US Monetary Selfishness is Devastating for 'RoW'

Remember the World Series? The naming of this League has always struck me as an interesting insight into how the US sees the rest of the world. In reality only US teams play in the league, implying that the US is the world. Their economic and monetary policy has always adopted a similar worldview.

The phrase 'the world is your oyster' has really described the approach the US has been able to take to global markets since the agreement at Bretton Woods in 1944 that dollars would become the fundamental backstop of all global value. This role used to be played by gold, which we all had a fighting chance of digging out of othe ground and so had some degree of neutrality. Since 1944 it has been paper money, under the control of the US bank the Federal Reserve.

The agreement also stated that the US had to hold enough gold in Fort Knox to back the dollars it issued. But Nixon unilaterally abandoned that agreement in 1971 and since then the US has been able to create money at whim, and import goods from the world in exchange. This extraordinary and deeply unfair situation has funded excessive consumption and an impossible deficit at home, and left foreign countries - particularly China - holding vast quantities of US debt.

Since the 2008 crisis, the US has used this unfair avantage to pour money into its economy to prevent it suffering the sorts of recessions we have seen in Europe - around $85bn. per month have been shovelled out through buying treasury bills back from financial institutions, in other words a massive amount of value being created and given to banks. Now the US has decided recovery is sufficiently secure to reduce or 'taper' this policy, but the financial institutions are objecting and the stock market has fallen radically as a consequence.

You can see this discussed in a useful video called The Epstein Report. It is also explains why this will lead to an increase in US interest rates. If you think of interest rates as the price of money it makes sense that, as the cheap or actually free money will be reduced, the price of money will tend to rise.

But the consequences of such an interest-rate rise in the US are small beer compared to the devastating consequence of this policy to other economies across the world. US monetary selfishness has led to a financial collapse in Argentina and devaluation of currencies in Brazil and Turkey as the US, in the words of the Brazilian central bank governer, hoovers out of 'emerging markets' the money it is no longer injecting into its markets at home. Decades of openness in global finance, forced on the world's economies by the IMF, have left them completely vulnerable to this US policy, as there are no controls on capital movement and they cannot now establish barriers.

Never has the US's selfishness been more clearly demonstrated. And never has the need for a global settlement on finance, agreed by all parties rather than imposed by the US, been more clear. Tweet

How to Solve the Eurozone Crisis

Inter-war Germany may not be the place you would look first for advice on tackling tricky financial issues, but on the other hand somebody did manage to move the country from the situation where you needed a wheelbarrow to buy a loaf of bread to the country that could afford to spend so much on arms that it could rapidly conquer the whole continent. That man was Hjalmar Schact: he was not a magician but rather a financial expert who was not in hock to financiers. That is a rare commodity and one we are in desperate need of just now.

What a coincidence, then, that I spent yesterday at a conference with Professor Richard Werner of Southampton University. A modest, self-effacing man, he has nonetheless managed to persuade the Telegraph's City correspondent to suggest something like the Schact Plan to solve the Eurozone crisis. The solution is simple: create enough money through quantitative easing to buy back the bad assets. According to Hurley, Werner then suggests that governments should stop selling bonds but rather 'fund themselves through loan contracts from banks in their countries', which strikes me as rather odd when the more obvious proposal would be simply to continue to issue money as public credit. 

What Richard does not tell us is what backed up the creation of vast amounts of new German money that Schact created. That is a point I covered in my book Market, Schmarket back in 2006. I like this better now, because it reminds us of the importance of land. Effectively, Schacht used the German land and its wealth as collateral:

‘Once confidence in a currency is so severely damaged the only feasible response is to create a new currency, which was a process managed by the Finance Minister Hjalmar Schacht. In November 1923 he created a new parallel currency called the Rentenmark; to create confidence it was backed by land, in this case the most solid asset of the German economy. The Rentenmarks allowed economic transactions to take place within the economy, although they were not legal tender, had no fixed relation to the Reichsmark they replaced, and could not be used for international payments. This made the Rentenmarks speculation proof. Bizarrely, much of the speculation against the currency that had destroyed it had actually been funded by loans from German banks. In The Magic of Money Schacht explains how the Reichsbank made loans to support the speculation against the German currency. Thus the government, which has always been blamed for economic mismanagement and for printing too much paper money, was not primarily responsible for the inflation. By 1924 the Rentenmark and Reichsmark were being treated equally and the Rentenmark could be withdrawn. The lessons of the German hyperinflation are twofold: first, that financial speculators’ only motive is to make profits and that they are unconcerned about the social and political consequences of their speculative activity; but, nonetheless, governments can use political power to control this speculation if they wish, exposing the myth of powerlessness.’

It just so happens that we are looking for an independent and skilful financial expert for a rather important job just now. I have suggested to Richard that he put together an application for the top job at the Bank of England. If he is agreeable we could start an interesting campaign, especially as the man who invented quantitative easing has much stronger credentials than most of the current front-runners.
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