The Global Effect of the U.S. Dollar

From Credit to Money, Part II

“Living in a credit era, we cannot go back to a currency era without massive upheavals.”

— Robert L. Smitley, Popular Financial Delusions (1933)

WHY DON’T WE JUST DO AWAY WITH all the different currencies of the world and settle on one single money to buy, sell, invest and light our cigars with?

Because as it is, the Babel we live in — where 143 different kinds of currency either change hands or act as a way of measuring prices around the globe — keeps finding itself in no end of trouble.

“The rupee rose on [Feb. 1],” reports Livemint, The Wall Street Journal’s Mumbai offering, “as investors bought the Indian unit for its higher yields after a hefty interest rate cut by the U.S. Federal Reserve.

“But concerns weighed that the Indian central bank would intervene against the local unit, as it is widely suspected of doing in recent months.”

“There was some suspected intervention against the Singapore dollar at 1.427,” a currency trader in the tiny Asian state told Reuters in January, “so I guess players are wary.” Across the Pacific, meanwhile, the Argentine peso has lost more than 10% of its value against the U.S. dollar over the last four years thanks to “continued central bank intervention,” says the newswire elsewhere.

And as the world’s stock markets tumbled last month, the central banks of the Philippines, Malaysia and Turkey are also rumored to have stepped into the open market, dumping their own currencies and buying the U.S. dollar in a bid to support it and thus keep their export economies cheap for foreign customers.

Put another way, as Benn Steil of the Council on Foreign Relations said at a recent meeting (or so The Washington Post reports), “The United States is exporting inflation worldwide” by forcing these sovereign nations to print up mountains of their own currency with which to buy the ailing greenback.

Countries like China and the Middle Eastern petro-kingdoms peg their currencies to the dollar — the world’s No.1 reserve currency, and still top dog after all these years. So they “thus [peg themselves] to U.S. monetary policy” too.

And U.S. monetary policy, quite clearly, is inflationary right now. That makes monetary policy inflationary everywhere from Abu Dhabi to Beijing. Even those of us lucky enough to sit outside the “dollar zone” can expect rates to slide in tandem.

Slashing almost a third off the cost of borrowing dollars inside eight days — and then offering to lend U.S. banks $60 billion in 28-day loans every two weeks — makes for quite the game of “follow the leader,” don’t you think?

Ah, but over in the dozy spires of pan-global political daydreams, abolishing sovereign currencies and anointing one single money in their place would smooth the wheels of commerce and boost world GDP overnight. Apparently.

“Annual transaction costs of $400 billion [would] be eliminated,” reckons Morrison Bonpasse, editor of The Single Global Currency (2007 edition), published by Munich University. “Global currency imbalances will [also] be eliminated,” he adds, along with “all balance of payments problems…currency crises…currency speculation…and the need for foreign exchange reserves (with a current annual opportunity cost of approximately $470 billion).”

Indeed, “Worldwide interest rates will be lower than the current average due to the elimination of currency risk” — and you’ve just got to love cheaper money!

So what’s not to like? “National currencies and global markets simply do not mix,” wrote Benn Steil in the policy wonk’s favorite glossy, Foreign Affairs, last May.

“Together, they make a deadly brew of currency crises and geopolitical tension and create ready pretexts for damaging protectionism. In order to globalize safely, countries should abandon monetary nationalism and abolish unwanted currencies, the source of much of today’s instability.”

Instability being a bad thing — the kind of thing that knocks the S&P lower by 7% inside one month, for instance — it should be abolished, right? The beautiful stability of Western Europe’s economies just goes to show how remarkable a single currency could prove:


“Spanish and Italian manufacturers are clearly struggling in the head winds of weaker global growth, the strong euro, high oil prices and eroding demand in domestic markets,” said Jacques Cailloux, economist at the Royal Bank of Scotland in London, to Dow Jones Newswires Feb. 1 after the eurozone’s Purchasing Managers’ Index for January showed a slight rise overall.

“Against this, French and German manufacturers continue to do well, at least for the time being, but German producers have failed to fully make up the pace lost last autumn.”

Why the disparity? According to most Spanish, Italian, Portuguese and Greek politicians, the cost of borrowing euros is too high. According to the latest inflation data for the 14-nation currency zone, however, it’s still way too low.

“Annual inflation in the eurozone jumped to a new high of 3.2% in January, the European Union’s statistics bureau Eurostat estimated on Friday,” reports the China Daily.

“The figure, including new eurozone members Malta and Cyprus for the first time, was the highest since the single currency was introduced to world markets as an accounting currency in 1999. It rose from 3.1% in the previous two months and stayed well above the 2% ceiling preferred by the European Central Bank (ECB) for the fifth consecutive month.”

Spain’s minister of finance, Pedro Solbes, said Jan. 24 that “there’s significant debate” inside the European Central Bank about whether or not to cut interest rates as the global slowdown looms over Europe. But then again, he faces re-election in March — and no one seemed to mind too much about interest rates being too low during the Spanish real estate bubble that began bursting last year.

Property prices nearly tripled in Spain between 1997-2007, thanks to a wave of British expats in search of a perma-tan and the sudden collapse in borrowing costs that preceded the birth of the euro in 1999. Mortgage rates went from 11% in 1995 to below 6% and then 5% as the single currency delivered the hope of German-style monetary policy and interest rates.

Across the sea in Ireland, house prices trebled in just seven short years after the introduction of the euro. But not even a peak of just 4% in the eurozone’s cost of money could keep the bubble inflating forever.

Now “Spanish banks are issuing mortgage securities and asset-backed bonds on a massive scale to park at the European Central Bank,” reports the London Telegraph, “using them as collateral to raise money at favorable rates from the official credit window in Frankfurt.

“The rating agency Moody’s said lenders had issued a record €53 billion [$78 billion] of mortgage- and asset-backed bonds in the fourth quarter of 2007, yet almost none of the securities have actually been placed on the open market. Most have been sent directly to the ECB for use in ‘repo’ operations.”

So for all its tough talk on inflation, the European Central Bank is still feeding the growth of credit and money supplies in Europe. Any wonder the broad M3 money supply is swelling at a three-decade record rate? Any surprise that consumer price inflation is surging beyond the ECB’s grasp?

And does anyone really imagine this isn’t a problem?

“Living in a credit era,” wrote Robert L. Smitley in his 1933 classic, Popular Financial Delusions, “we cannot go back to a currency era without massive upheavals. The cause of the great boom was credit expansion to an abnormal degree — the same cause as that for all booms under a credit system.”

The world’s central bankers know this all too well. Few of them, if any, believe a return to “cash only” possible, let alone desirable. So if the world’s consumers and investors choose to shut down the credit markets — both as borrowers and lenders — and pile into cash instead, then the world’s central banks will just have to destroy cash in the hope of forcing a flight back into credit.

How else would you characterize a cut of 125 basis points in the rewards paid on dollars inside eight days?

The panic starting last August — a panic that closed the West’s mortgage markets almost entirely — can be beaten by central banks buying mortgage-backed bonds themselves if need be. The stock market panic of January — a panic that knocked almost one-tenth off the value of equities worldwide — can be reversed by historic cuts to interest rates and a fresh flood of short-term loans to the banks.

Or so the central banks think. But the panic they’re then causing as a direct result — a panic revealed by the surging gold price since August — might prove worse than the flight into cash that they’re fighting:

A complete loss of faith in all official currency.

Might that lead to the one single money that daydreaming economists think can cure the world’s evils? Whatever comes when the dust settles, you can be sure the world won’t turn to using gold coins again.

Yes, Ben Bernanke’s depression theories might be disputed — and yes, his current credit inflation panic looks absurd. But history would seem to make clear that during the 1930s deflation those nations that abandoned the gold standard soonest turned the corner the fastest and began to recover.

The “barbarous relic” of tying the supply of money to a real quantity of gold bullion can’t make a comeback for as long as “deflation” and “depression” are still blamed on gold hoarders.

But that doesn’t mean you can’t hoard a little real wealth in the meantime. You might want to consider it if you’re losing your faith in government money.

Adrian Ash
February 5, 2008