E: What is the end game here? On one side of the equation we have rising commodity prices, and on the other side we have falling bond yields. I think if you went to the average portfolio manager five years ago and told him, "Five years from now silver will be five times the price it is today and the yield on ten-year Treasury bonds will be around 4.5%", they'd probably have thought you were crazy.
H: There's no way that you can project past trends to see where the intersection point is today, because we're in a quandary. The US economy has reached a wall of indebtedness. It can't take on more debt. A choice has to be made: Either write down the debts to the ability to pay, or flood the market with enough credit to keep the debt bubble growing. That's ultimately going to make it even harder for the economy as a whole to work its way out of debt. So I don't see what can happen, except more breaks in the chain of payments. We're now living under what James Galbraith calls the "Predatory State", a government taken over by the financial interests. They say, "We want all the debt to be paid, regardless of the effect on the economy as a whole. And we also want all of our financial gambles and CDOs to be made whole, even if it shrinks the economy. We don't care if you have to scale back pensions and Social Security, or reduce wages by twenty percent and lower living standards. We want to get paid." And they're telling politicians, "Don't forget that we're the guys who are paying for your Congressional and Senate campaigns. We expect you to do what we tell you to do, or else we'll back someone else."
So basically, the financial sector is saying to the economy, "Drop dead!"
E: Isn't it even worse? Paul Krugman wrote in his New York Times op-ed yesterday [October 18 2010] comparing US deflation to that of Japan. This is one of the favorite arguments for advocates of printing more money and increasing federal deficits further. They claim that we're making the same mistake that Japan did, by not being "aggressive enough" with fiscal stimulus.
H: On another plane we're doing the opposite of what brought on Japan's bubble crisis. The Basel II agreement in 1988 ruled that banks needed much higher capital reserves to bring them up to the new European standard. As a result of their weak position after World War Two, Japanese banks had been operating for half a century on much lower capital. All of the sudden, the Basel Agreement forced these banks to stop lending and rebuild their capital base. In conjunction with high interest rates (which the Americans insisted upon) and upward revaluation of the yen, this killed Japan's economy. So Japan's giving in to American financial demands destroyed it.
By contrast today, instead of lowering bank liquidity the US Federal Reserve is pushing liquidity into the financial system. This enables banks to increase their loans, on the theory that America can borrow its way out of debt - which is crazy, of course. So Bernanke and Krugman are drawing a false parallel.
E: I agree completely. The US was never slow on the gas pedal as the Bank of Japan was. We never did fall into a liquidity trap that some members of the Feds are claiming we are in today. The way I see it is that these [are] arguments for continuing to borrow - to use your phrase, to move debt from private to public accounts by the Fed's cash-for-trash swaps and bailouts.
Comparing our opportunity to Japan's, isn't our sovereign credit risk much higher than Japan's in terms of per capita GDP growth, structural balance-of-payments deficit, history of default and history of inflation?
H: The financial credit risk is really a political question of national policy. In the last few weeks China has negotiated currency swaps with Russia, Turkey and Brazil. The aim is to prevent losses on these swaps. There's a mutual guarantee that a central bank of a currency that loses value will reimburse the central bank that's holding its currency so that the latter will not suffer a loss as denominated in its own currency.
I suspect that all the United States would have to do (at least in the short run) would be to make the same deal so that foreign countries would not take a loss on their dollar holdings. Instead, America is saying bluntly: "In order for us to solve our economic problem at no cost to ourselves, you must take a loss. We are going to solve our problem at your expense. If you don't like it, you had better arm yourselves (preferably by buying our own weapons exports) because we're going to do things our way. What are you going to do about it?"
E: Yes.
H: Imagine what effect this is creating abroad! Other countries have gone along with US policy so far, because there was some mutual gain, at least in the US market for foreign countries' exports. But now that US consumers have little left to spend on goods and services (because they have to spend so much on debt service and housing), America has little to offer any more. So foreign countries are moving away. I was told two weeks before Turkey made the currency-swap agreement with China that they decided that America is going to be on the losing side, and they wanted to go with the winners - that is, with the growing economies, not those that are sinking into debt deflation.
The United States is playing as if other countries are still going to automatically obey it. The only ground for believing this is that other countries are looking at the United States as a "madman". It certainly looks as if people like Ben Bernanke are even nuttier than Alan Greenspan. They're disappointed with Obama, whom they see more as a continuation of Dick Cheney than of George Bush. He's turned over the shop to the Rubinomics gang of financial predators.
E: You're in Germany. What's the general feeling there about US economic policies?
H: There is resentment against Angela Merkel and her government for following American policy and not realizing that the world has changed from what it used to be. There is still high unemployment here, almost twenty percent. The economy is not doing well, and German exports - like other European exports - are being hurt by the euro's rise while the US Fed continues to pursue low interest rates to increase the capitalization rate of its real estate and corporate income - which has the side effect of lowering its exchange rate. So Europe is bearing the brunt of American financial aggression. There is a feeling that Merkel is turning as much into Obama's poodle as Blair was Bush's poodle. And her French friend Sarkozy is not popular here either.
E: Regarding the currency swap agreements between China and other countries to avoid the downside of holding dollars and doing trade in them, is this a gradualist approach?
H: It's an either/or approach. Foreign central banks know that holding dollars is like buying an asset that is going down in price. Nobody wants to do that, because they will have to show a loss on their books, which are kept in their own currency. Most central bankers expect China's currency to rise, just like the yen rose after 1985. They naturally would rather hold a rising currency asset than a depreciating one.
E: Speaking of which, one of the major changes in the global market over this year is that central banks have become net buyers of gold. Earlier this week the central bank of South Korea announced that they're beginning to diversify out of dollars. Do you see this as part of the process that I call decommissioning the dollar as a reserve currency?
H: Certainly. The United States, Germany and France hold half of their foreign reserves in gold. Korea has only 0.2% of its international reserves in gold. So it's saying, in effect: "Wait a minute. There's some hypocrisy going on here. You're telling us to hold dollars, but you're holding gold. We've decided to do as you do, not as you say." The corollary is to spell this out: "We don't know what the future global monetary system is going to be. But it looks like the United States is expecting a gold-based system. Otherwise, let the US Treasury sell off its gold stock."
Korea may have been discussed its gold purchase with other countries. Its act says, in effect: "We're hosting the G20 meetings next month. Why doesn't America hold down the price of gold by putting its money where it's mouth is, and announce that it's going to sell the gold in Fort Knox?" Other countries might well say, "By the way, can you give us back the gold we're holding in the New York Federal Reserve? Now that we don't have to worry about World War Two any more, we'd like to hold our own gold." There is a growing feeling that the US Government is acting on behalf of financial thieves, and that this theft is causing unemployment in Europe and other countries.
E: So this leads to my final question: Clearly the world needs a new global monetary system. This has been obvious for a while. My sense is that for most governments around the world, the final straw has been the financial crisis that we've imposed on everybody. So the question is, in the past such agreements were reached with at least one dominant power (that would be us) holding most of the cards and dictating the arrangements. This time around, that's not really an option any more. But it's not clear just where the leadership is. So is there any precedent for a multilateral agreement among countries for a new international currency regime?
H: I think this mischaracterizes the issue. There never was a multilateral currency system. There was the US dictating to the rest of the world, as you point out. It used an internationalist rhetoric for nationalistic financial and trade purposes. That's what my Super Imperialism (2003) was all about.
E: Yes, that's what I mean. That is what we always had before.
H: The United States said to other countries: "We'll never join a multinational system in which other countries can set our policy. We insist on veto power - or the power to simply ignore your recommendations. And for your part, you must do what we say, or we'll do to you what we did to Iraq or Afghanistan. So get out of our way!"
I think that other countries have given up hope of a multi-lateral system in which the United States will cooperate. So they're creating a parallel system, namely as the BRIC countries have done. They're saying, "We're going to avoid using the dollar altogether". And the dollar's own financial managers are turning it into nearly a pariah currency. This is what I wrote about in the Financial Times yesterday: the US refusal to cooperate with other countries, above all its double standard insisting that other countries must turn their foreign-exchange surpluses over to the US Treasury to promote US financial markets at their expense - and the demand that any country running a trade surplus with America spend the money on US arms - is so abhorrent that other countries are proceeding to create an alternative global financial system of settling trade and balance-of-payments transactions without the United States.
So what will emerge is a new multi-lateral financial system after all. But there will be two financial systems: one centered on the BRIC countries with strong trade balances and currency values, another system centered on the US dollar. Europe is likely to be left out, and may become an economic backwater, because so much of its politics are run by US aficionados. So I see a dual world monetary system and a dual world trade system operating under a different set of trade and financial rules.
US diplomats no doubt will call this socialism. Other countries can reply, "What we're doing is just what the French Physiocrats, Adam Smith, John Stuart Mill and the other major classical free-marketers wanted: no free lunch. If we're socialists, what are you guys? We're too polite to use the word, but it was used in World War Two."
E: On that note we'll wrap it up. We appreciate your thoughts on this. It's certainly going to be an interesting meeting coming up next month among the G20, and we'll see what comes out of it.
H: Have a glance at the article I wrote in the Financial Times [October 19 2010].
E: Will do.
H: I think that spelled out a lot of the logic of what I've just been talking about.
E: Very good. Thank you very much Michael. Appreciate your time.
H: It's always good to talk to you.
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