A Standard for All Nations

A Gold Standard, Back to the basics, Deflation-Inflation-Stagflation, Devaluation, Dismal Science-Ignorant Scientists?, Dollar Musings 4 Responses »

Aug 212011

DeGaulle On the Fiat Reserve Currency

Advantages

Long-term price stability has been described as the great virtue of the gold standard.^[16] Under the gold standard, high levels of inflation are rare, and hyperinflation is nearly impossible as the money supply can only grow at the rate that the gold supply increases.^[17] Economy-wide price increases caused by ever-increasing amounts of currency chasing a constant supply of goods are rare,^[17] as gold supply for monetary use is limited by the available gold that can be minted into coin.^[17] High levels of inflation under a gold standard are usually seen only when warfare destroys a large part of the economy, reducing the production of goods, or when a major new source of gold becomes available.^[17] In the U.S. one of those periods of warfare was the Civil War, which destroyed the economy of the South,^[18] while the California Gold Rush made large amounts of gold available for minting.^[19]
The gold standard limits the power of governments to inflate prices through excessive issuance of paper currency.^[17] It provides fixed international exchange rates between those countries that have adopted it, and thus reduces uncertainty in international trade.^[17] Historically, imbalances between price levels in different countries would be partly or wholly offset by an automatic balance-of-payment adjustment mechanism called the “price specie flow mechanism.”^[17]
The gold standard makes chronic deficit spending by governments more difficult, as it prevents governments from inflating away the real value of their debts.^[20] A central bank cannot be an unlimited buyer of last resort of government debt. A central bank could not create unlimited quantities of money at will, as there is a limited supply of gold.^[17]

Disadvantages

Gold prices (US$ per ounce) from 1968 to 2010, in nominal US$ and inflation adjusted US$.

The total amount of gold that has ever been mined has been estimated at around 142,000 metric tons.^[21] This is less than the value of circulating money in the U.S. alone, where more than $8.3 trillion is in circulation or in deposit (M2).^[22] Therefore, a return to the gold standard, if also combined with a mandated end to fractional reserve banking, would result in a significant increase in the current value of gold, which may limit its use in current applications.^[23]
Deflation rewards savers^[24]^[25] and punishes debtors.^[26]^[27] Real debt burdens therefore rise, causing borrowers to cut spending to service their debts or to default. Lenders become wealthier, but may choose to save some of their additional wealth rather than spending it all.^[28] The overall amount of expenditure is therefore likely to fall.^[28]
Mainstream economists believe that economic recessions can be largely mitigated by increasing money supply during economic downturns.^[29] Following a gold standard would mean that the amount of money would be determined by the supply of gold, and hence monetary policy could no longer be used to stabilize the economy in times of economic recession.^[30] Such reason is often employed to partially blame the gold standard for the Great Depression, citing that the Federal Reserve couldn’t expand credit enough to offset the deflationary forces at work in the market.^[31]
Monetary policy would essentially be determined by the rate of gold production.^[32] Fluctuations in the amount of gold that is mined could cause inflation if there is an increase, or deflation if there is a decrease.^[32]^[33] Some hold the view that this contributed to the severity and length of the Great Depression as the gold standard forced the central banks to keep monetary policy too tight, creating deflation.^[23]^[34]
Although the gold standard gives long-term price stability, it does in the short term bring high price volatility.^[33] In the United States from 1879 to 1913, the coefficient of variation of the annual change in price levels was 17.0, whereas from 1943 to 1990 it was only 0.88.^[33] It has been argued by, among others, Anna Schwartz that this kind of instability in short-term price levels can lead to financial instability as lenders and borrowers become uncertain about the value of debt.^[35]
James Hamilton contended that the gold standard may be susceptible to speculative attacks when a government’s financial position appears weak, although others contend that this very threat discourages governments’ engaging in risky policy (see Moral Hazard).^[34] For example, some believe that the United States was forced to raise its interest rates in the middle of the Great Depression to defend the credibility of its currency after unusually easy credit policies in the 1920s.^[34]
If a country wanted to devalue its currency, a gold standard would generally produce sharper changes than the smooth declines seen in fiat currencies, depending on the method of devaluation.^[36]
Mainstream economists believe that a low, steady rate of inflation is ideal for an economy because it incentivizes people to purchase consumable goods now rather than later. This low, steady rate of inflation is most easily achieved with a fiat currency system in which the monetary authority is free to regulate money supply. ^[37]
It is difficult to manipulate a gold standard to tailor to an economy’s demand for money, providing practical constraints against the measures that central banks might otherwise use to respond to economic crises.^[38]

WAVE GOODBYE TO THE DOLLAR

Death of the Dollar, Deflation-Inflation-Stagflation, Dismal Science-Ignorant Scientists?, Dollar Musings, Economic Analysis Isn't Science, Federal Reserve-Discussion, Greenspan is kind of stupid, HEY AMERICA-STICK 'EM UP!, Monetary Policy - Discussion, Our phony middle class, Patience is a virtue...Delusion is a vice, Politicians, TARP fruit loops, The American Financial Oligarchy, The Arrogance of Power, The Big Fat Greek Question, The Consequences of Greed, The Currency Wars Officially Begin, The Democrats Blew It Again, The Dollar's Demise, The End of American Capitalism As We Know It? - Discuss, The excellent adventures of Ben Bernanke, The Financial Elite, The Great American Heist, The Growing American Fascist State, The Importance of Strategic Planning, The Inherent Disorder of Empires, The Intrusion of UNLAWFUL Authority, The Joy of Being A Bank, The Judeo-Christian Political Coalition, The New American Socialism, The Obama OMG magic factory, The Sorry State Of American Manufacturing, The Suffering Poor, Time For A New Third Party, Unemployment Catastrophe, Unindicted Co-Conspiritors, USA Is the New Japan, Wage Deflation, Want To Buy A Car?, We Are All Cooked, We Have Become Beggars To The World, Who Guarantees the Guarantor?-You Do! No Responses »

Jun 112011

BEN BERNANKE’S speech on Tuesday got all the attention, but the speech later that day by Bill Dudley, head of the New York Fed, is more intriguing. In it he analyses the macroeconomic origins of the global imbalances that precipitated the crisis and prescribes the policy path forward.

He does so in logical, crisp and accessible language. Mr Dudley is, however, still a central banker, which means he must be translated, especially when it comes to the delicate subject of the dollar. In a nutshell, Mr Dudley tells us that aggressively easy monetary policy is essential to both the cyclical recovery and to a structural rebalancing of the American economy away from consumption and toward exports. This process will go more smoothly for everyone if emerging market economies (EMEs) cooperate and let their exchange rates appreciate (i.e. let the dollar fall), but absent such cooperation, don’t expect the Fed to change course.

Mr Dudley starts with some striking statistics. EMEs now account for 38% of world GDP, up from 23% in 1990, and 59% of world growth in the 2000s, up from 25% in the 1980s. Since 2007, the BRICS’ GDP has risen 31%; the G7’s, just 1%.

He retells the familiar story of how global imbalances bred the financial crisis, but with a twist. In the past, the Federal Reserve and Mr Bernanke (here and here) have denied culpability for the credit bubble, blaming instead the influx of excess savings from EMEs into developed-world assets. Mr Dudley, in effect, says both bear the blame:

[T]he combination of rapid gains in production capacity and relatively repressed consumption in the EME world helped foster a global deficiency of demand relative to supply. In these circumstances, the United States and many other industrialized economies had to sustain domestic demand at elevated levels in order to achieve “full employment” and prevent deflation. For the United States, the consequence was elevated consumption facilitated by asset price inflation, easy underwriting standards for credit and structural budget deficits.

Read This, Then Sell The Dollar – Economist

Who is in charge? Who is coordinating policy?

Geithner: Strong Dollar!

Bernanke: Weak Dollar!

Huh????????????

BJS

_________________________________________________________

The US is pursuing a policy of weakening its currency which is driving up exchange rates in the rest of the world, according to Alan Greenspan, the former chairman of the Federal Reserve.

Writing in today’s Financial Times ahead of the G20 meeting in Seoul, Mr Greenspan argues that with China also holding down the renminbi, the upward pressure on currencies elsewhere risks a return to widespread trade protectionism. Mr Greenspan criticises China for continuing to prevent the renminbi strengthening, saying it reflects a misguided view that a weak currency is necessary for export growth and political stability. “China has become a major global economic force in recent years,” he writes. “But it has not yet chosen to take on the shared global obligations that its economic status requires.” More unexpectedly, Mr Greenspan adds: “America is also pursuing a policy of currency weakening.”

The Gold Standard and the Great Depression

Analysis & Commentary, Dismal Science-Ignorant Scientists?, Dollar Musings, The excellent adventures of Ben Bernanke, The Importance of Strategic Planning, The Inherent Disorder of Empires, The Intrusion of UNLAWFUL Authority No Responses »

Oct 312009

Paul Krugman has concentrated his fire recently on those “thumping their chests” over the falling dollar. He has particular scorn for those recommending a return to the gold standard. In Krugman’s view, a simple look at the historical facts will show that it was a superstitious fetish for the yellow metal that prolonged the Great Depression.

A careful, comprehensive response to Krugman’s charges would involve an explanation of the classical gold standard, and the wonderful peace and prosperity it showered on the world. It was only after the major countries abandoned gold during World War I that major imbalances in international trade began to fester — imbalances that eventually exploded during the early 1930s.[1] As a good capitalist pig, I point the reader to my book on the Depression for the full story.

Fortunately, we can take a shortcut in the present article. Using Krugman’s own graph, we can see that the case for abandoning gold — and devaluing currencies in the process — is not nearly as straightforward as he seems to think.

http://mises.org/story/3778

The Falling US Dollar – Bane or Boon?

Dollar Musings No Responses »

Oct 172009

Summary: The US dollar is falling in value vs. most other currencies and gold. As usual, much of the material in the mainstream media about this important economic trend is misleading or wrong. It is potentially both bane and boon. Which depends upon us.

An excellent summary of the situation: ”Misguided Monetary Mentalities“, Paul Krugman, 11 October 2009 — Excerpt:

The truth is that the falling dollar is good news. For one thing, it’s mainly the result of rising confidence: the dollar rose at the height of the financial crisis as panicked investors sought safe haven in America, and it’s falling again now that the fear is subsiding. And a lower dollar is good for U.S. exporters, helping us make the transition away from huge trade deficits to a more sustainable international position.

Contents

Why is the US dollar falling in value?
Is a falling dollar inevitable?
Is a weaker dollar bad for us?
What should the US do about the dollar?

Investment Future

401(k) Issues, Analysis & Commentary, Back to the basics, Bond Market, Devaluation, Dollar Musings, Figures don't lie but Liars can figure, Investment Portfolios No Responses »

Oct 102009

The Future of Investing
FT writers join major world figures in examining the implications of the credit crunch on our investment system.

Genie needed: The magic of getting liquidity back into the bottle!

Consumption Ran the Old Economy, Death of the Dollar, Deflation-Inflation-Stagflation, Devaluation, Dollar Musings, The Democrats Blew It Again, The excellent adventures of Ben Bernanke No Responses »

Oct 032009

Prof. Jim Hamilton at Econbrowser (thanks Mark Thoma for the link) addresses one of the Fed’s standard methods of draining liquidity from the banking system: reverse repurchase agreements. Basically, the Fed will transfer some of its assets to the banking system via short-term loans taken out with its Primary Dealers, presumably offering standard (Treasuries) and less standard (MBS or agency bonds) assets as collateral.

Reverse repurchase agreements simply slosh around the assets (MBS, agencies, and Treasuries) between the Fed and the Primary Dealers, rather than removing the assets from the Fed’s balance sheet permanently. Eventually, though, the Fed must sell the securities outright onto the open market – we are far, far from that!

This is all hot air for now. How can the Fed soak up the expansionary liquidity, let alone unwind $1 trillion in assets, when the banking system is still shedding pounds?

The Fed is considering another route, too: conducting the same repurchase agreements with the money-market mutual fund industry in tandem. An excerpt from the FT:

The Federal Reserve is looking to team up with the money-market mutual fund industry as part of its strategy to ensure that its unconventional policies to stimulate the economy do not produce a bout of post-crisis inflation.

The central bank envisages eventually draining liquidity from the financial system by engaging in trades called “reverse repos” with the deep-pocketed money-market funds. In these, the Fed would pledge mortgage-backed securities and Treasuries acquired during the crisis as collateral for short-term loans from the funds.

The obvious counterparties for reverse repo deals are the Wall Street primary dealers. However, the Fed thinks they would only have balance sheet capacity to refinance about $100bn of assets. By contrast, the money-market funds have $2,500bn in assets, which means they could plausibly refinance as much as $500bn in Fed assets. Officials think there would be appetite on the part of the funds, which are under pressure from regulators and investors to stick to low-risk liquid investments.

The Fed is solely attempting to assuage inflation angst at this time; it’s still very premature to talk about an exit of expansionary policies when credit markets still crimp the stimulus that the Fed so desperately wants to get into the open market (much of the base, roughly $855 billion on September 23, 2009 and up from $2 billion in August 2008, remains on balance with the Fed in the form of “excess reserves). Just look at the crunch in the consumer credit space (chart to left).

As Prof. Hamilton suggests, the mechanisms of the reverse repos should successfully sterilize the base before it starts to become inflationary (with either the Primary Dealers and/or the Mutual Funds industry). However, one of the programs through which the Fed utilized previously to sterilize its liquidity, and to which Prof. Hamilton refers, – the Supplementary Financing Program – is unlikely to be an avenue for removing liquidity.

In fact, it’s quite the opposite. The Treasury already announced its imminent plan to liquidate the bulk of its $200 billion account with the Fed. There’s another $200 billion in excess reserves with which the Fed must contend (see my previous post here).

It’s easy to get the liquidity into the financial system. But getting it out without collapsing the economy or allowing inflation pressures to build? Well, that’s a different story.

The ECB and Inflation

Deflation-Inflation-Stagflation, Devaluation, Dollar Musings No Responses »

Sep 132009

The Importance of ECB Wording on Inflation – Euro Thoughts Sep 7-11 2009 – UniCredit Group

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Aurelio Maccario | Sep 9, 2009

Last Thursday my boss, Marco Annunziata, did not hesitate to define President Trichet a true statesman for his wise and transparent conduct of the ECB September press conference. In the last few weeks, with his intervention in Jackson Hole, the Sep 4 presser, and the op-ed in the Financial Times the following day, Mr. Trichet has been able to reassure markets that the ECB is aware that the economic and financial cycles remain fragile, that the weapons of mass salvation employed over the last year need to remain in place (e.g., the decision not to apply a spread on the upcoming 12-month fixed rate-full allotment operation), thus steering market rates’ expectations in the desired direction. The publication of bearish staff forecasts has contributed to finish the job. The ECB stance remains quite accommodative and any decision on rates and on the unwinding of unconventional measures is postponed to next year.

As U.S. deficits increased, global investors edged away from the dollar into the German mark, the Japanese yen, the Swiss franc, the Euro, and more recently baskets of Asian currencies.

Which brings us to today. Only goodwill (defined both as an accounting term and as political deference to military might) now supports the U.S. dollar as a reserve currency, which is what allows the United States to issue dollar-denominated bonds in world money markets.

It is this borrowing capacity that allows the Obama administration to bailout the banking industry, offer to pay for universal health care, fight colonial wars in the Middle East, stimulate the economy, send billions to Egypt and Israel, buy out General Motors, and subsidize every windmill start-up company in Nancy Pelosi’s home district. (Madoff’s problem was that he failed to set himself up as a country. He otherwise understood deficit spending.) But the shell game requires full faith in the dollar.

For those riding out financial storms by “sitting on cash,” here is what’s under your seat: in recent months U.S. federal debt has grown to $11.3 trillion, almost equivalent to gross domestic production. About one quarter of this indebtedness, or $2.8 trillion, is held abroad, and China and Japan hold just under half of those assets (liabilities to Uncle Sam).

Elsewhere on the American balance sheet is another $11.4 trillion in household debt, an annual trade deficit of about $725 billion, and a federal budget deficit that is estimated in 2009 to be approaching $1.8 trillion. That’s if the economy grows at 3 percent.

Off-balance sheet risks, what accountants call contingent liabilities, include about $10 trillion in new bailout guarantees (Fannie Mae, Bear Stearns, Countrywide, and whatever the administration launches as its New Deal of the Day). None of the above includes the unfunded liabilities of Social Security ($41 trillion), which, by comparison, make the shares of Lehman Brothers and AIG look like Scottish bonds held for widows and orphans.

The geese laying the golden eggs of U.S. financial stability are the printing presses of the U.S. Treasury, and, for now, those collecting them in their Easter baskets include a number of countries and regions perhaps tiring of American arrogance, if not of the drop in the dollar’s value. Who would blame such popular targets of moral abuse as China, Russia, Switzerland, Arabia, or Latin America for dumping their dollar-denominated assets?

All that lies between the U.S. dollar and a financial Armageddon is the Faustian house of credit cards under which Asian economies invest their trade surpluses in U.S. Treasury instruments — to keep the dollar strong, their own currencies weak, and purchases brisk between the likes of Wal-Mart and the Asian Greater Co-Prosperity Sphere.

Sooner than we think, China and Japan, like all nervous creditors, may send the United States a letter, suggesting that, henceforward, if Washington needs to borrow money, the bonds be issued in renmimbi, yen, or a basket of Asian currencies (a Pacific Euro).

Wall Street bankers did the same to the farm interests in the late nineteenth century, when they insisted that debt be based on a gold standard, as opposed to “free silver.” President Obama may be as eloquent as William Jennings Bryan. But at that point he will need to use all his oratory for the business of selling junk bonds.

The Dollar: Running On Reserve – Matthew Stevenson, newgeography

Last Call for Monetization?

Death of the Dollar, Deflation-Inflation-Stagflation, Dollar Musings, How do you dampen the inflation dragon?, The excellent adventures of Ben Bernanke No Responses »

Jul 012009

In the past three weeks there have been several indications that the Federal Reserve is reconsidering the extent and perhaps necessity of its extraordinary liquidity provisions to the Treasury market. How far have the chairman and governors pulled back from their quantitative easing policy?

On June 3rd Chairman Bernanke commented in Congressional testimony that federal deficits cannot continue forever. In fact the deficits can continue, but the Fed’s $300 billion Treasury purchase plan will end unless additional funding is authorized by the Fed governors. At this past week’s FOMC meeting the board specifically did not authorize further Treasury purchases. The Fed is also letting one of its emergency liquidity programs expire and curtailing two others. None of these developments is an overt change in policy, but they are assurances that the chairman and the board view these liquidity measures as crisis expedients and not as permanent institutions of monetary and economic policy.

It is easy to forget that the Fed policy of direct support for credit markets was an emergency response to the crisis of confidence that overwhelmed the financial system last fall. Fed purchases of various securities supplied liquidity to non-functioning markets; they were not intended to be permanent. The Fed said as much at the time, though in the ensuing months market focus shifted from the programs themselves to the lack of a clear strategy for absorbing the excess money supply from the economy.

In March the market reaction to the financial crisis was at its peak. Treasury prices had been driven to historical highs by sustained panic buying of US Treasuries. Treasury interest rates and rates on 30-year fixed rate mortgages were at record lows. But even though mortgages rates were extraordinarily low the Fed judged that the reeling economy could not tolerate the surge in interest rates that would occur if Treasury prices began to fall. The governors may have suspected that the Treasury market would begin to drive prices lower and rates higher on its own as credit conditions normalized

In that context the Fed announced its $300 billion Treasury purchase in the FOMC statement of March 18th. The governors may also have been worried about the impact of the federal deficit on the bond market whose reaction was then an unknown quantity. But despite the Fed backstop the Treasury market fell relentlessly after March 18 with the 10-year rate rising more than 1.5%. More dangerously the dollar index fell 10% from March 18th to June 2nd. For the currency markets the Fed Treasury program has had one meaning, monetization of the Federal debt. Judging by the subsequent rise in Treasury rates the Fed governors may have known that the $300 million committed would be insufficient to hold the line on Treasury rates. But that relatively minor amount had a deadly effect on the dollar. The merest suspicion that monetization of US debt was possible sent the dollar into a three month swoon. The inflation that would result from a rapidly falling dollar and the effect of a collapsing dollar on the Treasury market itself could undo much of the economic and rate stabilization that the Fed was striving to achieve.

The Fed concern about the Treasury market was for the economic effect of higher interest rates on the US economy, particularly on the housing market thought by many to be at the heart of the economic collapse. But higher Treasury yields and mortgage rates have not, at least so far, choked whatever positive change in the economy has occurred since March. 30-year fixed mortgages have gained more than a point but the housing market has stabilized; new home and existing home sales in May were both in the center of the range they have exhibited since January.

The Personal Consumption Expenditures Index has revived since last December. It gained 0.9% in January, 0.4% in February, 0.3% in May, was flat in April and lost 0.3% in March. The half year prior to January had six negative months in a row. Non Farm Payrolls were substantially improved in May at -345,000, with the three month moving average (-500,000) having gained almost 200,000 since March (-691,000). Consumer sentiment numbers have moved up steadily since the beginning of the quarter. The economic situation that prompted the Fed quantitative easing has returned to more normal territory.

The Treasury market has also stabilized in the past two weeks. After reaching 4.00% the yield on the 10-year note had declined to 3.54% on the Friday close. The government Treasury auctions, a record $104 billion in the past week alone, have been subscribed at higher rates than normal. The bond markets are not demanding substantially higher rates on American debt, despite the vast continuing supply of US issuance.

The key to the extension of the Fed Treasury program is the attitude of the credit markets. It is relatively simple. If bond purchasers do not demand higher yields for US debt, then whatever the long term effect of the ballooning US debt and inflation the government will not be forced to pay higher rates. If Treasury prices are not falling the Fed will not have to support the market with further Treasury purchases and the currency markets will not be stampeded away from the dollar by monetization.

Foreign central banks have been unusually critical of the US government’s fiscal and debt policy. The Chinese were so again this week. But what matters are not the banker’s words or their musings about a world reserve currency. What matters is action. As long as the Chinese, Russians, Japanese and private investors continue to buy US Treasuries, the Fed will not have to choose between supporting the US economy and supporting the dollar.

It is a delicate balance but so far the Fed has, with the cooperation of the Treasury markets, kept the pointer right in the middle of the scale. The Fed has managed to mitigate the scare it threw into the currency markets in March with its recent statements and actions.

There are still a huge amount of Treasuries to be sold over the next three months and the economic situation is still dangerous. But the Fed view as reflected in the FOMC statement, no more quantitative easing and a slight though significant withdrawal from the credit markets may be the right and artful balance between keeping down US interest rates and avoiding a dollar panic in the currency markets

Last Call for Monetization? – Joseph Trevisani, FX Solutions

Dollar Doldrums

Dollar Musings No Responses »

Jun 192009

Everybody’s got an opinion on the dollar, ranging from its aesthetics (for the most part, people think greenbacks lack that) to its utility (we hear a lot from folks bemoaning its use as a fiat currency).

Voices were raised in recent months in favor of doing away with the dollar as a reserve currency, the most strident emanating from exporters of dollar-denominated commodities, such as Russia, and nations like China that hold large swatches of U.S. government paper.

So, what’s a reserve currency and why should the buck get the boot?

A reserve currency is a simply a store of value, held by a central bank and denominated in the legal tender of another nation, that facilitates international trade and foreign exchange. The modern notion of a reserve currency came about in the late 19th century along with the emergence of the international gold standard.

The U.S. dollar is the most widely held reserve currency, representing about two-thirds (10-year weighted average: 65.9%) of central bank foreign exchange holdings. The hegemony enjoyed by the greenback makes it easier for the U.S. to run and maintain high trade deficits, a consequence of the nation’s debt-financed consumerism and low savings rate. The greenback’s preeminence is eroding, though. Its allocation in central bank reserves has been chipped away at a rate of 70 basis points (0.7%) a year over the past decade.

Dollar Ain’t Perfect, but What’s Better? – Brad Zigler, Hard Asset Investor

New Jersey CFO