Sunday, November 23, 2008

The Return of Bretton Woods

I believe it might be escaping all of us why the US cannot deflate without deflating the world. There is a lot more than trade deficits, bonds, interest rates and connects or disconnects involved here. There is the existence of currency worldwide at stake, something that could be possibly eluding all involved in speculation as to what each country might do. It appears to me that the nature of Bretton Woods is not only intact, but in full force.

For all those that are confused, what would make a dominant power like the United States totally lose its productive industry, especially when looking at the power of its financial structure and its domestic resources? One couldn't point to the behavior of the people, as the US gained economic prominence in the early 1900's with 8 million drug adicts and an alcohol problem so bad that it was banned in the 1910's. At the same time, what causes the world to bend over backwards to finance their exports to the United States and when these exports fall, their economies come to a screeching halt? The entire game defies logic.

What is going on when an economy like Russia goes from claiming over $1 trillion in foreign reserves to sweating default in a matter of a few months? The entire world has been made flush in cash only to suddenly be short of it. The whole idea of the matter makes one sit up and wonder what is going on.

Because none of us are educated in the international creation of money, it may be something that needs to be figured out by observation. I am sure someone in this world knows what is happening here or the system wouldn't be set up the way it is set up, but then again are the people that know the people that are running the game?

Here is what I propose is happening and has happened since 1944. Bretton Woods was set up to allow for the fixed exchange of currencies around the world with the reserve currency, the dollar, being exchangable at $35 an ounce in gold. What this did is put the onus on the United States after the world had recovered from the war, to keep producing money for the world. Once the French decided they would be better off making a run on the gold behind the dollar than holding dollars, that system fell apart and was replaced with a floating system. What wasn't replaced was what collateralized the money around the world, the dollar. Thus the game switched from hard money to strictly bank credit. The dollar had been exchangable on an international trade basis at $35 an ounce since FDR effected devaluation in 1933. Prior, the dollar was gold and silver and only represented by currencies. For those that don't understand, the gold was the money, the currency the receipt or note.

I believe it is beyond theory that once all money in circulation becomes bank credit, the only real purchasing power in the economy comes from new money being created and the failure to create new money greatly diminished purchasing power for goods and services. The old money is used to collateralize what collateralizes it, assets. Thus the more money piles up, the greater the asset base. But this game comes with a penalty, that the supply of money and the weight of interest grow faster than the economy as a whole and eventually the engine that supplies the power becomes too small to propel itself forward. In the old days, it was never the money supply that imploded, but the credit system that was representative of the money supply. In the current sense, there is no money supply, as the real property of the world is now the money and the credit the recepits for it. This gives the dollar more credence because the US is one of the places around the world where real property is property and can be owned outright subject only to taxes and liens and in some cases use restrictions.

Here is my theory and it explains why the talk of the Chinese or Japanese are going to sell their US Treasuries, that the dollar is going to zero and all the other crap is not only wrong, but so far in error that nothing could be farther from the truth. It is far from the truth because the world set sail on the dollar back in 1944 and there isn't a lifeboat sufficient to get off the dollar. The European market would like to believe they could do it with their new currency, but truth be known, this currency needs the flow of dollars for collateral and should they attempt an exit, they would find money to back their exit lacking. In short, the world money supply is created by the Federal Reserve of the United States.

You might note how many emerging markets tied their currencies to the dollar in an effort to ride the game. The ones that weren't in shape to attract export business, like Argentina, ran into deep trouble, but those that succeeded in attraction export business like China, prospered. The stability allowed them to mirror the US without the liabiity of being the US. This game works as long as a country can continue to attract dollars in sufficient amounts to allow their own banking system to work.

There are 2 examples of what happens when the amounts aren't sufficient that come to mind, Japan and Argentina. In the case of Argentina, the export business never developed and they used their anchor as so many consumers in the US use it, as an advantage to consume. In the case of Japan, they used inflows to develop internal bubbles in real estate and banking and when the US slowed down after 1990, their bubbles broke. The inflows of dollars haven't been sufficient since for the reflation of the system, as their own system can't reflate what is not actually based on its own value. The Japanese banking system, to the surprise of many of you, may be totally supported by their supply of American dollars. Its bank credit is supported by domestic collateral, but the yen itself is not. Thus the capacity of the domestic central bank has to be able to expand at an exponential rate or the system runs into trouble. In this case, the US cannot slow down or the rest of the world collapses.

This is why they never sell the bonds. The dollar and its collateral are the only chairs available for other currencies. It is also why the US is stuck in an ever ending system of expanding debt and diminishing output. The US can't quit consuming because there is really no exchange that can be made to create the currencies the rest of the world need. In fact, not a country in the world is really interested in collateralizing their own currencies because it would expose them to the same financial looting that has wiped out the US. Most of them would have to give up their industrial growth and face the prospect that their major industries take on the look of General Motors. Plus, few could stand the continued drain that goes with supporting their money with their own assets.

Here is the rub of it. The world is addicted to US trade deficits in the $500 billion range and the US consumer has finally run out of its capacity to take on more debt. No more than the rest of the world can get off its credit collateral, neither can the US. We are stuck in an end game situation and the result of this end game is clearly the shrinking value of assets we are seeing around the world. Remember, the existing money isn't here to spend so much as it is to value the assets in the market place. So we have 3 problems to support, debt devaluation, economic growth and asset return support. In order to keep the game going, more than enough money has to be borrowed into existence to keep the majority of debt being serviced, so the system can at least claim current solvency. The assets have to have enough return to justify their prices and allow for the support of the collateral values attached to them.

If you take China, for instance, in order that their economy expand 5%, they need to expand the monetary base by 5%, plus they need enough extra money to pay the return on the money already in existance along with the stream of income to the investments made around the country. Some of this money recycles back through the economy, but most of it accumulates. If they need to encourage loan solvency as well, they will need even more money. This means they need to attract enough dollars to expand their monetary reserves by maybe as much as 15% or more in order to run in place. To do less would expose the economy to deflationary forces that threatened the value of the asset base of the country and the capacity of the system to pay its debts. I am sure this is behind them not wanting to let the yuan appreciate, as this would lessen the number of new yuan they could issue.

One might recall what occurred in Japan in the late 1980's. For one, the yen apprecited to the point that I believe they could only issue about 90 new yen for every dollar they got in trade. This was down from 200 earlier in the decade and 300 in the 1970's. The yen was definitely deflating and their asset bubble was inflating as money flowed to Japan to take advantage of appreciating currency and rising asset prices in stocks and real estate. Japan started buying sizable investments in the US as well, when the US caught cold from its own financial problems and its incapacity to generate enough new credit to pay the high interest rates of the Volker Federal Reserve regime.

As strange as this may seem, the trade deficit of the US cannot be balanced and the US cannot be treated as a normal debtor nation. People over and over again differentiate Japan from the US by saying Japan was a creditor nation but not the US. What they miss is that the US owes Japan its entire monetary base, which means that if the US paid Japan off, Japan would need to find something else to use as money. Thus the Japanese economy would literally cease to exist.

Truthfully the only way the US can solve this problem is to allow consumers to pay down their debt load, if this actually could be accomplished. The problem with this is that to do so would deflate every country in the world, as the US consumer would have to earn back what the rest of the world is using as money. This would of course cause the collapse of banks around the world.

I am going to develop this idea forward, but I do know enough to know that the outline of the system is as I described it, that there is little chance the Chinese or any other outfit sells off their US bonds and for that matter, that the oil producers leave the dollar, as to do so would immediately collapse their business and the world economy. Of course, if they should wish to bring down the west, this would go a long way to doing it.


Steve D said...


Thank you for these wonderful posts. I look forward to reading more.


Lenin said...

Please espouse more on this topic. I have read it about 4 times and still find very hard to grasp how US $ serves as world’s collateral for global money supply. Although, I intuitively know that your theory is correct, I just can’t reconcile how it works.

mannfm11 said...

quite interesting Lenin. Basically, Bretton Woods started this mess and due to necessity, it never stopped. The US went off the gold conversion standard in the early 1970's out of necessity, but this never stopped the use of dollars to collateralize currencies around the world. In fact, most emerging market countries either had to have dollars or they were out of luck. My point is that I believe the savings rate for China revolves around the hoarding of dollars as collateral for Chinese money, thus the recycling dollars are appeared to be saved while in fact they only lie there because they have been duplicated. Thus, you could take $100 billion in American money and swap $100 billion worth of Yuan, allowing for the Yuan to be spent domestically. The fact that there was $100 billion there might be evidence it was saved, but it might also only be evidence it was received in the country. The fact that it is immediately returned to the US as credit does not allow it to be spent. We are going to find that the BRIC countries without expanding amounts of dollars from exports and investment are incapable of supporting their own banking systems. Russia is already in full collapse.

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