Snow Job

Sooner or later, people in charge of money seem to say the wrong things. Wim Duisenberg was the fool three years ago. The head of the European Central Bank said something stupid, (we do not recall what), and suddenly, the euro hit the skids.

Now it is John Snow’s turn. Not that he said anything much more asinine than Duisenberg or than his own fellow Americans at the Federal Reserve; McTeer, Bernanke, and the rest of the bunch seem to have a special gift for it. Nor did he say anything that was untrue. A currency does depend on ‘faith,’ after all.

But Soros was selling and the dollar was falling; the press needed a simple, understandable reason: The U.S. Treasury secretary had ‘let the cat out of the bag,’ they said, revealing to the world that the current administration no longer backed a strong dollar policy.

Here at the Daily Reckoning, we are more keenly aware of the dollar than most other kibbitzers. Since we take our meager income in dollars and spend it in euros; we feel each drop in its value like a whiskey spill; it practically brings tears to our eyes.

The Bretton Woods Agreement: Don’t Blame John Snow

But we are resigned to it. Not just the 25% drop the dollar has suffered at the hands of Wim Duisenberg’s euro this year…but a lot more. In 1985-’87, the dollar lost 50% against the German mark. That was before Alan Greenspan took his post…and before the greatest spree of dollar creation in history.

You see, dear reader, poor John Snow is not to blame for the dollar’s fall any more than Alan Greenspan deserved the credit for its rise. Today, we let the cat out of the bag ourselves — the dollar is going down, no matter what U.S. monetary officials say.

Decent men and women are not normally interested in the working of the international monetary mechanism anymore than they are interested in the workings of the digestive tract. We wouldn’t blame them for setting aside today’s column in disgust or boredom. But there is a time and place for everything. Suddenly, the world’s money system is in the news…and at risk. Readers are urged to send the young and weak out of the room…fortify themselves with a shot of whiskey …and continue reading. It isn’t pretty, but it is necessary, sometimes, to understand how these things work.

There was a time when America had honest money. Both the Gold Standard and the Bretton Woods agreement required nations to settle their debts in real money — number 79 on the periodic table — which none of them could create at will. Even in its late, corrupted version, under the Bretton Woods agreement, international accounts could still be settled in gold. If a country bought more from abroad than it sold, it could be forced to make good the difference in metal. America might have the dollar. Germany might have the mark. But the world’s money was gold.

The bretton Woods Agreement: Closing the Gold Window

Then began a remarkable chapter in the history of monetary chicanery. The Nixon Administration ‘closed the gold window,’ at the Fed, meaning that foreign nations could no longer turn in their excess paper dollars in exchange for gold. The Dollar Standard was begun. With no access to gold, nations settled their international trade and currency imbalances in dollars…and built up dollar reserves, in place of gold reserves, for that purpose.

During the 20 years of the Bretton Woods agreement — 1949 to 1969 — total international reserves — money held in central banks to settle accounts and protect the currency — went up only 55%. Since then, the increase has exceeded 2000%, most of it coming since Alan Greenspan took over the Fed in 1987.

The Fed did not merely increase the supply of dollars in the U.S. — it increased the entire world’s money supply, which set the wheels of international commerce turning. So fast did they turn that a pile-up on the highway of the globalized economy was almost inevitable.

Richard Duncan explains:

“This explosion of reserve assets has been one of the most significant economic events of the last 50 years. Today, Asian central banks hold approximately $1.5 trillion in US dollar- denominated reserve assets. Most of the world’s international reserves come into existence as a result of the United States current account deficit. That deficit is now $1 million a minute. Last year, it amounted to $503 billion or roughly 2% of global GDP. The combined international reserves of the countries with a current account surplus increase by more or less the same amount as the US current account deficit each year. So central bankers must worry not only about their existing stockpile of dollar reserves, but also about the flow of new US dollar reserves they will continue to accumulate each year so long as their countries continue to achieve a surplus on their overall balance of payments.”

The Bretton Woods Agreement: A Marvelous System?

Since the breakdown of Bretton Woods, the U.S. has been able to do something that other nations could only dream of; it could settle its debts in ‘money’ that it could create, as Fed governor Ben Bernanke recently explained, at near zero cost. The rest of the world could sell as much as they wanted to the U.S. — on credit, which Americans could by creating more dollars.

What a marvelous system this was! And not just for Americans. In fact, while they appeared to be its greatest beneficiaries — for weren’t they getting something for nothing? — they were actually its biggest victims.

For a very long while, the whole world was snowed. People believed that a dollar was as good as gold. Foreigners were willing to take as many of them as were offered, the last one at the same value as the first. And they were willing to work far into the night, for minimal wages, to produce things they could exchange for dollars.

The first major beneficiary of the new system was Japan. The Japanese wore their company uniforms and sang their company songs…and transformed their island into Japan, Inc., a nation that whose heart beat with a single purpose — to sell to Americans. But what could they do with all the dollars they earned?

Duncan continues…

“This arrangement has had the benefit of allowing much more rapid economic growth, particularly in large parts of the developing world, than could have occurred otherwise. It also has put downward pressure on consumer prices and, therefore, interest rates in the United States as cheap manufactured goods made with very low-cost labor have been imported into the United States in rapidly increasing amounts. However, it is now becoming increasingly apparent that The Dollar Standard has also resulted in a number of undesirable and potentially disastrous consequences.

The Bretton Woods Agreement: Hyperinflation

First, it is clear that countries which built up large stockpiles of international reserves through current account or financial account surpluses have experienced severe economic overheating and hyper-inflation in asset prices that ultimately resulted in economic collapse. Japan and the Asia crisis countries are the most obvious examples of countries that suffered from that process. Those countries were able to avoid complete economic depression only because their governments went deeply into debt to bailout the depositors of their bankrupt banks.

“Second, flaws in the current international monetary system have also resulted in economic overheating and hyper-inflation in asset prices in the United States as that country’s trading partners have reinvested their dollar surpluses (i.e. their reserve assets) in dollar-denominated assets. Their acquisitions of stocks, corporate bonds, and US agency debt have helped fuel the stock market bubble, facilitated the extraordinary misallocation of corporate capital, and helped drive US property prices to unsustainable levels.

“Third, the credit creation The Dollar Standard made possible has resulted in overinvestment on a grand scale across almost every industry worldwide. Overinvestment has produced excess capacity and deflationary pressures that are undermining corporate profitability around the world.”

Will it surprise you, dear reader, to find that getting something for nothing hurts the gettor more than the gettee? There is something so elegantly correct about it. Three decades of the Dollar Standard have produced jobs, factories, savings, profits — mostly overseas.

More to come…

Bill Bonner
May 23, 2003


OK, here’s a riddle for you:

What’s the difference between Nasdaq 5,000 and a 30-year Treasury bond yielding 4.30%?

Answer: Absolutely nothing…just kidding…

Everyone knows that a 30-year bond paying 4.30% per year is a terrific value, especially when the issuing party — which, by the way, is running a half-billion dollar annual current account deficit — promises to repay the bond with money that it has promised to debase.

Who WOULDN’T want to buy an investment like that?

Yesterday, the lumpeninvestoriat scrambled to by more long-dated US bonds, pushing the yields down to new 45-year lows. The 10-year treasury gained about half a point yesterday pushing its yield down to a new 45-year low of 3.32%.

In the stock market, the Dow rose 77 points to 8,594, while the Nasdaq jumped 1.2% to 1,507. While stocks and bonds were rallying, the gold market took a well-deserved rest, as the June contract for gold fell $4.10 to $368.10 an ounce.

The precious metal had risen in each of the past six sessions, adding a total $22 an ounce prior to yesterday’s selloff…

Here’s Eric with the news far from Wall Street…


Eric Fry writing from Florida…

– 1,000 miles or so south of Wall and Broad, the Amelia Island confab was winding down. The final day’s discussion ranged as freely as an organic chicken, but somehow, the discussion kept ranging back to the gold market. Nearly all of those in attendance believe that gold has commenced the early stages of an epic bull market. But some of the guys down here are little sheepish about admitting their affinity for the barbarous relic…after all, they have their credibility and their reputations to protect.

– Most of the discussion about gold focused on the “inevitability” of a gold bull market, rather than the precise TIMING and EXTENT of said inevitable event. However, “soon” and “big” would aptly describe the IM-precise timing and extent of the gold rally that the Amelia Island consensus anticipates.

– John Hathaway, manager of the Tocqueville Gold Fund, was not in attendance at Amelia Island. But his bullish views toward the yellow metal would have found a ready audience. Hathaway is one of a small crowd of mega-bulls who expect the price of gold to soar well above $1,000 in coming years.

– “The market capitalization of the gold mining sector is a relatively tiny $50 billion to $60 billion,” Hathaway explained recently. “The market cap of the amount of physical gold available for investment, excluding central bank holdings, is very approximately $1 trillion. Even after making the extreme assumption that all central bank gold is in play, the investment gold market cap is only $1.4 trillion.”

– By comparison, financial wealth in the form of bonds and stocks totals more than $50 trillion. Obviously, Hathaway giddily observes, a small shift from the big pile of wealth that’s in stocks and bonds to the little pile of wealth that’s in gold could produce a much higher gold price. “Such an allocation would in time cause gold to trade comfortably in excess of four digits ($1,000) in terms of U.S. dollars,” Hathaway predicts.

– But isn’t there something a little bizarre about a $1,000 gold price flowering from the soil of a deflationary world…if that is indeed what we inhabit? The cohabitation of a US deflationary funk with a gold bull market seems a little strange — or, as we would say down here on Amelia Island, “It just ain’t natural.” And yet, this is exactly what appears to be happening — emphasis on “appears.”

– Your New York correspondent is as suspicious of the deflation scare as he is of the bond market rally. He suspects, therefore, that the gold market is “looking ahead” to a coming inflation… And yet, deflationary symptoms continue to beset our economy.

– The world’s growth engine continues sputtering, says Morgan Stanley’s Richard Berner. “U.S. manufacturing has taken it on the chin again, with factory output declining at a 3.2% annual rate over the three months ending in April…In Detroit, producers have stepped hard on the brakes in the past three months, producing another down leg in the stop-start automotive expansion. Output of motor vehicles and parts tumbled 22% annualized in the past three months…

– “Outside Detroit,” Berner continues, “Smokestack America is also still floundering…The energy shock was a double-whammy, hurting both demand and supply. Going forward, the hike in natural gas prices to a stubbornly high level ($5-6/mcf) is still particularly worrisome, because natural gas accounts for about one third of industrial America’s energy consumption.”

– It is a strange world indeed — natural gas, oil, gold, bonds and stocks are all rallying in unison. Can all of these markets be “right” at the same time?

More questions from Bill Bonner below…