Dollar danger directly ahead

Saturday, 16 December 2006 Last Wednesday the NYT reported an event that few noticed, but has immense historical significance. The United States Mint, concerned that rising metal prices could lead to widespread recycling of pennies and nickels, has banned melting or exporting them. For those of you not familiar with economic history this probably doesn't mean much to you (hence the lack of public attention). But those of you that are familiar with historical currency exchange controls, this story is as old as empire. The only difference in this case is that historically this involved precious metals. Today the dollar is worth so little that it involves base metals. Until 1982, pennies were made of 95 percent copper. The commodity metal value of one of those coins, which still make up a large percentage of the pennies in circulation, is 2.13 cents, according to the Mint. "Government is the only agency that can take a valuable commodity like paper, slap some ink on it, and make it totally worthless." Ludwig von Mises This past week Treasury Secretary Paulson, Federal Reserve Chief Bernanke, and an entourage of leading American banking figures are all meeting in China. Why? Most likely it has to do with two facts: 1) China holds nearly $1 Trillion in American bonds, and 2) China's central bankers have recently made noises about diversifying away from the dollar. "Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation." - Federal Reserve Chief Ben Bernanke, 2002 The most important thing to understand is what inflation actually is: "In economics, inflation is a fall in the market value or purchasing power of money." Dollar Purchasing Power To put it another way, inflation isn't caused by greedy oil companies, greedy labor unions, or in fact, any supply side developments. What causes inflation in the world today is the fall in the value of the dollars in your pocket, not the rise in value of what you buy. So what causes that? Supply and demand causes that. In other words, too many dollars chasing the same number of goods. The only way in today's world that can happen is if too many dollars get printed and put into circulation. Only one entity can cause that - the Federal Reserve. This isn't a conspiracy theory here. What I just said is Economics 101. "A capitalist will sell you the rope you will hang him with if he can make profit on it." - Lenin Up to this point all the focus on currency levels have been on China. However, it shouldn't be. Attention instead should be focused on the Persian Gulf and what they plan to do. The oil-producers of the middle east have been diversifying their reserves away from the dollar for a couple years now, but as long as their currencies are linked to the dollar and the oil they sell is priced in dollars then no major changes will happen. Counting only the Middle East oil exporters, the surplus has surged from $30 billion in 2002 to an estimated $280 billion this year. One reason why this gets much less attention than the smaller $160 billion increase in China is that only a fraction of it has gone into official reserves, which are publicly reported. Most of it is stashed in government oil-stabilisation or investment funds, such as the Abu Dhabi Investment Authority, which are much more secretive than the People's Bank of China—but which probably hold just as many dollar assets. Since September 2005 the Chinese have been gradually loosening their currency peg to the dollar. It hasn't happened quickly enough for many American politicians, which is why our banking leaders are in China. What doesn't get reported is that all six members of the Gulf Co-operation Council, or GCC (Saudi Arabia, United Arab Emirates, Kuwait, Bahrain, Oman and Qatar) still peg their currencies firmly to the dollar. Yet there is absolutely no outcry from American politicians and industry leaders for them to remove those pegs. Why is that? The fact is that those oil producing nations simply don't have the domestic infrastructure to handle such massive current account surpluses. That means they have to recycle that money back into American debt. "You have meddled with the primal forces of nature, Mr. Beale, and I won't have it. Is that clear? You think you've merely stopped a business deal? That is not the case. The Arabs have taken billions of dollars out of this country, and now they must put it back. It is ebb and flow, tidal gravity. It is ecological balance. You are an old man who thinks in terms of nations and peoples. There are no nations; there are no peoples. There are no Russians. There are no Arabs. There are no third worlds. There is no West. There is only one holistic system of systems; one vast, interwoven, interacting, multivaried, multinational dominion of dollars." - Arthur Jensen, from the movie Network To manage these currency pegs the middle east (like China) has had to maintain artificially low interest rates and massive printing of local currency. This has led to an outrageous real estate bubble (like China) in places like Dubai. All this cheap and easy money has also led to price inflation (like China). And with all those dollars flooding back into America, this has led to lots of cheap and easy credit which has also flooded into real estate. In order to "manage inflation", these gulf nations have done what every government has tried to do - managing inflation expectations. Official price indices almost certainly understate inflation. According to government figures, prices are rising in the UAE at an annual rate of 7%, but independent estimates put it at 15%. But now that is approaching an end. These gulf nations have another plan - a common currency. The six-member Gulf Cooperation Council countries are committed to issue the GCC common currency in the year 2010, Finance Minister Dr. Ibrahim Al-Assaf stated yesterday. According to a study, the new currency will be the world’s most important currency union after the euro. Once established, the GCC leadership may decide to invoice their hydrocarbon sales in the new common currency, moving away from the current dollar pricing system. It could also become the reserve currency of choice for Islamic and Arab central banks for a combination of religious and political reasons. To put it simply, once the GCC has a currency union they will no longer need to peg their currencies to the dollar, nor keep their currency reserves in dollars, nor recycle their trade surpluses into American debt. This will drastically reduce the demand for dollars around the world. Until recently, every nation had to buy dollars in order to buy oil on the world markets, thus making a worldwide demand for dollars. Russia, another major oil producer, has already diversified their currency reserves out of dollars, and created an oil Bourse that is priced in Rubles. Venezuela is making moves to price their oil in Euros. However, one thing won't change - we will still have to buy mid-east oil. But if they no longer need our dollars what will we be able to buy their oil with, especially if they are selling it in a currency other than dollars? We would need create a currency reserve of other nation's currencies (like every other country does) in order to buy the oil. But how can we build up this reserve if we don't sell things to the rest of the world that they want? Gold used to function this way, which brings us back to the ban on exporting pennies. A brief history of paper money "It is well that the people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning." -Henry Ford If you want to read a more complete history of money, please see this diary. When China went to paper money in 1131 A.D. they outlawed all redemption rights into metal coins. Three decades later that paper money was worthless. The Mongols who conquered China then issued their own fiat money. Gold, silver, and gems were forbidden from being sold except to the emperor. The Mongol's money vanished in a wave of hyperinflation a few decades later. John Law was the first westerner to try shifting his country to unbacked fiat currency. That experiment ended in less than a decade after hyperinflation left the paper money worthless. But before that happened laws were passed in France that anyone holding gold and silver would be thrown in jail. It has been a common tactic in history for the government to outlaw real money so that it doesn't compete with their fiat money. It has never once worked, but they keep trying. Is that what our government is doing today? No. But then we aren't even talking about precious metals. We are talking about restrictions on base metals. I don't recall any time in all of history that a government has moved to protect their base metal currency. That should make you pause and think about the paper in your pocket. "It’s dishonor, sir. This great government, strong in gold, is breaking its promises to pay gold to widows and orphans to whom it has sold government bonds with a pledge to pay gold coin of the present standard of value. It is breaking its promise to redeem its paper money in gold coin of the present standard of value. It’s dishonor, sir." - Senator Carter Glass, 1933 In 1933, FDR outlawed private ownership of gold bullion with Presidential Executive Order 6102. A $100,000 fine could be imposed on anyone violating this law. the internal gold standard that existed in America since the Revolution was ended. Up to this point you could exchange your paper currency for gold at any federal bank. After seizing an unknown amount of gold from private citizens, FDR then devalued the dollar from being worth $20.67 to one troy ounce of Gold to $35.00 to one troy ounce of Gold - or 40.94%. In other words, your dollars immediately became worth 40% less than they were before FDR seized your gold. If you were allowed to hold onto your gold then you wouldn't have cared how much the dollar was devalued because the government couldn't devalue gold. Americans were only allowed to hold gold again when Nixon took the country off of the external gold standard in 1971. "The money power preys upon the nation in times of peace and conspires against it in times of adversity. It is more despotic than monarchy, more insolent than autocracy, more selfish than bureaucracy. I see in the near future a crisis approaching that unnerves me and causes me to tremble for the safety of my country. Corporations have been enthroned, an era of corruption in high places will follow, and the money power of the country will endeavor to prolong its REIGN by working upon the prejudices of the people until the wealth is aggregated in a few hands and the Republic is destroyed." President Abraham Lincoln, 1863 My point is that whenever the government starts putting restrictions on currencies, or on metals, there is reason to be concerned. You should be concerned. Written by Garrett Johnson