What is to stop U.S. banks and their customers from creating $1 trillion, $10 trillion or even $50 trillion on their computer keyboards to buy up all the bonds and stocks in the world, along with all the land and other assets for sale, in the hope of making capital gains and pocketing the arbitrage spreads by debt leveraging at less than 1% interest cost?
This is the game that is being played today.
The outflow of dollar credit into foreign
markets in pursuit of this strategy has bid up asset prices and foreign
currencies, enabling speculators to pay off their U.S. positions in cheaper
dollars, keeping for themselves the currency shift as well as the arbitrage
Who needs an army when
you can obtain monetary wealth and asset appropriation simply by financial
means? Victory promises to go to the economy whose
banking system can create
the most credit, using an army of computer keyboards to appropriate the
U.S. officials demonize countries suffering these dollar inflows as aggressive,
Oscar Wilde would have struggled to find a more convoluted term for other countries protecting themselves from raiders trying to force up their currencies to make enormous predatory fortunes.
“Competitive non-appreciation” sounds like “conspiratorial non-suicide.”
These countries simply are trying to protect their currencies from
arbitrageurs and speculators flooding their financial markets with dollars,
sweeping their currencies up and down to extract billions of dollars from
their central banks.
The Federal Reserve is pumping a tidal wave of liquidity and reserves into the financial system to reduce interest rates, ostensibly to enable banks to “earn their way” out of negative equity resulting from the bad loans made during the real estate bubble. This liquidity is spilling over to foreign economies, increasing their exchange rates.
Joseph Stiglitz recently acknowledged that instead of helping the global recovery, the “flood of liquidity” from the Fed and the European Central Bank is causing “chaos” in foreign exchange markets.
What U.S. quantitative easing is achieving is to drive the dollar down and other currencies up, much to the applause of currency speculators enjoying quick and easy gains.
Yet it is to defend this system that U.S. diplomats and bank lobbyists are threatening to derail the international financial system and plunge world trade into anarchy if other countries do not agree to a replay of the 1985 Plaza Accord,
The Plaza Accord derailed Japan’s economy by raising its exchange rate while lowering interest rates, flooding its economy with enough credit to inflate a real estate bubble.
IMF managing director Dominique Strauss-Kahn was more realistic.
At issue is how long nations will succumb to the speculative dollar glut. The world is being forced to choose between subordination to U.S. economic nationalism or an interim of financial anarchy.
Nations are responding by
seeking to create an alternative international financial system, risking an
anarchic transition period in order to create a fairer world economy.
After its financial and property bubble burst in 1990, the Bank of Japan sought to enable its banks to “earn their way out of negative equity” by supplying them with low-interest credit for them to lend out. Japan’s recession left little demand at home, so its banks developed the carry trade: lending at a low interest rate to arbitrageurs to buy higher-yielding securities.
Iceland, for example, was paying 15%.
So yen were borrowed to convert into
dollars, euros, Icelandic kroner and Chinese renminbi to buy government
bonds, private-sector bonds, stocks, currency options and other financial
intermediation. Not much of this funding was used to finance new capital
formation. It was purely financial in character - extractive, not
And after it burst in 2008, they did what Japan’s banks did after 1990. Seeking to help U.S. banks work their way out of negative equity, the Federal Reserve flooded the economy with credit. The aim was to provide more liquidity, in the hope that banks would lend more to domestic borrowers.
The economy would “borrow its way out of debt,”
re-inflating asset prices for real estate, stocks and bonds so as to deter
home foreclosures and the ensuing wipeout of collateral on bank balance
is to pull home ownership out of negative equity, rescuing the banking
system’s balance sheets and thus saving the government from having to
indulge in a
TARP II, which looks politically impossible given the mood of
Just as hoarding diverts revenue away from being spent on goods and services, so debt repayment shrinks spendable income.
Why then would banks lend more
under conditions where a third of U.S. homes already are in negative equity
and the economy is shrinking as a result of debt deflation?
This quantitative easing has been sent abroad, mainly to the BRIC countries: Brazil, Russia, India and China.
According to the IMF,
This is what has led gold prices to surge and investors to move
out of the dollar since early September, prompting other nations to protect
U.S. officials say that this is all part of the free market.
So other countries are obliged to solve the problem on their own.
Japan is holding down its exchange rate by selling yen and buying U.S. Treasury bonds in the face of its carry trade being unwound as arbitrageurs pay back the yen they earlier borrowed to buy higher-yielding but increasingly risky sovereign debt from countries such as Greece.
These paybacks have pushed up the yen’s exchange rate by 12% against the dollar so far during 2010, prompting Bank of Japan governor Masaaki Shirakawa to announce on Tuesday, October 5, that Japan had “no choice” but to,
This “sterilization” of unwanted inflows is what the United States has criticized China for doing.
China has tried more normal ways to recycle its
trade surplus, by seeking out U.S. companies to buy. But Congress would not
CNOOC buy into U.S. oil refinery capacity a few years ago, and the
Canadian government is now being urged to block China’s attempt to purchase
its potash resources. Such protectionism leaves little option for China and
other countries except to hold their currencies stable by purchasing U.S.
and European government bonds.
As noted earlier, arbitrageurs obtain a twofold gain: the margin between Brazil’s nearly 12% yield on its long-term government bonds and the cost of U.S. credit (1%), plus the foreign-exchange gain resulting from the fact that the outflow from dollars into reals has pushed up the real’s exchange rate some 30% - from R$2.50 at the start of 2009 to R$1.75 last week.
into account the ability to leverage $1 million of one’s own equity
investment to buy $100 million of foreign securities, the rate of return is
3000% since January 2009.
To deter the currency’s rise, the government imposed a 4% tax on foreign purchases of its bonds on October 4.
Such inflows do not provide capital for tangible investment.
They are predatory, and cause currency fluctuation that disrupts trade patterns while creating enormous trading profits for large financial institutions and their customers.
Yet most discussions treat the balance of payments and exchange rates as if they were determined purely by commodity trade and “purchasing power parity,” not by the financial flows and military spending that actually dominate the balance of payments.
The reality is that today’s
financial interregnum - anarchic “free” markets prior to countries hurriedly
putting up their own monetary defenses - provides the arbitrage opportunity
of the century. This is what bank lobbyists have been pressing for. It has
little to do with the welfare of workers in their own country.
The House Ways and Means Committee is demanding that China raise its exchange rate by the 20 percent that the Treasury and Federal Reserve are suggesting. Revaluation of this magnitude would enable speculators to put down 1% equity - say, $1 million to borrow $99 million - and buy Chinese renminbi forward.
The revaluation being
demanded would produce a 2000% profit of $20 million by turning the $100
million bet (and just $1 million “serious money”) into $120 million. Banks
can trade on much larger, nearly infinitely leveraged margins, much like
CDO swaps and other derivative plays.
During the week leading
the IMF meetings in Washington, the Thai baht and Indian rupee soared
in anticipation that the United States and Britain would block any attempts
by foreign countries to change the financial system and curb disruptive
This prompted Chinese officials to counter U.S. attempts to blame it for running a trade surplus by retorting that U.S. financial aggression,
global financial system threatens once again to break apart, deranging the
world’s trade and investment relationships - or to take a new form that will
leave the United States isolated in the face of its structural long-term
This “money of the world,” as Sir James Steuart called gold in 1767, formed the basis of domestic currency as well. Until 1971 each U.S. Federal Reserve note was backed 25% by gold, valued at $35 an ounce. Countries had to obtain gold by running trade and payments surpluses in order to increase their money supply to facilitate general economic expansion.
And when they ran trade deficits or undertook military campaigns,
central banks restricted the supply of domestic credit to raise interest
rates and attract foreign financial inflows.
spanning World Wars I and II enabled the United States to accumulate some
80% of the world’s monetary gold by 1950. This made the dollar a virtual
proxy for gold. But after the Korean War broke out, U.S. overseas military
spending accounted for the entire payments deficit during the 1950s and ‘60s
and early ‘70s, while private-sector trade and investment were exactly in
But replacing gold - a pure asset - with dollar-denominated U.S. Treasury debt transformed the global financial system.
It became debt-based, not asset-based. And geopolitically, the
Treasury-bill standard made the United States immune from the traditional
balance-of-payments and financial constraints, enabling its capital markets
to become more highly debt-leveraged and “innovative.” It also enabled the
U.S. Government to wage foreign policy and military campaigns without much
regard for the balance of payments.
that this deficit is largely military in nature - for purposes that many
foreign voters oppose - makes this lock-in particularly galling. So it
hardly is surprising that foreign countries are seeking an alternative.
Banks lent to foreign
governments from Third World countries to other deficit countries to cover
their national payments deficits, to private borrowers to buy the foreign
infrastructure being privatized or to buy foreign stocks and bonds, and to
arbitrageurs to borrow at a low interest rate to buy higher-yielding
U.S. “quantitative easing” is coming to be perceived as a euphemism for a predatory financial attack on the rest of the world.
Trade and currency stability are part of the “collateral damage” caused by the Federal Reserve and Treasury flooding the economy with liquidity to re-inflate U.S. asset prices. Faced with this quantitative easing flooding the economy with reserves to “save the banks” from negative equity, all countries are obliged to act as “currency manipulators.”
So much money is made by purely financial speculation that
“real” economies are being destroyed.
Prior to the United States going off gold in 1971, nobody dreamed that an economy could create unlimited credit on computer keyboards and not see its currency plunge. But that is what happens under the global Treasury-bill standard.
Foreign countries can prevent their currencies from rising against the dollar (which prices their labor and exports out of foreign markets) only,
Malaysia used capital controls during the 1997 Asian Crisis to prevent short-sellers from covering their bets.
This confronted speculators with a short squeeze that George Soros says made him lose money on the attempted raid.
Other countries are now reviewing how to impose capital controls to
protect themselves from the tsunami of credit flowing into their currencies
and buying up their assets - along with gold and other commodities that are
turning into vehicles for speculation rather than actual use in production.
Brazil took a modest step along this path by using tax policy rather than
outright capital controls when it taxed foreign buyers of its bonds last
This trend threatens
to lead to the kind of international monetary practice found from the 1930s
into the ‘50s: dual exchange rates, one for financial movements and another
for trade. It probably would mean replacing the IMF, World Bank and WTO with
a new set of institutions, isolating U.S., British and Eurozone
However, other countries already have complained that voting control remains dominated by the major promoters of arbitrage speculation - the United States, Britain and the Eurozone. And the IMF’s Articles of Agreement prevent countries from protecting themselves, characterizing this as “interfering” with “open capital markets.” So the impasse reached this weekend appears to be permanent.
As one report summarized matters:
Paul Martin, the former Canadian prime minister who helped create the G20 after the 1997-1998 Asian financial crisis, noted that,
And in a Financial Times interview, Mohamed El-Erian, a former senior IMF official and now chief executive of Pimco, said:
The BRIC countries are simply creating their own parallel system.
In September, China supported a Russian proposal to start direct trading between the yuan and the ruble. It has brokered a similar deal with Brazil.
And on the eve of the IMF meetings in Washington on Friday, October 8, Premier Wen stopped off in Istanbul to reach agreement with Turkish Prime Minister Erdogan to use their own currencies in tripling Turkish-Chinese trade to $50 billion over the next five years, effectively excluding the U.S. dollar.
On the deepest economic plane today’s global financial breakdown is part of the price to be paid for the Federal Reserve and U.S. Treasury refusing to accept a prime axiom of banking:
They tried to “save” the banking system from debt write-downs in 2008 by keeping the debt overhead in place while re-inflating asset prices.
In the face of the repayment burden shrinking the U.S. economy, the Fed’s idea of helping the banks “earn their way out of negative equity” is to provide opportunities for predatory finance, leading to a flood of financial speculation. Economies targeted by global speculators understandably are seeking alternative arrangements.
It does not look like these can be
achieved via the IMF or other international forums in ways that U.S.
financial strategists will willingly accept.