The Money Printers
This weekend, I started Currency Wars: The Making of the Next Global Crisis by James Rickards. Rickards is an investment banker and is tied into the U.S. financial and defense circles so he is well positioned to understand the international monetary and financial system. It is a good read (so far) but one section really opened my eyes to not only the interconnectedness of it all but how the world financial system is a self-perpetuating mise-en-abyme of debt creation.
This is the scenario:
As part of its strategy to spur growth and especially employment (made altogether more urgent after the Tiananmen uprising in 1989), China embarked on a program whereby its abundant labour could be made available to the world. As part of this, it pegged its currency to the U.S. dollar. As of 1997, the yuan was pegged at 8.28 to the dollar and China’s GDP growth more than doubled in the 1990s.
Meanwhile, in the U.S. financial deregluation and ultra low interests rates fuelled bubblenomics. The tech bubble bursting and, later, 911 and the ensuing war on terror… coupled with Chinese growth… kept the U.S. Federal Reserve scared enough to keep rates at these low rates. As Rickards adds, Federal Reserve Chairman Alan “Greenspan’s low rates… were also a kind of intravenous drug to Wall Street.” (104) ‘Helicopter Ben’ Bernake arrived at the Fed (first as a governor but then as Greenspan’s replacement), underlining the deflation-fighting low interest rates with a plan for the printing of money to monetize government deficits. The stage was set for the housing bubble and the grand printing of money involving the U.S. Treasury, the Federal Reserve System, Wall Street and Congress. Oh yeah, and let’s not forget China and the many Western corporations taking advantage of extremely poorly paid Chinese workers (as well as the non-existent labour and environmental laws), because here is where it all gets so very interesting:
When a Chinese exporter ships goods abroad and earns dollars or euros, it must hand over those currencies to the People’s Bank of China in exchange for yuan at a rate fixed by the bank. When an exporter needs some dollars or euros to buy foreign materilas or other imports, it can get them, but the PBOC makes only enough dollars or euros available to pay for the imports and no more; the rest is kept by the bank.
The process of absorbing all the surplus dollars… produced a number of unintended consequences. The first problem was that the PBOC did not just take the surplus dollars, but rather purchased them with newly printed yuan. This meant that as the Fed printed dollars and those dollars ended up in China to purchase goods, the PBOC had to print yuan to soak up the suplus. In effect, China had outsourced its monetary policy to the Fed, and as the Fed printed more, the PBOC also printed more in order to maintain the pegged exchange rate.
The second problem was what to do with the newly acquired dollar. The PBOC needed to invest its reserves somewhere… preferring highly liquid government securities issued by the United States Treasury. (106)
And this doesn’t even get at the internal debt financing happening inside China as part of its economic expansion and domestic building spree, nor does really include the Euro Zone. Truly, the global financial system is out of control.
The U.S. Debt Limit; Just More of the Same
Building upon the last post, here is interesting news about the U.S. debt limit:
Obama to Seek $1.2 Trillion Increase in U.S. Debt Limit Dec. 30
http://www.bloomberg.com/news/2011-12-27/obama-to-seek-1-2-trillion-increase-in-u-s-debt-limit-dec-30.html
My favourite line in the article is this:
“Obama may have little difficulty financing a fourth consecutive year of $1 trillion budget deficits after the U.S. government received record demand for its bonds in 2011, pushing longer-maturity Treasuries to their best performance since 1995.”
It’s just so matter-of-fact. The way that governments in the early 21st century pay for its services is simply by selling high-performing debt (translation: by selling the future wealth of its citizens).
I can’t wait to see what happens in three days time.
Peace
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Let’s Play ‘Capitalism’!! The Bizarre World of Western Financial Markets
For me, yesterday was a bizarre day. On the one hand, a BBC interview with a European trader was making its way through the financial blogosphere where the trader basically said he believed a large, global meltdown in the stock markets would happen in the next twelve months and that politicians worldwide are helpless to really do anything as the financial industry (Goldman Sachs) basically rules the world. On the other hand, rumours that the European zone might come up with some ungodly large amount (I heard 2.5 trillion, which is supposedly not enough) to basically insure that the global banking system will not go belly-up.
Of course, and showing their complete disconnection with reality, the stock markets shot up (hey, rumours of band-aid solutions are as good as anything to trade upon I guess).
And then, this morning, markets are already up as much as they were yesterday because the Greek P.M. went begging, telling potential investors (bail-outers) that they would be investing in the ‘new’ Greece. Consequently, clueless media-talking-heads on the radio, TV, and online are confidently gushing and in Canada this is especially worrying since there are a lot of people that believe the country is fundamentally sound and well-run (even though we have a similar debt-to-GDP ratio as many other countries, governments cannot balance the books (even in Alberta), and most people are themselves over-leveraged).
All this tells me just how much we rely on wishful thinking and good news… and just how much economic activity is based on small amounts of poor quality information. It also shows to me that we have no idea what ‘capitalism’ and ‘free-market economy’ even mean anymore. Let’s survey the situation. Western governments everywhere are living completely beyond their means and when you include future liabilities like health care and pensions, we are essentially bankrupt. The financial/banking system, which is on the hook for billions because of bad loans to governments, has also created an unregulated, derivatives market that is basically one giant casino… except this one deals in the hundreds of trillions (with a ‘T’) of dollars. If this system is not bailed-out by taxpayers world-wide, it will fall in on itself, taking with it the savings and investments and pensions of millions of people across the globe. This system fits the definition of a Ponzi scheme to a ‘T’ (which is of course measured in trillions).
So, for the Western system to continue, we need to have further bailouts… that is, on top of the bailouts of three years ago. And then you have to think of all of the quantitative easings (basically, injecting more monopoly-money into the financial system and stock markets). And, of course, there are all of the government loan-guarantees that are given out regularly (this morning, the promised loan-guarantee for the asbestos industry in Canada is in the news). Oh, and then there are the subsidies and tax-breaks for massive industries ranging from petroleum to agriculture to biotech. And, then there are those industries–communications, aerospace, weapons, defense, etc.–that are dependent upon government spending for the majority of their annual sales. When you add it all up, it seems we capitalists are indeed socialists… or corporate-socialists. (Hmmm… isn’t that partly the definition of fascism?)
At any rate, that pretty much sums up the world economy. I do see more capitalism and competitive markets around me but these are mostly restricted to local, small businesses and entrepreneurs. Anything on a larger scale (where one can afford lobbyists) seems to feed almost entirely from the public trough of make-believe money and the future wealth of taxpayers.
Peace.
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What Does the U.S. Downgrade Mean?
It will be interesting to see what happens on the various stock indexes tomorrow. Asian markets (which opened 8pm EST today) were down and futures for the exchanges are all off. Others are worried but many in the U.S. government and financial establishment are blaming S&P or saying its numbers are off or saying it doesn’t matter because other (major Western) debt rating agencies still have the U.S. at AAA. Some say it will not have long-term effects and others are worried about contagion or market meltdowns and what this will do to already flagging Western economies and the still-emerging emerging economies.
From my (humble) perspective, this is what is going down:
The S&P downgrade might be somewhat flawed and comes from a flawed institution, but it is spot on and much too late.
This is, in itself, not going to be disastrous and completely crash an already declining system. It might get ugly but it has to happen. Bubbles need to deflate and right now there is much too much monopoly money in the system simply because Western governments are terrified of their populations realizing that their lifestyle is unsustainable and so have been (with the complicity of the financial system) pumping trillions into the financial system, and preventing losses from being counted. That is why we don’t really have a capitalistic, free market system today because the financial systems (that which is usually but falsely referred to as ‘the market’) and politicians have colluded to keep a ‘too big to fail’ and corrupt system afloat. Anyway, that is why S&P’s downgrade is overdue (but let’s not hope it is too late to fix the system). And that is also why S&P’s downgrade will NOT be the cause of further financial decline… because the system is already gaining momentum downward… it is already in decline.
Yes, there are other (Western) ratings agencies that are still maintaining that U.S. government debt is AAA, but it is they who are mistaken… or, more likely, are too afraid to also admit that the emperor just might not be wearing any clothes. (So, again, hats off to S&P for finally waking up.)
As well, S&P should not be blamed here or vilified. It seems clear that the markets were beginning to price in the next, anticipated round of quantitative easing by the U.S. federal reserve and bailouts of the banking systems (who, after all, are the ones loaning billions of dollars to countries like Greece and Ireland and the rest of the PIIGS). That is, the market was confident that the financial and banking system would be bailed out yet again by governments/taxpayers and therefore the market exuberance that has brought stock markets high again after the 2008 collapse was beginning to build once even more. Essentially, this is classic market distortion and on a huge scale. Thankfully, S&P’s downgrade seems to be one event that caused at least a little bit of reality to set in.
Sure, the U.S. economy is not a basket case and it could still pay its bills. But the era of American Exceptionalism has ended. The U.S. economy has been hollowed out, its financial system is rotten to the core (and I am not exaggerating here… just look into the whole murky world of financial derivatives) and what we are witnessing is the end of the American Empire. So, what the S&P downgrade means is that it will become increasingly difficult for the U.S. to service its debt, maintain spending (to maintain its position in the world), and maintain the standard of living that most U.S. citizens aspire to. The U.S. is now AA+ and will probably be downgraded further. What this means is that buying U.S. treasuries will become less desirable as will the U.S. dollar.
Leave it to Zero Hedge to quickly sift through the opinion/information out there when trying to make sense of this. The following quote comes from QBAMCO’s Paul Brodsky and Lee Quaintance, courtesy of ZH) and lucidly identifies what the downgrade means:
The stark difference separating nominal return of principal and interest from the return of inflation-adjusted principal and interest for holders of US Treasury obligations is the critical issue. The necessity to manufacture more money to service and repay existing Treasury debt suggests substantial diminution of the purchasing power of existing US dollars in which Treasury interest and principal have to be repaid. We believe unlevered holders of Treasury obligations are locking-in negatve real interest rates and levered holders of longer duration Treasury obligations are at great risk of capital loss in real terms.
What they are saying is that by purchasing U.S. treasuries one would be losing money because the U.S. government would–in the future–pay back the principle and interest in weakened, future U.S. dollars… and that is because the U.S. has to print money to pay its debt and will have to print even more in the future (since it seems incapable of dealing with its problems). Describe this any way you want but the U.S. dollar is a bad investment that will only get worse.
What the ridiculous ‘debt-ceiling debate’ did was pretty much cement in many people’s minds that the U.S. political system is corrupt and incompetent. It is a fascinating political system but it is ruled by political ideology and corrupting corporate interests… which means it has no seeming capacity to solve actual problems. I watched some of the Sunday morning political shows today and it is strange how the pundits and politicians seem to be walking around in another reality. The spell of American Exceptionalism/Empire is very strong and most inside that system just cannot get a grasp of anything else. Call it what you want: the blue pill (or is it the red pill?), the koolaid, spectacle, the ideology of empire, but the ideal/illusion that has fed the American Dream is for some all-encompassing and continues to colour the perceptions of many inside that system.
China and other emerging markets/economies will certainly be affected… because they already have been affected. But imagine what this means. The U.S. consumes an enormous amount of resources and commodities. The U.S. military spends slightly more than all of the rest of the world combined. It is the U.S., along with other Western nations, that keeps the emerging markets humming. China could not survive without the U.S. current rate of consumption… that is why they have been buying so much U.S. debt. But they will be paid is the future U.S. dollar that will be worth much less than it is now and the flood of printed U.S. monopoly money also creates inflation in those countries buying the debt too (kind of a double whammy… and that is why so many countries are actively trying to devalue their currencies too). So, when Vladimir Putin said today or yesterday that the U.S. is basically a parasite living off of other countries, he was partly right. IN fact, it is a fascinating, abstracted form of economic exploitation.
At any rate, tomorrow will be interesting. I unfortunately will be preoccupied for most of the day so I will not be able to follow the goings-on very closely but what is of real consequence is not whether North American markets will take a beating but the near future and whether politicians and policy makers can get their act together enough to steer us through this mess. (My bet is that they will do nothing but jockey for political position and hand over more wealth to the financial system that got us in this mess in the first place… god help us all.)
Peace.
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Telling it like it is… for a change
Well, the conversosphere is atwitter with the fact that the U.S.A. was just downgraded from Triple-A to a mere AA+. Even though there seems to be little to separate the two, it’s more than symbolic. Certain investment instruments only allow for fixed percentages of ratings levels for its investments. So, this will have an effect of things. But more important–to my mind at least–is it forces some reality to creep into our lives for a change. I don’t have much respect for the ratings agencies–insiders with tremendous amounts of conflict of interest with respect to the financial and economic systems they are supposed to rate or grade–but I have to tip my hat at S&Ps’ description of the current political-fiscal situation that the U.S. is both in and slowly cluing into:
The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year’s wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.
The financial press was reporting of ‘persistent rumours,’ that S&P would not ‘comment upon,’ about how the ratings agency would actually downgrade the U.S. financial rating and it seemed pretty obvious that it would happen. But I was a little shocked at the frank and sober language used. Hopefully, this will force more politicians to clue into the desperate situation that the U.S. (and the West more generally) is actually in.
Peace.
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