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President Bush,
Senators Miller & Chambliss,
Congressman Linder,
Other Members of the Georgia Congressional Delegation,
Other Members of Congress,
The excerpts below are from an article by Reginald H. Howe titled Déjà vu: Central Banks at the Abyss. It was posted on www.goldensextant.com on December 7, 2004. Mr. Howe's article includes excerpts from a June 2004 speech given at the London Bullion Market Association in Moscow. The speaker was Mr. Oleg V. Mozhaiskov, Russia's top central banker.
This is followed by a Kurt Richebacher Daily Reckoning article published on December 9th, 2004. My additional comments follow at the very end.
Please take a few moments to read these several pages. They may help you comprehend the gravity of our financial position and your diminishing ability to mitigate it.
Sincerely,
Wes Alexander
Reginald Howe - At the spring meeting of the London Bullion Market Association held in Moscow on June 3-4, 2004, the Deputy Chairman of the Bank of Russia delivered an extraordinary speech that has recently been posted at the Gold Anti-Trust Action Committee's website.
Oleg Mozhaiskov - Now the time has come to admit that investment demand was, and still is, the main driving force behind price fluctuations on the gold market. The changing character of demand heavily depends on what is going on in the international foreign currency and financial markets.
The investors pay continuous attention firstly to the dollar rate of exchange and secondly to the level of interest rates for financial assets. The volatility of these indicators directly influences the investors' interest in gold.
I would also like to note that recently the central banks have been playing a significant role in the gold market. Low interest rates in the money markets and revaluation of gold reserves in line with lower market prices have exacerbated the problem of the financial efficiency of gold stock management. To earn some income on the stock and compensate for "book losses" caused by its revaluation, a number of central banks have started to place a part of their reserves into deposits with commercial institutions -- leasing operations.
The present state of the gold market and its future cannot be analyzed in isolation from the problems of the international monetary system.
Some people may question this conclusion because of the incompatibility of the present volumes in the respective gold and foreign currency markets. I would suggest that the volumes do not matter for this particular purpose. The modern monetary system, although undoubtedly robust and long-standing, in fact has a number of flaws and weaknesses.
This disconcerting phenomenon occurs because, by taking gold out of international payments turnover, people are undermining payment discipline. The discipline I have in mind is at a macro-level; that is, the discipline of rich industrial countries whose convertible currencies have taken the role of an international trade medium by virtue of their economic strength and have been accepted by the world community as reserve units of payment.
Although there are several reserve currencies, the blatant lack of discipline is demonstrated by the U.S. dollar. I am leaving aside the main aspects of this problem, such as the social and economic injustice of a world order that allows the richest country in the world to live in debt, undermining the vital interests of other countries and peoples. What is important for us today is another aspect, which is connected with the responsibility of the state issuing the reserve currency and for the international community preserving that currency's buying power.
Given the actual behavior of the dollar on the foreign exchange markets, the problem could be more accurately termed the irresponsibility of the U.S. government in relation to the market valuation of its currency in international circulation.
Today the net debt owed by the United States to the outside world is in the region of US$3 trillion. To understand the scale of this figure, let me remind you that it exceeds the total official currency reserves in all the world's countries (including the United States itself). According to the International Monetary Fund statistics at last year-end, the world pool of foreign currency reserves totaled Special Drawing Rights 2,013 billion or about US$2,800 billion. The volume of cash only available outside the United States totals about US$400 billion.
The world has come to a paradoxical situation in which the creditor countries are more concerned with the fate of the dollar than the U.S. authorities themselves are.
Thus, the evolution of the U.S. dollar's reserve role in recent years has given ground to some quite pessimistic forecasts, based on rational economic theory. No wonder that the number of people who have held assets in dollars and now wish to diversify them partly into gold -- the traditional shelter from inflation and political adversity -- is steadily growing.
Reginald Howe - Just as war is too important to be left to generals, money is too important to be left to economists, even when they are anointed as central bankers. Too often, however, higher political authorities also show poor judgment or lack of wisdom in dealing with these important matters. Fortunately, the doctrine of mutual assured destruction has so far managed to restrain generals, statesmen, politicians and even dictators from launching a disastrous nuclear conflict. But in the international economic and financial arena, essentially the same doctrine now operates to produce dangerous instability.
Absent worldwide paper money wholly unchained from the discipline of gold, the twin deficits of the United States that lie at the heart of today's global economy could not exist. But as it is, the U.S. Federal Reserve facilitates the creation of unlimited amounts of purely debt-based liquidity to support the American economy while foreign central banks accumulate huge amounts of U.S. paper to support the exports of their own economies to the United States. A reduction or even slowing of the debt buildup on either side threatens the economies and prosperity of all, yet there is widespread agreement that the process is unsustainable and must at some point end.
Charged with improving the operation of the classical gold standard, the central banks have degenerated into producers of MAD money. In the process, they have financed the new American empire, which despite its almost unchallengeable military power stands virtually defenseless to a global loss of confidence -- spontaneous or engineered -- in the U.S. dollar, the principal reserve currency in the MAD money system. When it collapses, as have all prior experiments with unlimited paper money, neither that empire nor the central banks that invested too heavily in it are likely to survive in anything close to their present form. And though gold prices soar beyond their wildest dreams, gold bugs will not escape the nightmarish world thus unleashed.
Exactly when the American republic became the American empire is a matter for historians to debate, but there can be little doubt that the American victory over Japan in World War II and the postwar security and economic arrangements between the two nations played a crucial role. Under the American military and nuclear umbrella, the land of the rising sun developed the export-oriented model for economic growth subsequently followed by most of its Asian neighbors and now the main generator of MAD money.
In the political as in the physical universe, a rising sun must eventually set. Rome fell. The sun has long since set on the British Empire. In historical perspective, the late Soviet Union disappeared with the rapidity of a shooting star, testimony to the folly of erecting an economy on the principle that markets do not work and cannot be trusted. Setting national stars have no guaranteed tomorrows. They almost always flame out amidst chronic currency debasement and depreciation
Ludwig von Mises in A Theory of Money and Credit, Ch. 21 (1952):
It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of rights. The demand for constitutional guarantees and for bills of rights was a reaction against arbitrary rule and the nonobservance of old customs by kings. The postulate of sound money was first brought up as a response to the princely practice of debasing the coinage. It was later carefully elaborated and perfected in the age which--through the experience of the American continental currency, the paper money of the French Revolution and the British restriction period--had learned what a government can do to a nation's currency system.
A NEW ILLUSION: THE FALLING DOLLAR
By Dr. Kurt Richebächer
In his recent speech in Berlin, Greenspan was amazingly frank about the "increasingly less tenable U.S. current account deficit," suggesting that foreign investors would eventually reach a limit in their desire to finance the deficit and diversify into other currencies or demand higher U.S. interest rates.
In essence, he expressed the new consensus view in America that the dollar has to bear the brunt of reducing the U.S. current account deficit. Clearly, American policymakers want a lower dollar, apparently entertaining strong hopes that this will take care of the U.S. trade deficit, and we suspect that they regard it as an easy solution for this problem.
We doubt first of all that it is a solution at all. Such expectations essentially presuppose that an overvalued dollar is the main cause of the U.S. trade deficit. This is bogus. By the measure of purchasing power, the dollar was hardly out of line with the currencies of other industrialized countries.
The favorite American explanation for the huge and growing trade deficit is the U.S. economy's superior growth performance and lacking foreign demand. But the Chinese economy is growing much faster than the U.S. economy yet has a big trade surplus. So had Japan in the late 1980s, and so had Germany in the decades to the late 1970s
This explanation of the trade deficit with superior U.S. GDP growth is another illusion among many others. What crucially matters for a country's trade balance is not its economy's growth rate, but its internal resource allocation between consumption and investment. High rates of saving and investment make for a strong trade balance, while high rates of consumption make for a weak trade balance. America's unusually poor trade performance reflects extremely poor rates of saving and investment. Overconsuming and undersaving America lacks the necessary capital stock to increase its exports.
These observations essentially raise the question of whether or not the falling dollar is prone to rebalance the U.S. economy's foreign trade. It is argued that the dollar's slide did a great job slashing the U.S. trade deficit from 1989-1993. This is true, but was it really the falling dollar that did it? It actually happened against the backdrop of a sharp slowdown in credit growth and a recession in 1991.
During the four years 1989-93, total credit in the United States - financial and nonfinancial - grew by a cumulative $3,255 billion, or $819 billion per year. In flagrant contrast, during the four years to mid-2004, overall credit grew virtually three times as fast, by $2.4 trillion per year, and there is no letup in sight. Drawing on past experience, a fall of the dollar, however steep, will hardly make a dent in the trade deficit by itself.
Lowering the trade deficit first requires a lowering of domestic demand growth, and a drastic shift in resource allocation away from consumption and toward investment in the longer run. A mere fall of the dollar is definitely no solution. Yet we very much doubt that policymakers in Washington have the slightest intention to implement or foster the necessary changes in demand and resource allocation with policy measures.
What about the risks for the dollar and the markets? In short, they are frightening. The most frightening risk is that the dollar's fall gets out of control. Superficially, the dollar's steep fall in the 1980s and '90s may seem encouraging in this respect.
However, there is something that makes all the difference between then and now. When the dollar's decline started in 1985, dollar assets held by foreigners were close to zero. This time, they are close to $9,000 billion, one-third of which is held by central banks.
The dollar's further behavior will largely depend on the flow of news about the U.S. economy. Bad economic news is bad for the dollar. For the reasons explained earlier, we expect very bad news that will shatter the hollow optimism about the economy and the stock market. While economic growth is sharply decelerating, inflation is accelerating, a main reason for this being an accelerating rise in import prices.
In such circumstances, the Fed will face a Catch-22. With CPI inflation above 3% at annual rate and a falling dollar, a new easing of monetary policy is absolutely impossible. Rather, the market will expect the Fed to continue its rate hikes. But doing so, it would prick the carry trade bubble in bonds with disastrous effects, first on the bond market and then on the economy.
A steeper fall of the dollar, just by itself, might please U.S. policymakers. Unfortunately, it is bound to have a variety of harmful effects - in particular on psychology, inflation rates and interest rates. It may finally dawn on people that due to the horrendous magnitude of the existing imbalances, the development in the economy and the markets is out of control.
After many months of stability during 2004, the dollar has turned south all of a sudden. Observing the U.S. economy's deteriorating performance since early this year, its protracted stability surprised us. Now its sudden slide perfectly concurs with our dismal expectations for the U.S. economy in 2005. Yet the abrupt general bearishness of dollar forecasts strikes us as ominous in comparison with the highly bullish consensus growth forecasts for the economy (those for Europe are distinctly bearish).
Let us try to make sense of these contradictions. Over time, we have learned the hard way that two different things govern the behavior of markets: first, the objective facts; and second, the general perception of the facts. They can differ like black and white.
Our opinion about the economic situation in the United States has been and remains diametrically at variance with the optimistic consensus view that discarded the economy's slowdown as a "soft patch" due to the rising oil price. In our view, the economy is rapidly losing steam because prior aggressive monetary and fiscal stimulation has largely spent itself, while having failed to initiate the desired self-sustaining investment recovery. Moreover, we hold a strong opinion that the existing outrageous imbalances and structural dislocations in the economy make a normal, sustainable economic recovery flatly impossible.
Pondering the causes and implications of the dollar's sudden plunge, it ought to be recalled that global currency experts were overwhelmingly forecasting a strong dollar and a weak euro, commensurate with expected strong economic growth in the United States and sluggish economic growth in Europe.
There rules a perception in the markets that the U.S. economy is fundamentally strong and, in addition, vastly superior to that of Europe in resilience and flexibility. All that is sheer nonsense. Due to years of unimaginable credit excesses and resulting monumental imbalances, the U.S. economy is highly vulnerable to a sudden downturn. It is, in fact, in worse shape than in 2000.
U.S. policymakers and economists are hailing the dollar's fall as a boom for exports, employment and profits. They fail to realize that the consumer borrowing and spending excesses of the past few years have grossly depleted the economy of available resources for sharply higher exports. A plummeting dollar does nothing at all to offset the profound structural shortfall of savings and capital formation. Rather, it fuels inflation.
Remarkably, the dollar has plummeted despite highly optimistic expectations about the economy's outlook as reflected in stellar growth forecasts. It is our assumption that increasingly bad economic news will shake this overconfidence and speed up the dollar's decline.
For reasons already explained, we expect that sharply weaker consumer spending will soon distinctly slow the U.S. economy. Two events in particular are putting the brakes on economic growth: first, the full stop of the income creation through tax cuts; and second, the waning of the housing and mortgage refinancing booms.
The risks are frightening.
Regards,
Kurt Richebächer
for The Daily Reckoning
Editor's note: Former Fed Chairman Paul Volcker once said: "Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong." A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer's insightful analysis stems from the Austrian School of economics. France's Le Figaro magazine has done a feature story on him as "the man who predicted the Asian crisis."
Wes Alexander comments to Congress- There is a very specific reason Article I, section 10 of the U.S. Constitution specifies the use of gold and silver for the coining of money. The reason, long forgotten, will become clear again.
Many times I have advised that your legacy will be one of poverty and despair. The only question for posterity (and perhaps a jury) will be whether or not your involvement was based on ignorance or criminal intent. Modern politicians will be like the one speeding car of many speedsters that finally gets pulled over and ticketed. Unlike the benign traffic ticket, those elites unfortunate enough to be judged "in charge," will do good to settle for prison time instead of firing squads.
The existing economic distortions will not be rebalanced quietly. They were kicked into high gear when President Nixon removed the last barrier to government fiscal restraint and counterfeit (MAD) money. You cannot repeal economic law any more than you can repeal the laws of physics. Unfortunately your mitigating actions are limited. You should at least refrain from throwing additional debt logs on the fire. I see no political backbone even in this small regard.
Recommend you immediately contact the Mises Institute and begin sorting through your limited options. You should also make an appointment to discuss this issue with Congressman Ron Paul. Good luck to us all. We'll need it.
Reginald Howe's Deja vu Central Banks at the Abyss
Murray Rothbard's 1963 book (only 60+ pages) about how government has destroyed sound American money.
Wes Alexander's U.S. Purchasing Power Decline - For those who want the short version.
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