monsieur le president this week.

“If we’re not careful,” he went on — apparently using “we” to mean both himself and the U.S. Congress — “monetary disarray could morph into economic war. We would all be its victims.”

Ooh la la again! Did Sarkozy need to take liquid courage before speaking his mind?

“What the United States owes to foreign countries it pays — at least in part — with dollars that it can simply issue if it chooses to,” barked French president Charles de Gaulle in a landmark press conference in February 1965.

“This unilateral facility contributes to the gradual disappearance of the idea that the dollar is an impartial and international trade medium, whereas it is, in fact, a credit instrument reserved for one state only.”

De Gaulle did more than simply grumble and gripe, however. Unlike Nicolas Sarkozy, he still had the chance to exchange his dollars for a real, tangible asset — physical gold bullion.

Gold “does not change in nature,” de Gaulle announced in that 1965 speech, as if he were telling the world something it didn’t already know. “[Gold] can be made either into bars, ingots, or coins…has no nationality [and] is considered, in all places and at all times, the immutable and fiduciary value par excellence.”

How to collect this paragon of assets? Back in the 1950s and ’60s, world governments could simply tip up at the Fed, tap on the “gold window,” and swap their unwanted dollars for gold.

So that is what de Gaulle did.

Starting in 1958, he ordered the Banque de France to increase the rate at which it converted new dollar reserves into bullion; in 1965 alone, he sent the French navy across the Atlantic to pick up $150 million worth of gold. Come 1967, the proportion of French national reserves held in gold had risen from 71.4% to 91.9%. The European average stood at a mere 78.1% at the time.

“The international monetary system is functioning poorly,” said Georges Pompidou, the French prime minister, that year, “because it gives advantages to countries with a reserve currency.

“These countries can afford inflation without paying for it.”

By 1968, de Gaulle pulled out of the London “gold pool” — the government-run cartel that actively worked to suppress the gold price, capping it in line with the official $35 per ounce ordained by the U.S. government. Three years later, and with gold being air-lifted from Fort Knox to New York to meet foreign demands for payment in gold, Richard Nixon put a stop to de Gaulle’s game. He stopped paying gold altogether.

De Gaulle called the dollar “America’s exorbitant privilege,” repeating a phrase of his favorite economist, Jacques Rueff. This privilege gave the United States exclusive rights to print the dollar, the world’s “reserve currency” and force it on everyone else in payment of debt. Under the Bretton Woods agreement of 1944, the dollar could not be refused.

Indeed, alongside gold — with which the dollar was utterly interchangeable until 1971 — the U.S. currency was real money, ready cash, the very thing itself. Everything else paled next to the imperial dollar. Everything except gold.

And today?

“Printing a $100 bill is almost costless to the U.S. government,” as Thomas Palley, a Washington-based economist wrote last year, “but foreigners must give more than $100 of resources to get the bill.

“That’s a tidy profit for U.S. taxpayers.”

This profit — paid in oil from Arabia…children’s toys from China…and vacations in Europe’s crumbling capital cities — has surged since the Unites States closed that “gold window” at the Fed and ceased paying anything in return for its dollars.

Now the world must accept the dollar and nothing else. So far, so good, but the scam will work only up until the moment that it doesn’t.

“The U.S. trade deficit unexpectedly narrowed in September,” reported Bloomberg on Nov. 9, as “Customers abroad snapped up American products from cotton to semiconductors, offsetting the deepening housing recession that is eroding consumer confidence.

“Exports have reached a record for each of the past seven months, the longest surge since 2000,” the newswire goes on, which “may help explain why the Bush administration has suggested it’s comfortable with the dollar’s drop. It has declined in all but one of the past five years, even as officials say they support a ‘strong’ dollar.”

What Bloomberg misses, however, is the surge in U.S. import prices right alongside. They rose 9.2% year on year in October, the Department of Labor said on Friday, up from the 5.2% rate of import inflation seen a month earlier.

Yes, the surge in oil price must account for a big chunk of that rise — and the surge in world oil prices may do more than reflect dollar weakness alone. The Peak Oil theory is starting to make headlines here in London. Not since the Club of Rome forecast a crisis in the global economy in 1972 have fears of an energy crunch become so widespread.

But if you — an oil-producing nation — were concerned that one day soon your wells might run dry, wouldn’t you want to get top dollar for the barrels you were selling today? Especially if the very dollar itself was increasingly losing its value?

“At the end of 2006, China’s foreign exchange reserves were $1,066 billion, or 40% of China’s GDP,” notes Edwin Truman in a new paper for the Peterson Institute. “In 1992, reserves were $19.4 billion, 4% of GDP. They crossed the $100 billion line in 1996, the $200 billion line in 2001, and the $500 billion line in 2004.”

What to do with all those dollars? “If all countries holding dollars came to request, sooner or later, conversion into gold,” warned Charles de Gaulle in 1965, “even though such a widespread move may never come to pass…[it] would probably shatter the whole world.

“We have every reason to wish that every step be taken in due time to avoid it,” the French president advised. But the step chosen by Washington — rescinding the right of all other nation-states to exchange their dollars for gold — only allowed the flood of dollars to push higher.

Nixon’s quick-fix brought such a crisis of confidence by the end of the ‘70s, gold prices shot above $800 per ounce — and it took double-digit interest rates to prop up the greenback and restore the world’s faith in America’s paper promises.

The real crisis, however, the crisis built into the very system that allows the U.S. to print money that no one else can refuse in payment — was it merely delayed and deferred? Are we now facing the final endgame in America’s postwar monetary dominance?

If these sovereign wealth funds — owned by national governments, remember — cannot tip up at the Fed and swap their greenbacks for gold, they can still exchange them for other assets. BCA Research in Montreal thinks that “sovereign wealth funds” owned by Asian and Arabian governments will control some $13 trillion by 2017 — “An amount equivalent to the current market value of the S&P 500 companies.”

And if China doesn’t want to buy the S&P 500 — and if Congress won’t allow Arab companies to buy up domestic U.S. assets, such as port facilities — then the sovereign wealth funds will simply swap their dollars for African copper mines, Latin American oil supplies, Australian wheat…anything with real intrinsic value.

They might just choose to buy gold as well. After all, it is “in all places and at all times…the immutable and fiduciary value par excellence,” as a French president once put it.

Charles de Gaulle also warned that the crisis brought about by a rush for the exits — out of the dollar — might just “shatter the world.” It came close in January 1980. Are we getting even closer today?

Regards,
Adrian Ash

November 20, 2007

A Crisis to Shatter the Whole World was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.