Milton Friedman was a proponent of so-called “floating” exchange rates between the various irredeemable paper currencies that he promoted as the proper monetary system. Many have noted that the currencies do not “float”; they sink at differing rates, sometimes one is sinking faster and then another. This article focuses on something else. Under gold, a nation or an individual cannot sustain a deficit forever. A deficit is when one consumes more than one produces. One has a negative cash flow, and eventually one runs out of money. The economy of a household or a national is therefore subject to discipline—sooner or later. Friedman asserted that floating exchange rates would impose the same kind of forces on a nation to balance its exports and imports. He claimed that if a nation ran a deficit, that this would cause its currency to fall in value relative to the other currencies. And this drop would tend to reverse the deficits as the country would find it expensive to import and buyers would find its goods cheap to import. Friedman was wrong.
Ideological deflationists and inflationists alike find themselves both facing the same problem. The former still carry the torch for a vicious deflationary juggernaut sure to overpower the actions of the mightiest central banks on the planet. The latter keep expecting not merely a strong inflation but a breakout of hyperinflation. Neither has occurred, and the question is, why not? The answer is a 'cold' inflation, marked by a steady loss of purchasing power that has progressed through Western economies, not merely over the past few years but over the past decade. Moreover, perhaps it’s also the case that complacency in the face of empirical data (heavily-manipulated, many would argue), support has grown up around ongoing “benign” inflation. If so, Western economies face an unpriced risk now, not from spiraling deflation, nor hyperinflation, but rather from the breakout of a (merely) strong inflation. Surely, this is an outcome that sovereign bond markets and stock markets are completely unprepared for. Indeed, by continually framing the inflation vs. deflation debate in extreme terms, market participants have created a blind spot: the risk of a conventional, but 'hot,' inflation.
On a long enough timeline, all things come to an end. Even for such venerable venues as the London Metals Exchange, with its 130 year history, and its annual turnover of over $11 trillion in metal contracts, which also makes it the largest market for non-ferrous metals. As the English FT reminisces, "When the LME was established in 1877, Britain was one of the world’s most important manufacturing powerhouses, and the LME’s benchmark contracts for delivery in three months were designed to mirror the length of time needed to reach British ports for shipments of copper from Chile and tin from Malaysia." Furthermore, in the beginning, and all the way through 1993, the flagship copper contract was denominated in sterling, at which point it was switched to the USD following the "Black Wednesday" ERM sterling crisis, courtesy of George Soros who made about $1 billion by shorting the GBP, and formally ended the sterling's role as even an informal backup reserve currency. As of today, insult follows inury, as the LME has formally asked the members of the exchange to drop the sterling contract denomination (in addition to USD, EUR, and JPY contracts) and replace it with the Chinese renminbi. Why this sudden and dramatic, if gradual and tacit, admission that the CNY is the ascendent reserve currency? Because, as the FT reminds us, China has become the market for non-ferrous metals: it is "the dominant force in the market, accounting for more than 40 per cent of global demand for most metals and a rapidly increasing share of trading in LME futures." Add that to yesterday's news of a widening in the CNY band (which incidentally is much ado about nothing, at least for now: at best it will allow China to devalue its currency when and if it so desires much faster than before, much to Geithner's final humiliation), and to the previously reported extensive network of bilateral CNY-based trade agreements already kris-crossing Asia, and one can see why if America is not worried about the reserve status of the dollar, it damn well should be.
In the end having a system without rules is not the same as having a system without consequences. It may be hard to figure out the consequences in such a poorly articulated system, but in time the system will tell you.
That is what EMU is finding out and what the rest of the world is discovering as the flaws in the global financial system become more apparent. But we are much better at finding flaws that at finding solutions.
Americans have been listening to the mainstream financial media’s song and dance for around four years now. Every year, the song tells a comforting tale of good ol’ fashioned down home economic recovery with biscuits and gravy. And, every year, more people are left to wonder where this fantastic smorgasbord turnaround is taking place? Two blocks down? The next city over? Or perhaps only the neighborhoods surrounding the offices of CNN, MSNBC, and FOX? Certainly, it’s not spreading like wildfire in our own neck of the woods…Many in the general public are at the very least asking “where is the root of the recovery?” However, what they should really be asking is “where is the trigger for collapse?” Since 2007/2008, I and many other independent economic analysts have outlined numerous possible fiscal weaknesses and warning signs that could bring disaster if allowed to fully develop. What we find to our dismay here in 2012, however, is not one or two of these triggers coming to fruition, but nearly EVERY SINGLE conceivable Achilles’ heel within the foundation of our system raw and ready to snap at a moment’s notice. We are trapped on a river rapid leading to multiple economic disasters, and the only thing left for any sincere analyst to do is to carefully anticipate where the first hits will come from. Four years seems like a long time for global banks and government entities to subdue or postpone a financial breakdown, and an overly optimistic person might suggest that there may never be a sharp downturn in the markets. Couldn’t we simply roll with the tide forever, buoyed by intermittent fiat injections, treasury swaps, and policy shifts? The answer……is no.
In a very thin market, the S&P futures came very close to hitting their 50 DMA on Friday. The S&P futures went from a high of 1,418 on Monday, to trade as low as 1,372 on Friday. A 46 point swing is healthy correction at the very least, if not an ominous warning sign of more problems to come. There were 3 key drivers to the negative price action in stocks this week. All 3 of them will continue to dominant issues next week.
Who will buy our debt in the coming months and years? Europe is saturated with debt and doesn’t have the means to purchase our debt. Japan is a train wreck waiting to happen. China’s customers aren’t buying their crap, so their economic miracle is about to go in reverse. The Federal Reserve cannot buy $1 trillion of Treasury bonds per year forever without creating more speculative bubbles and raging inflation in the things people need to live. The Minsky Moment will be the point when the U.S. Treasury begins having funding problems due to the spiraling debt incurred in financing perpetual government deficits. At this point no buyer will be found to bid at 2% to 3% yields for U.S. Treasuries; consequently, a major sell-off will ensue leading to a sudden and precipitous collapse in market clearing asset prices and a sharp drop in market liquidity. In layman terms that means – the shit will hit the fan. The Federal Reserve and Treasury will be caught in their own web of lies. The only way to attract buyers will be to dramatically increase interest rates. Doing this in a country up to its eyeballs in debt will be suicide. We will abruptly know how it feels to be Greek....The entire financial world is hopelessly entangled by the $700 trillion of derivatives that ensure mass destruction if one of the dominoes falls. This is the reason an otherwise inconsequential country like Greece had to be “saved”.
Even Zhou Xiaochuan, Governor of the mighty People’s Bank of China, is worried....
On Thursday morning, President Hu Jintao of China, President Dmitry Medvedev of Russia , President Dilma Rousseff of Brazil, President Jacob Zuma of South Africa and Prime Minister Manmohan Singh of India shook hands at the start of the one day meeting in New Delhi. Top of the agenda was the creation of the grouping's first institution, a so-called "BRICS Bank" that would fund development projects and infrastructure in developing nations. Less noticed and commented upon is the aspirations of the BRIC nations to become less dependent on the global reserve currency, the dollar and to position their own currencies as internationally traded currencies. The leaders of BRIC nations and other emerging market nations have adopted the idea of conducting trade between the five nations in their own currencies. Two agreements, signed among the development banks of Brazil, Russia, India, China and South Africa, say that local currency loans will be made available for trade between these countries. The five fast growing nations participating in local currency trade will allow participants to diversify their foreign exchange reserves, hedging against the growing risk of a euro or dollar crisis. The BRICS want to have easy convertibility of currency to make it easier to use the real, ruble, rupee, renminbi and rand amongst themselves without having to always use the US dollar. Higher intra-Brics trade, conducted in their own currencies would shield their economies from economic dislocations in the west. Left unsaid so far is the possibility that one of the BRICs or the BRICs in unison might peg the value of their respective currencies to the ultimate store of value and money - gold.
The United States of America (and the rest of the world for that matter) has not fundamentally grown much at all over the last 40 years. We have instead replaced fundamental growth with the illusion of growth brought on by constantly increasing the monetary supply, aka, inflation. But like any good Ponzi scheme, even this one has a limit and investors briefly approached it in 2008. When it looked like our global banking system was going to collapse, investors started dumping everything in site, essentially a de facto rejection of dollar based assets. Alas, this terrible 'fiat' system is finally coming to its' inevitable end. And good riddance at that. The death of fiat money will be the best thing to happen to human freedom and liberty in over 100 years. However, you must realize that the deflation associated with the collapse of the dollar-based fiat monetary system will wipe out decades worth of false asset price growth in a very short time. Think days or months.
A few words on this IMO must watch lecture - Niall Ferguson: Empires on the Edge of Chaos While Fergie is brilliant in his historical analysis, he gets a few niggling points wrong - Which I suspect is in part from having an Anglocentric viewpoint, which leads one to ignore some fairly hushed up (by the MSM) points of the good 'ol US of A, and in part from his rather British nature of believing in above all else, order, honoring of contracts, rule of law, and other quaint genteel notions of civil society.
It appears that these days a EUR1 trillion hot liquidity injection (such as that from the ECB's LTRO 1+2) will buy you about 3 months of breathing room. Then the ostriches have no choice but to pull their head out of the sand, especially in Europe, where after three months of spread tightening, and hence the belief that "all is fixed", things are starting to turn ugly again: sovereign government spreads are beginning to widen, Europe is demanding more money from the IMF (i.e. America, even as the BRIC countries are starting to consider a world without the USD as a reserve currency, and are now forming their own bank) to boost its firewall, strikes are promptly converting to riots, Italian bank stocks are being halted due to rapid moves lower, the LTRO stigma trade is at 2012 wides, in short everything we grew to know and love in Q3 and Q4 of 2011. Ironically, having papered over the symptoms courtesy of fresh new money, the underlying causes were never addressed, and only got worse as the deteriorating European economic data suggests. What is scary, as UBS shows, is that this is just the delayed carryover from 2011! Just like the US which had the benefit of abnormally warm weather to mask a "bounce" in the economy which was never structural, so Europe had a relatively quiet quarter in terms of newsflow. Things are about to change: read the following for why the eye of the hurricane is about to pass over Europe and why this time around there is $1.3 trillion less in firepower to delay the onset of reality.
"Even Wile E. Coyote had to come back down to earth sooner or later", says Charles Biderman, founder of TrimTabs Investment Research. In his opinion, the prices of stocks and bonds - enabled by excessive financialization of our economy and central bank money printing - have been defying gravity for a dangerously long time. If we continue to do all we can to preserve the status quo -- to maintain "phony" asset price levels as Charles calls them -- at best we will restrict overall growth and handicap the economy. The problem isn't so much the unfairness and malinvestment evident in a rigged market. As Charles shrewdly asks: what happens when the market becomes un-rigged? We've never experienced the unwinding of an entirely manipulated financial system, so we can't predict for sure. But at this point, a painful collapse of our markets and loss of the US dollar as the world's reserve currency seem entirely plausible.
Oil as a commodity has always been a highly valuable early warning indicator of economic instability. Every conceivable element of our financial system depends on the price of energy, from fabrication, to production, to shipping, to the consumer’s very ability to travel and make purchases. High energy prices derail healthy economies and completely decimate systems already on the verge of collapse. Oil affects everything. This is why oil markets also tend to be the most misrepresented in the mainstream financial media. With so much at stake over the price of petroleum, and the cost steadily climbing over the past year returning to disastrous levels last seen in 2008, the American public will soon be looking for someone to blame, and you can bet the MSM will do its utmost to ensure that blame is focused in the wrong direction. While there are, indeed, multiple reasons for the current high costs of oil, the primary culprits are obscured by considerable disinformation… The most prominent but false conclusions on the expanding value of oil are centered on assertions that supply is decreasing dramatically, while demand is increasing dramatically. Neither of these claims is true…
American investor (and longtime CM.com member) Erik Townsend has spent the past several years living internationally, with an eye to which countries may be good alternatives if economic crisis and/or Peak Oil start to materially impact life in the US. His main observation as an expat? Through its misguided policies, the US has been exporting inflation to the rest of the world, raising prices all over the globe (as an example, he cites a $57 chicken pot pie from the menu at a 'working class' restaurant in Australia). This inflation is affecting the rest of the world harshly, but is not yet being felt in the US due to our ability to export it as the issuer of the world's reserve currency. Our immunity will not last forever though, and when it ends, a massive upwards spike in prices is going to hit US markets.