Wednesday, March 25, 2009

The American Black Hole of Value

David Seaton's News Links
Martin Wolf, chief economist of the Financial Times is worried about the Geithner plan, he writes:
The crisis has broken the American social contract: people were free to succeed and to fail, unassisted. Now, in the name of systemic risk, bail-outs have poured staggering sums into the failed institutions that brought the economy down. (...) If this scheme works, a number of the fund managers are going to make vast returns. I fear this is going to convince ordinary Americans that their government is a racket run for the benefit of Wall Street. Now imagine what happens if, after “stress tests” of the country’s biggest banks are completed, the government concludes – surprise, surprise! – that it needs to provide more capital. How will it persuade Congress to pay up? The danger is that this scheme will, at best, achieve something not particularly important – making past loans more liquid – at the cost of making harder something that is essential – recapitalising banks.
Nobel Prize winner, Joseph Stiglitz, was blunt:
"Quite frankly, this amounts to robbery of the American people. I don't think it's going to work because I think there'll be a lot of anger about putting the losses so much on the shoulder of the American taxpayer."
And of course that other Nobel, Krugman, blogged:
"What an awful mess."
In my opinion there was something much more important than Geithner's plan floated this week:
Are the Chinese just worried about the sagging value of the $1.4 trillion in U.S. Treasuries they hold or are they really on to something? That's the big question now that China's central banker, Zhou Xiaochuan, has called for the greenback to be jettisoned as the world's dominant currency and replaced by a new type of benchmark controlled by the International Monetary Fund. Zhou made his call in an essay that appeared on the website of People's Bank of China, China's central bank, on Monday. It was clearly timed to make a splash in the run-up to the G20 meeting that starts in London on April 2. Calling the use of the dollar as the world's benchmark currency "a rare special case in history," Zhou urged the "creative reform of the existing international monetary system towards an international reserve currency." Zhou said the reserve currency, managed by the IMF, should be "disconnected from individual nations and is able to remain stable in the long run." Talk about a vote of no confidence on the future of the U.S. economy! Washington Post
Of course the moment the US dollar ceases to be the world's reserve currency, the American economy will no longer be able to pay its debts with money it prints in its basement... The jig will up. Meatloaf will take the place of Camembert on many a formerly festive board from that day out.

Pushing aside all the epidemically anecdotal sound and fury, what has happened?

One of the world's most interesting and influential, even seminal, economists, the Peruvian, Hernando de Soto wrote the following article in the Wall Street Journal that gets right to the heart of the present situation:
Today's global crisis -- a loss on paper of more than $50 trillion in stocks, real estate, commodities and operational earnings within 15 months -- cannot be explained only by the default on a meager 7% of subprime mortgages (worth probably no more than $1 trillion) that triggered it. The real villain is the lack of trust in the paper on which they -- and all other assets -- are printed. If we don't restore trust in paper, the next default -- on credit cards or student loans -- will trigger another collapse in paper and bring the world economy to its knees.

If you think about it, everything of value we own travels on property paper. At the beginning of the decade there was about $100 trillion worth of property paper representing tangible goods such as land, buildings, and patents world-wide, and some $170 trillion representing ownership over such semiliquid assets as mortgages, stocks and bonds. Since then, however, aggressive financiers have manufactured what the Bank for International Settlements estimates to be $1 quadrillion worth of new derivatives (mortgage-backed securities, collateralized debt obligations, and credit default swaps) that have flooded the market.

These derivatives are the root of the credit crunch. Why? Unlike all other property paper, derivatives are not required by law to be recorded, continually tracked and tied to the assets they represent. Nobody knows precisely how many there are, where they are, and who is finally accountable for them. Thus, there is widespread fear that potential borrowers and recipients of capital with too many nonperforming derivatives will be unable to repay their loans. As trust in property paper breaks down it sets off a chain reaction, paralyzing credit and investment, which shrinks transactions and leads to a catastrophic drop in employment and in the value of everyone's property.
Something truly stupefying has occurred, something which has not yet been fully taken in. The United States of America, precisely at its moment of triumph and mastery, its moment of unique preeminence, has chosen to destroy the concept of value itself.

At the risk of offending Catholic readers everywhere, imagine this "parallel universe", a metaphorical, Saramago-like scenario by which I have chosen to describe through analogy the American financial sector's crisis and by extension the social crisis it brings with it:
One Sunday, all over the world, every Catholic, man woman and child, who takes Holy Communion develops a persistent diarrhea and an unsightly rash.... Health authorities discover that the pathogen causing these ailments is only found in consecrated communion wafers... unconsecrated wafers are found to be harmless, scientific tests determine that the transformation occurs precisely upon the Host's elevation and is not due to faulty storage procedures.

Priests all over the world try consecrating other forms of bread, but with the same result: anything any of them consecrates brings on the diarrhea and the rash. The diarrhea and rash are not fatal, but this universal outbreak brings into question all the sacraments of the Church, especially other vital ones of "deferred payment", such as baptism and the forgiveness of sins.

On one hand this rationally inexplicable crisis is taken as the definitive proof of a supreme being, one who actually and unmistakeably intervenes in human affairs, but on the other it also undoubtedly damages the Church's franchise as a credible representative of that being on earth.

Without a viable sacramental role, what would be the status then of the Pope? He would still have the trappings of the office, the "pope-mobile" and the stunning wardrobe, but what of his apostolic authority?

Having proven God's existence, while simultaneously demonstrating his disfavor, would this then lead to mass conversions to Islam or to Pentecostal sects?

What would be its effect on the Italian tourist industry?

The blow-back and knock-on effects of the proven or potential toxicity of the Church's most important assets, its sacraments, might be endless.
Business and the sanctity of property are and have always been America's religion.

In America's case read commercial paper and the dollar for "communion wafers" and POTUS for "Pope" and you get my drift.

America has in a sense committed suicide. Can its stomach be pumped out in time? DS


Anonymous said...

I'd be interested to see the UN come up with an "international reserve currency". It would be the first time the UN has presented a united front on anything, ever.


RC said...

"America has in a sense committed suicide" is not exactly accurate, but the US is quickly approaching mortality especially if the USD fails to remain the reserve currency.
The death of the US economy can be traced back to the seventies and the failure to deal with the energy problems there and then and also to the colossal delusions that set in at that time about having a domestic economy based on any possible type of activity except manufacturing production.
But more than those fatal errors, saying that the current US dollar and economic crisis has anything to do with subprime or the American public is like saying the
Chinese public, decades ago, was responsible for the Gang of Four and the Cultural Revolution. Scum that rose to the top in China and the US are the parties responsible and if one subscribes to the concept that a populace gets the leaders it deserves, then fine, US citizens and Chinese citizens are committing suicide, but to my way of thinking, it is more like a small class of phages has occupied the body politic and economic and they will kill the host and also themselves.

Anonymous said...

America will need a new currency before Geithner and the politicians are finished expanding the debt and destroying the dollar but the solution is a gold backed currency free of government manipulation. The Campaign to Cancel the Washington National Debt by 12/21/2012 through constitutional amendment begins. See our facebook page at

We are also planning to have a booth at FreedomFest 2009, the world’s largest gathering of free minds! July 9–11 in Las Vegas. Ron

Forensic economist said...

True, the consequences of a failure of confidence in the dollar are horrific.

There are those in the US who want the dollar lower against the Euro and against the Yuan/renminbi. That is playing with fire if it starts a run against the dollar.

But what will replace the dollar?

The Euro? The financial industry in Europe is just as weak as in America. European governments would not want the Euro to rise substantially against the dollar. The ECB, however, is unlikely to expand the supply of Euros as dramatically as the Federal Reserve is doing with dollars. The market may force this solution on - when the Saudis and Chinese don't want their reserves primarily in dollars anymore, some of their reserves will have to be in Euros.

An international currency based on something like the SDRs? I don't see that as workable.

Gold? Too small a supply to serve as the world reserve currency. Too easily manipulated; and the supply is concentrated in a few not necessarily stable places.

Nothing? And countriess revert to barter?

Other consequences of a dollar decline would be a much higher price in dollars of anything not produced in the US - such as oil. This would lead to a reduction in ability to project military force around the world.

Foreign creditors of the US would get paid back in depreciated dollars. We have played a neat trick on the Chinese - we got their clothes, electronics, and other goods, and we gave them bits of soon to be worthless paper.

Anonymous said...

Please take up some different themes than "America" into your blog. All this self-centered childish whining is just as bad the self-aggrandizing that is the normal topic of "american" blogs.

For heavens sake, you are in Europe and the world is still big, bright and colourful!

David Seaton's Newslinks said...

Maybe when America sinks into its "black hole" and the dollar ceases to be the world's medium of exchange, then we can stop talking about it. I would be the first to be happy when that happened. Happy for the world and very happy for the Americans who are the first victims of their system.

Anonymous said...

For decades we, in Europe, have known that the use of the dollar as the world reserve currency was one gigantic'scam', yet our politicians, bankers and business leaders colluded in this. Can you please explain why?

bailey alexander said...

Yes, everyone here in Europe knew it was a 'scam'.

But consider the time in history.

After WW11, America was in position to set up the system, the IMF and the world bank. It was the most powerful at that time, it could dictate the terms.


David Seaton's Newslinks said...

Look at Germany, sometimes a country has to be destroyed to survive. Now Germany seems to be the only country in the (blue eyed) world that makes any sense.

bailey alexander said...

Absolutely, I blogged about that last year after spending time in Berlin. Amazing what that city has done.

It's the only country that has such experience because eating East Germany was really, really difficult.

As I've told you, my father in law is German and my husband worked their for many years, I'm very aware of their history, it's painful. All of it.

They've not only learned to figure shit out, but they are one of the few countries that has been forced and learned more than any other, how to apologize for its sins. I've been many times, my grandfather came from Germany after the first war and worked his ass to make stuff happen in San Fran, as did all our german cousins.

Much pride and no surprise.