Skip to comments.Currency Wars and Gold
Posted on 12/07/2012 9:07:00 AM PST by Katechon
A currency war in the simplest form is basically when there is too much debt and not enough growth.
- James Rickards, Currency Wars: The Making of the Next Global Crisis
Currency wars are real wars. But they are waged with currencies, stocks, bonds, derivatives, commodities, rather than guns and other kinetic weapons.
In a currency war, countries try to manipulate their own currency to gain an unfair trade advantage. There is a currency war when one country tries to devalue its currency relative to others in order to promote exports and create jobs.
Let's take an example. Some countries manufacture jet aircraft. The United States has Boeing, Europe has Airbus, Brazil has Embraer and there are a few others. Now imagine you are Thailand. You want to buy aircrafts for your airline industry, but you dont make them yourself. You have to go shopping. But where are you going to go? The theory behind the practive of currency war is that if the US cheapen the Dollar, it will make the Boeing aircraft a little more attractive than an Airbus or an Embraer. Boeing would sell more planes and create more jobs.
But once you go down that road, you quickly invite RETALIATION. In return, other countries will devalue their own currency too. There are unintended consequences. It creates a spiral of retaliations that ends up with a contraction in world trade, a GLOBAL DEFLATION. And in this context, the temptation to steal growth from your trading partners by trashing your own currency becomes overwhelming.
Suppose you are a Chinese manufacturer. You sell goods to the United States. They pay you in dollars and you take those dollars back to China. When you exchange those dollars into Yuans (¥), thats going to drive UP the value of the Yuan. But instead of that happening, the value of the Yuan stays the SAME... You do exchange those dollars for Yuans, but the Chinese central bank prints Yuans TO BUY those dollars, so as to keep their currency where it is. By doing this however, China is importing INFLATION from abroad.
The USA are also doing the same thing. They are cheapening the Dollar to increase exports, by making export prices less expensive. The problem here is that a country like China or the US does not just export, it also IMPORTS. The USA for instance import more than it exports. So if the Federal Reserve cheapens the Dollar, the price of those imports is going to go UP, which will bring inflation into the United States from abroad. The American people will be paying much more for iPads and iPhones and flat-screen TVs and French wine and vacations in Italy and clothes made in Korea. It brings inflation into a country, and thats why a currency war is always a losing game.
And when you devaluate your currency that way, it generates retaliation from other countries. China reacted to the devaluation of the Dollar by trashing the Yuan in return. (Weaker countries who can not do that develop measures of capital control, such as freezing the assets of foreign investors for extended periods, which can trigger trade wars.)
Growth (gross domestic product) = consumption + investment + government spending + net exports
There is too much debt around the world now: sovereign debt, corporate debt, consumer debt, individual debt, student loans, car loans, etc. Too much debt that cant be paid, and won't EVER be paid.
Individuals can default, corporations can go bankrupt, but governments usually don't. The US government is not going to default on its $16 trillion debt. It will just print the money, and pay the debt with severely devalued, virtually worthless "money." Governments who print their own currency dont have to default. They can just inflate their way out of their debt.
The US governement and the Federal Reserve want higher inflation in the USA because the dominant force in the global economy nowadays is deflation. Widespread debts lead to generalized deflation.
So to fight deflation and to boost exports, the USA began in 2009 to "print" a lot of money. A LOT. By "printing money," we mean that the Federal Reserve buys Treasury bonds from the market in exchange of dollars. The Fed credits bank accounts electronically. We are talking about computerized entries into the Federal Reserves ledger. The Fed literally types in an addition of X billion or Y trillion dollars into its balance sheet, creating dollars out of thin air that exist as zeroes and ones on a computer server, and then use those new dollars to purchase US Treasury bonds. In this way, by INFLATING the supply of dollars, the Fed devaluates the Dollar. It has debased the US dollar by roughly one half the total GDP in less than four years.
But why are not the prices out of control in the USA yet, despite the Fed having increased the money supply by several trillion dollars?
First, a lot of inflation (US dollars) went to China.
Second, the VELOCITY of money is very low now. Velocity is the turnover of money, how quickly money turns over: do I take it and spend it, or do I stick it in the bank.
The Fed can increase or decrease the money supply, but it can not control how it is being spent or saved.
Well, if I take my friends out to dinner and you know, the restaurant owner uses the money to buy some new equipment or whatever, that money starts to have velocity, which means its getting used; but if I take it and stick it in the bank, or if I take it and buy gold, that money has a velocity of zero because its not being used.
The Fed can not control how money is being spent. It's behavioral, it depends on how I feel and how you feel and how everybody feels. And frozen money does not affect prices.
The government has to affect behavior in order to control the velocity of money, which means they have to make the people worry about inflation, or scare you into spending your money. They think that by holding "interest rates" low, they can encourage inflation. And they bet on the people, spooked by inflation, will get out and buy cars or houses before the prices go up. The US government also tries to increase "lending" because it wants to get inflation ABOVE the interest rates. If borrowing rates are two percent and inflation is four percent, thats a NEGATIVE interest rate. Which means that you can pay back the loan in cheaper money. So its actually not only a low interest rate, its FREE MONEY. The bank is PAYING you to borrow because you can pay them back in cheaper dollars, in dollars of lesser purchasing power.
And that is precicely what is happening. The US and many other countries want to do pay back their debt in a severely devalued currency. It's called "monetizing" the debt.
They're doing so by cutting interest rates to near zero, and by printing money. Printing money de facto creates negative interest rates because the value of the dollar is eroded by this inflation of the money supply.
In this world of negative interest rates, we need to FIGHT inflation, in order to preserve our wealth. If you put your money in a bank at zero or one percent interest rate, and you get 3, 4, 5 percent inflation, the value of your money is going to be cut in half in 15 years. Savers or investors are actually in a difficult position because the Fed is trying to drive the economy off of consumption, rather than investment.
With investment, you get growth when you make the investment. And then you get MORE growth down the road because you improve productivity as a result of that investment. Not so with consumption. Consumption is a one time thing. You buy something, you consume it. But investment pays off year after year, after year.
Higher interest rates encourage people to save. And that attracts investment from around the world. And that can drive growth. But in context of negative interet rates, many savers think they have no choice but to go into the stock market or the property market, which are very risky and volatile assets. They feel they are being forced to spend, to consume, to gamble, rather than to save.
But we the people can RESIST by buying gold or anything of physical value that can not be trashed by massive inflation, in order to store and preserve our wealth.
Because inflation is lethal for a lot of unprepared folks. You need to be prepared. There are winners and losers. The losers are the savers and retirees, people on a pension. They are going to see their wealth erode every year quickly.. The winners are banks, hedge funds, speculators, people who got into gold. Because of that, gold is nowhere near a bubble. People are underinvested in gold. Institutional allocations are anemic. They are investing a lot in stocks, in bonds, in hedge funds and so forth, and a skinny little one percent in gold. If institutions just doubled their allocation from say one-and-a-half percent to say three percent, theres not enough gold in the world at these prices to absorb that kind of inflow. Gold is volatile though. But it preserves your pruchasing power in a world of high inflation and negative interest rate.
Winners will include people who own businesses that can increase their prices to keep up with inflation even in tough economic times.
A chicken farmer would be one such business. The worse the economy gets, the more people will be eating chickens they cook themselves.
The costs to chicken farmers affect all chicken farmers, for example, if feed prices go up, they all will raise their prices.
Any business that can make sales during a depression would be a good business to own, privately, lock stock and barrel. It can produce an income for the owner that will keep up with inflation. Alternatively, an owner that does not need the salary can allow investment gains on the principal invested to stay in the business (i.e., reinvesting them, perhaps setting up more business locations) to defer tax. Some people during the last depression actually quietly made money.
When central banks print additional money, they are diluting the value of each existing unit that is in circulation. It is embezzling of wealth by dilution similar to when the bartender dilutes the booze.
The author notes that when the Chinese manufacturer takes his dollars to the bank to exchange for Yuan and the Chinese central bank prints the money to make the exchange. This is clearly deliberate dilution of fiat money.
The Federal Reserve (and all other fiat central banks) has been doing this exact thing since the day it started printing money. Worker compensation is directly tied to productivity which increases on average at between 2% and 3% per year. If the central bank did not increase the money supply, over time as the economy grew through improved productivity, each money unit would become valuable. This means that the general level of wages and prices would slowly drop even though this did not mean anyone was getting less poor. In fact, everyone would be getting more wealthy. they would be working fewer hours for the same goods.
There are a lot of participants in the economy who prefer the currency to have a stable value over time. So, as the value of the currency units become more valuable due to increased productivity, this gives the central bank a reason and excuse to create additional money in proportion. This dilutes the value of the currency and gives the appearance of a constant value. What has happened is that for every percent the economy grows, the central bank can expand the money supply in exact parallel and the added money is used by government for its purposes. The beauty of this stealth tax is that nobody sees what government is doing.
The scheme of fiat money, when coupled with an income tax on the changes in values of capital goods like land and securities, is the grandest scheme of theft in all human history. When coupled with deficit spending upon the good credit serviced by all future earnings of all citizens, it operates to also place the entire country in debt serfdom from which escape is forbidden. This is identical to when Pharoah purchased his citizens in exchange for food. We have allowed ourselves to be sold into servitude to government in exchange for “benefits” at our own expense, with our own money, income and assets.
But, happily, we can call for a Convention to revoke the authority of the Leviathan State to continue this outrage. We will do so when we realize the existing Federal Government is more a threat to our liberty and well being then what damage a Convention could produce that would also pass ratification of the surviving states.
Not true. The money you put in the bank is usually then lent out to customer to buy the restaurant equipment, etc., and in a highly leveraged way. The money you spent to buy the gold is also recycled into the economy.
The problem is not that -- the problem is that when the economy contracts, businesses have excess capacity and don't need or want to borrow money from that bank. That's why the velocity is so low.
The formula of:
Growth (gross domestic product) = consumption + investment + government spending + net exports
is straight from Keynes. One implication is that government spending of one dollar has the same effect on the GDP as the private sector spending one dollar.
Let me ask: How often does government go to the store and spend one dollar but gets less than one dollar of end-use value? The news is full of stories of government waste, where government pays millions of dollars for stuff that sits rusting in a warehouse because of some bureaucratic mistake.
How many of you go shop to find more than one dollar of value for each dollar you spend?
On balance, private business must gain more than one dollar of value for each dollar it spends. That difference is profit.
But when your economic theory says that one dollar of government spending is just the same as one dollar of spending from the private sector, then a wasteful government project has the same economic effect as a well run project. Digging holes and then filling them up is just as important as building a needed highway bridge. Giving money to Solyndra has the same effect as anything else.
But a key is also that each dollar comes from somewhere. If it was borrowed, the cost of servicing the debt comes from somewhere. And that somewhere is only the private sector, which is using all the dollars it has to make a profit. So, when government takes a dollar from WalMart in taxes, because WalMart makes a 3.47% profit on each dollar, unless government puts that dollar to work in an activity that earns greater than 3.47% profit, we are actually less prosperous, and wealth was actually destroyed by the government, even though the money was spent digging holes and filling them back up.
Austrian economists understand this. Keynesians cannot and don’t want to.
You’re right. I was talking from the perspective of the one who deposits his money in the bank or in his gold stash. From this perspective, the velocity of money is zero. Of course, if the bank use the deposited money to invest or to make loans, then the velocity ain’t zero from their perspective.
I'm not sure it is appropriate to sweat so much about the money that the Fed is 'printing', as long as the velocity of money is so low. The private side has been pulling money out of the economy at a rapid rate (e.g., mortgages are being paid off but few new mortgage loans for new home sales, businesses de-leveraging, etc.) and the Fed is just trying to replace this money to stop us going into a deeper recession. The problem will arise when private business and consumer lending increases, and velocity goes up. Then, the Fed will have to upll that money back very smartly.
The gold standard would stabilize our currency. So woudl abolishing the Fed.
If you put a negative sign in front of the government spending term, the growth equation would be closer to reality.
Hmm. The usual definition of ‘fiat money’ presupposes government issue, along with the inevitable legal tender laws.
In an unregulated situation, which assumes no legal tender laws, a private issuer may create ‘fiat money’ in the sense that there’s nothing to back it up (kinda like government money, come to think of it!).
But this money would be found out, and eventually shunned in the marketplace, by becoming worthless or nearly so, relative to other competing currencies with better reputations.