Currency Wars

The last week or so has seen some serious instability in both the Japanese Yen and the Swiss Franc. This instability has the potential to become very serious. In my opinion, the wolves {speculators like Hugh Hendry} are testing these currency's defenses; of late, their defenses have proven to be feeble indeed. Like all carnivores, these wolves will move in where they see a weakness and attack. It's happened before.

In 1992, the Bank of England stubbornly refused to raise interest rates to the European norm or to let it's currency float, resulting in an abnormally strong sterling. George Soros, upon advice of Stan Druckenmiller, shorted approximately $10 billion worth of the GBP on Black Wednesday, September 16th 1992. The Bank of England at first tried to defend it's currency's worth, but at the end of the day they simply got out of the way. Great Britain withdrew it's currency from the EERM (European Exchange Rate Mechanism) and formally devalued the Pound. Soros and his wolves made $1.1 billion on Black Wednesday; the BoE lost over $3.7 billion in this debacle.

It was at this point that the world's Central Banks, aghast at how devastating and profitable it was to attack a currency en masse, banded together in an unwritten agreement never to let this kind of thing happen again and that they would assist one another should such an attack occur again.

This last May the EU banking system, with Greece as the first domino, had a world class crisis on it's hands. Large numbers of people, fearing for the worth of the Euro, began doing what all Europeans have done since the 1800s.. get to the Swiss border and exchange your local currency for Swiss Francs. Today it's a little simpler.. you just call your broker and he does it over the telephone. Still and all, this had the effect of making the Swissy skyrocket in value versus the Euro.. and of sucking the liquidity out of Switzerland itself, resulting in a pretty serious bout of deflation. The Bank of Switzerland, like the Bank of England, fought back valiantly.. later it came out that the Swiss National Bank had lost over $8 billion defending it's currency.. and sadly with the same result.. the market forces were too powerful, and the SNB eventually just got out of the way. Speculators were also a part of this, though it must be said this mini crisis had it's genesis in the Euro Zone's problems and not George Soros. For whatever reason.. probably the same old reason (the European banking catastrophe) Europeans began buying the Swissy again in the last week or so. So far, the SNB has stood by and done nothing. When the SNB threatens action, the Swissy goes down.. but after a day or two of inaction, the wolves crank it back up even further. We are rapidly approaching another Black Wednesday in Switzerland. At this point, after taking a beating last May, the SNB very likely isn't strong enough by itself to curb this. It will need help. Other Central Bankers, Bernanke and Trichet in particular, are nervously watching.. and so far, that's all. Their inaction emboldens the wolves. Today the Swissy hit a record versus the Euro. The silence is deafening.. and dangerous. A nation's currency simply cannot be at the mercy of speculators and scared neighbors, yet here we are. The wolves are pocketing millions and with their profits pile on further.

In Hungary, a good percent of all mortgages are written in Swiss Francs, amounting to half the nation's GDP. The problem is, as the Swissy appreciates, so does the mortgage payments of those Hungarians who took out mortgages in Francs. In January, there were 182 Hungarian Forints for each Swiss Franc; today that figure hit 222.. a better than 22% increase. So the average Hungarian worker, being paid in the local currency {the forint}, must then exchange these Forints for Francs with which to pay their mortgages. Thanks to this, Hungarian and the already vastly overleveraged Swiss banks are taking a nasty hit because of foreclosures. It's consequences like this that make currency games dangerous. Hungary is already in the IMF's doghouse. This is being played out in a number of other Eastern European nations.. with predictably bad results.

Japan's problems have been detailed endlessly here.. way too much debt, Bond rates that are way too low. The Yen keeps appreciating versus other currencies because the way other Central Banks lower rates is to buy their own government's bonds. In Japan, the problem is that their bond rates are already so low that lowering them further would make them essentially zero interest, thus making them completely unattractive to even Japanese investors. Therefore the Bank of Japan has very little power left {after two decades of doing this} to affect the rise in it's currency. Speculators, as ever, dog piled onto Japan's problems and bought the Yen. This week the Bank of Japan announced a small bond purchase.. and because it was so small and feeble, the markets immediately pounced, buying the Yen. It was a very wild ride. In the end, as of this writing, the wolves have succeeded in bidding up the Yen past the day of the intervention, all while Japan's government and central bank look on helplessly.

Bernanke and Trichet are rapidly approaching the River Styx.. at some point, they will be asked by the Swiss, and perhaps even the Japanese, to quietly intervene. I think they'll do it because currency wars like this are dangerous to a nation's economic well being, and this is particularly serious when it comes to Japan, the world's second largest economy. A drastic appreciation in the yen will make Japan's exports uncompetitive, thus worsening their already dire debt and demographic problems.

In a semi related announcement, the IMF today announced that they have extended their FCL (flexible credit line) program and have removed the borrowing cap on this program, which was already quite high, should any nation be in need of rescue. In short, it's their way of expanding their ability to loan in any emergency. Today, in the aforementioned Hungary, the Prime Minister said in an interview that his nation should'nt have to abide by IMF rules, though they are happy to take IMF loans. Only the desperate say such things. It's looking grimmer by the day for the Hungarians.. and their unlucky Swiss bankers.

Currency: A History & the Future

The first currency system developed in the region known as the Fertile Crescent; the Babylonians, Assyrians and Persians developed metal coins as a means of exchange and store of value in and around 1,000bc. This advance led to trade, increased prosperity.. and a better form of taxation. But flaws appeared in each of these Imperial systems.. over time, debasement of the coins by unscrupulous rulers occured. Also, in an era where there was no place that was safe to store value, the value of a circulating medium could only be as sound as the army that defended that store. Trade could only reach as far as the credibility of that military. When the Empires fell, so went the wealth one tried to store. By the late Bronze Age however, a series of international treaties had established safe passage for merchants around the Eastern Mediterranean, spreading from Minoan Crete and Mycenae in the northwest to Bahrain in the southeast. Although it is not known what functioned as a currency to facilitate these exchanges, it is thought that ox-hide shaped ingots of copper, produced in Cyprus may have functioned as a currency. In Africa, ivory was used as a currency. This developed in the age of Athens and Sparta into a system of gold, silver and copper coins, which continued throughout the end of the Roman Empire.

Paper money was first used by China's Tang Dynasty {610ad} as these banknotes authorized by the Imperial government were used essentially as letters of credit in place of large amounts of coinage by larger merchants and others such as shipbuilders. The medieval Muslim nations took it a step further, recording the first uses of credit, cheques, promissory notes, savings accounts and loans. In Europe, the first use of paper money was introduced by Sweden in 1661, which issued copper and iron ore notes. They were also the first to bring the sale of stocks to the public.

The problem with several of these attempts, beginning with the ancient Chinese, was the same as today.. the reliability {and corruptability} of those issuing these notes. In Rome, the amount of silver in the dinari was time and again reduced and replaced with base metals. During the Middle Ages, it was a real crap shoot using coin.. one never really knew it's complete content, hence the practice began of actually biting the coin itself. Political changes usually also brought with it the demise of a paper currency or the debasement of coinage.

By 1900, most industrialized nations were on some form of gold standard, where the paper currency could be exchanged for gold. President McKinley signed the Gold Standard Act in 1900 here in the States. This proved a reliable form of currency as well as a store of value. The Federal Reserve Act of 1913 was enacted here in the States, and so began the practice known today as fractional reserve banking, whereby a bank could loan out roughly ten times the amount of cash it had on hand. It was thought at the time that this increase in liquidity would lead to an increase in trade and expansion of the economy, and indeed it worked well for a time. The idea was that there would be enough gold to ensure the value of the physical currency in circulation, if not the entire amount in the credit system, and that this would act as a restraint on Central Bank authorities from printing too much paper money.

Unfortunately for the United States, we began to do just that.. print too much money. By the late 1960s, many investors worldwide {notably Arab states} began exchanging US Dollars for gold in vast sums. President Nixon ended the "gold standard" in 1971 and let the dollar "float".. ie.. letting the markets determine the value of the currency. This came to be known as FIAT money {from the Latin word fiat, meaning "let it be done"} The US was actually one of the last to do this; Britain, Japan and others had long since abandoned the gold standard. Currency markets arose during this period as a way of determining the fair value of a particular currency vs other currencies and commodities. In 1988, the Royal Bank of Australia introduced the first polymer currency {as opposed to paper} with the idea that it would last longer than paper and be much harder to counterfeit. Most industrialized nations quickly followed suit.

In the 1980s, the United States began printing and loaning out vast sums of money; the old ten to one peg of loans to deposits went out the door. Europe and others soon replicated the process, leading to a vast expansion of debt in industrialized societies and the slow but sure degradation in the value of the currency versus finite commodities. Today, big American banks are leveraged around thirty to one; European banks, not to be outdone by the evil Yankees, leveraged themselves up in some cases to sixty to one. In the early 2000s, the price of silver and gold began to rise precipitously versus all fiat currencies. It is, simply put, a debasement of the currency. Some have begun to openly question the worth of this type of currency and are calling for a return of the Gold Standard. Taken to an extreme, the debasement of the currency leads to hyperinflation. The most recent example of this was Zimbabwe, which issued the 100 trillion Z-Dollar note in 2008. Germany, which had been supplying them with the polymer with which to print this, simply stopped selling them the paper.

In all currencies, especially paper, the same problem exists today as did in ancient times.. the percieved value of the currency is only as strong as the nation who does the printing. Confidence is the key to any currency system; as I write this, the confidence of most of the world's fiat currencies is badly flagging due to the banking crisis of 2008 and subsequent Central Bank printing.

At it's heart, the Federal Reserve and other central banking fiat currency systems are, whether intentional or not, a way in which all of a nation's currency in introduced into the system as debt owed to banks, thus empowering banks. It's no coincidence that the biggest buildings in any big city are banks and the wealthiest members of the community are bankers. In my opinion, this is a system {unjustly} designed to give the banks a slice of all transactions in a nation. In short, it's a parasitic system that robs working people of a part of the fruit of their labors. Woodrow Wilson, who signed the Federal Reserve Act under intense pressure, came to regret this act. Well he should. Worse, the system has a very basic flaw; it needs to have an ever increasing amount of debt and currency to function. It's rather like a pyramid scheme; it works well so long as there are more and more people entering the system. The problem is, today this is going in reverse; the system seems to have begun it's final implosion. Texas Reprersentative Ron Paul has been warning us of the flaws of this system and passes up no chance to warn Congress and the people, most of whom have simply tuned him out as a whack job. Until 2008, that is.

In my very humble opinion, this is a currency and financial system who's days are numbered, and well they should be.When this happens, it will happen ungodly fast and the entire financial system will crash, likely leading to Martial Law and a Depression to end all depressions.

In my opinion we need to go back to a simpler system, one where all leveraged transactions are prohibited under pain of prison. One in which the currency is introduced into the system in a manner other than thru banks as debt. One in which the currency itself can reliably store value and would thus be accepted by merchants. If merchants do not trust a currency, they will refuse to accept it in exchange for their goods.We simply cannot allow another parasitic currency system.

So.. what exactly is the future of currency, given that the current system is fatally flawed ? What will be accepted by the people and merchants ?

John Maynard Keynes, the father of an economic school of thought known as Keynesianism who believed that government intervention in the market system made it better, came to the Bretton Woods economic conference in 1944 and attempted to persuade the leaders to introduce a global currency known as the "Bancor". The United States countered with an idea known as the "Unita". Neither came into place. Of late, the IMF has issued what's called SDR's {special drawing rights} against the IMF. It's the first attempt at a currency not under the direct control of a government. Many would like to see this expanded. Many others believe the answer lies in a return to the Gold Standard. In a way, the US Dollar has essentially become an international currency accepted by nearly all nations. But will this last ? I doubt it. Some believe that in this digital age, physical money itself is simply outdated.

In my opinion, what will have to come first is a coin system; copper, silver and gold. After the debacle of paper money and central bankers, most people and merchants will be very hesitant to part with their goods and labors in exchange for some paper with a history of failure. The government might attempt another paper currency, but without the confidence of the people it will in the end fail. I believe that a coin system will come into place in combination with a 'letter of credit" system with a central exchange.. a bonded clearing house perhaps. In the middle ages, the term guilder {later to become the Dutch currency} was used to describe a letter of credit upon a guild {a group of shipbuilders, for example}. Slowly but surely another more advanced system is likely to develop, but it will take decades to rebuild confidence in any paper system, and rightly so. This puts some nations in good positions; others in a weaker position, depending on how much copper, silver and gold one produces. I can see in other nations a coin system where something akin to the gold standard is used, only instead of gold it'll be whatever commodity is locally produced. A "lumber dollar" coin which would be guaranteed by a certain amount of lumber as opposed to gold; even evolving into a basket of commodities envisioned by Keynes. A reputable clearing house could be used for oversight purposes to guard against overproduction in these cases. Clumsy as it is in the beginning, it is at least trustworthy. In other words, a far cry from today's paper notes.

The US Bonds Circle Jerk

"US Treasury data show that China has cut its holdings of Treasury debt by roughly $100bn over the past year to $844bn. ZeroHedge reports that net purchases by the big three of China, Japan, and the UK (Mid-East petro-dollars) have been sliding for two years. In August they bought the least amount of US debt this year"

During World War II, the US Government needed to borrow vast sums of money in order to wage war on two different fronts. The American people, then a frugal, hard working lot, lined up by the tens of millions to buy "War Bonds" with their paychecks and savings. We as a nation got no loans from abroad.. our own people were able to foot the bill thanks to a high savings and very low debt of the average American. Even into the 1980s, the United States was the world's largest creditor nation. Then Alan Greedspan become Fed Chairman.

Today, the US Government spends approximately three dollars for every two dollars it takes in. We need to borrow that extra dollar.. well, $1.5 trillion of them actually.. from somebody. For the last decade, the Chinese, Japanese and English (actually the wealthy Arab states invest thru the UK) have been funding us; the economy was good, deficits were a quarter of today's levels, and the overall US debt picture was fair. It was considered a safe, if boringly low yield, bet.

Today, however, the picture is drastically different for all of the participants. China, the largest buyer of bonds, is having a pretty difficult time with a real estate implosion that's much more serious than Beijing is letting on. They have entire cities that are empty. The mess is, according to Jim Chanos {former VP of DeutscheBank and a man who's made bazillions betting against Enron and other companies and nations that seemed too good to be true} approximately a trillion dollars.. about half the size of China's GDP. Speculators have bid up the price of housing to stratospheric levels.. and we here know the result of such policies. Of late, the Chinese have been buying Korean, Japanese and other Asian bonds.. as well as metals. They're buying gas reserves in Africa. It seems they're simply looking for something to do with the money other than pump it into US treasuries and their historic low rates. Soon enough, they'll be bailing out their banks from this speculator and liquidity induced catastrophe.

Japan is in a different pickle. Their government's debt is more than 200% of their GDP. Their currency is appreciating due to deflation; just today the Bank of Japan threatened to sell yen on the open market; the yen market today was a wild ride for sure. Worse.. and perhaps terminally.. their working age population is entering a terminal decline and the number of pensioners recieving government Social Security and Medicare is rocketing upwards. Simply put, those fewer and fewer working Japanese are simply unable to keep the US afloat. In my predictions for this year, I predicted the Japanese would become net sellers of US Bonds, and indeed they have become just this. This is more than a cyclical or temporary decline.

The Gulf Arabs have also been a reliable source of funds.. but they are also in a financial pickle thanks to declining oil revenues and an increasing youth population demanding jobs and a better life. US Treasuries and their 2.5% yield over ten years just isn't going to cut the mustard; they must develop their own economies. Iran is also a threat, and many have been beefing up their security forces. Abysmal returns have forced many to look elsewhere for better returns.

But.. US Bond yields are near historic lows; indeed the US 2 year bond today reached it's historic low. So.. just who is it that's buying up these Bonds ?? Some of it is foreigners in troubled nations who are abandoning their own sinking ships (fearful Europeans head this list). Some of it is American investors and their Mutual Fund managers, who are seeing the equities markets stall and increasingly are seeking the safety of Bonds. The Fed is also a buyer; just last week they agreed to purchase another $340 billion or so over the next year or so. But the biggest buyers of US treasuries is American banks, who can borrow at 0.5% from The Fed and get 2.5% on the ten year Bond. It's safe, easy and much, much safer than loaning to individuals or businesses. This lovely three legged animal has a problem.. it leaves Main Street with very little liquidity. Obama himself understands this, as does Bernanke; indeed Obama has chided banks several times on this very issue. But he's essentially helpless to change the current situation; he simply cannot order private banks to loan to people they don't want to. Part if it is also the lack of credit worthy applicants; many consumers have too much debt, bad credit, or a reduced income. Deflation is what it's called, and it's only going to get worse as confidence in the US "recovery" sinks on a daily basis. Today the US existing home sales came in at the worse level ever, spurring another "Hindenburg Omen". These are not the headlines that inspire confidence.. or bank lending.

In the short term, the Fed-US Banks-Treasuries circle jerk will hold water, each of them supporting the other, all at the expense of the value of the US currency. But in time, this cozy little arrangement will have to give way as the value of the US dollar begins to crater. Look for physical commodites to continue to appreciate vs the USD, despite the raging deflation all about us. One day this will end very badly, as all numbers games do.. and with it, our way of life. Keep an eye out on Japan; they are a few steps ahead of us in this Keynesian Death March. So goes Japan, so we go. It'll happen with startling speed.