29 June 2010

Currency Wars: Jim Rickards on Financial Warfare

This is likely to be the spin:

The problem is not that an irresponsible Fed and a corrupt Congress ruined the US dollar through a failure in stewardship, crony capitalism, and a series of control frauds culminating in a financial collapse that caused great harm to other countries, particularly in Europe. The dollar is a 'victim' of the evil empire that is jealous of our success and who hates freedom. (Let me have some 'freedom dressing' on my sandwich, please.) Markets are only useful when they do what we wish them to do, when they support our agenda and serve our will to power. The rest of the world is required to obey our enlightened rule, and serve their proper roles in the New World Order."

I am not quite sure where Rickards is coming from on this, but read the entire paper and judge for yourselves. What seems ironic is that the US has been the dominant user of economic warfare, economic hitmen if you will, since WW II. For example, US Banks Financing Mexican Drug Cartels. This is in part the natural outcome of its being the clear financial superpower, supplanting the City of London and the British Empire of private corporations against which the US had itself rebelled successfully, an event which it will commemorate in a few days on 4 July. But it has also gotten much worse in the past twenty years because of the erosion of regulation and the capture and corruption of key political processes.

You should also be aware that one of the financials bestsellers in mainland China is a book, with a recently published sequel, titled 'Currency Wars.' The author is said to fall into the old memes of scheming international bankers, which has been used by some to issue a blanket condemnation and discredit his premise in the West. I confess I have not read it, since it is not available in translation. What is most important is that the book has a wide readership and influence in the Chinese intelligentsia.

"Worse even than the long, slow grind along the bottom described in the foregoing section is a sudden catastrophic collapse. In that context, the greatest threat to U.S. national security is the destruction of the U.S. dollar as an international medium of exchange. By destruction we do not mean total elimination but rather a devaluation of 50 percent or more versus broad-based indices of purchasing power for goods, services, and commodities and the dollar’s displacement globally by a more widely accepted medium.

The intention of Central Bank of Russia would be to cause a 50 percent overnight devaluation of the U.S. dollar and displace the U.S. dollar as the leading global reserve currency. The expected market value of gold resulting from this exchange offer is $4,000 per ounce, i.e., the market clearing price for gold as money on a one-for-one basis. Russia could begin buying gold “at the market” (i.e., perhaps $1,000 per ounce initially); however, over time its persistent buying would push gold-as-money to the clearing price of $4,000 per ounce. However, gold selling would stop long before Russia was out of cash as market participants came to realize that they preferred holding gold at the new higher dollar-denominated level. Gold will actually be constant, e.g., at one ounce = 25 barrels of oil; it is the dollar that depreciates.

Another important concept is the idea of setting the global price by using the marginal price. Russia does not have to buy all the gold in the world. It just has to buy the marginal ounce and credibly stand ready to buy more. At that point, all of the gold in the world will reprice automatically to the level offered by the highest bidder, i.e., Russia.

Basically, the mechanism is to switch the numeraire from dollars to gold; then things start to look different and the dollar looks like just another repudiated currency as happened in Weimar and Zimbabwe. Russia's paper losses on its dollar securities are more than compensated for by (a) getting paid in gold for its oil, (b) the increase in the value of its gold holdings (in dollars), and (c) watching the dollar collapse worldwide."

Jim Rickards, Economics and Financial Attacks