Doublewood: The World’s Money

An Important Meeting This Week
An important meeting will be held at the end of this week in Shanghai. It is the G-20 finance ministers meeting in preparation for the formal G-20 gathering of the world’s leaders next month. The main topic of discussion is expected to be the state of the world’s currencies and the monetary actions of the various nations.

It all started last month when Japan surprisingly adopted a negative interest rate policy, effectively taxing depositors’ money. The central bankers in Europe, some of whom already have negative interest rate in place, soon reacted with an urgent call for a “new Plaza Accord”. The IMF called China. China agreed that some sort of global coordination leading to an eventual new international currency concord will be vital to world stabilty. The scheduled G-20 meeting thus becomes a forum to attempt to come to some consensus on the way forward.

The Ailing Of The World’s Money
The arrival at the cross-road to the future of the world’s money was generally anticipated. After years of de facto quantitative easing (“QE”) by every major country in the world since the financial tsunami of 2008, the global economy is once again slowing down. All along, practically nobody would have believed that the printing of fiat money (or legal tender that is not backed by any tangible reserve formula) can go on indefinitely.

Japan started this practice as early as 1999 and infamously coined the term “quantitative easing” (a euphemism almost as startling as “comfort women”) to describe a form of monetary policy that all economists back then would have given their thumbs-down to. Ironically, ten years later, all the major countries in the world started to do the same.

The US, which had taken the largest dose of this emergency “medicine” to prevent another Great Depression, was the first to snap out of it a year ago. While trying to head back in the direction of “normal” interest rate, it found itself saddled with even higher debts than before and, therefore, the constraints on the new policy are more potentially hazardous than anticipated. On top of that, the economic and financial conditions of the rest of the world are so troubled that the US dollar keeps going up (which is inconvenient in many ways, including having to pay off debts with more expensive, rather than, cheaper dollars). Suddenly, the US is feeling like a heavy elephant in a global china shop, having to tread carefully, but unsure how. The Fed calls China (with the capital C) and realises that it too is an elephant, maybe even bigger, and unable to convince others that it is telling the truth.

The Forgotten History Of Mr. John Law
The world had conveniently forgotten the history of a Scottish rogue named John Law. In the early 18th century, he counselled France into creating massive amounts of fiat money currency. They were channeled into financial instruments that generated huge amounts of paper profits (John Law called them “wealth”) through speculative trading of stocks. The original intention for the scheme was to help the French monarchy, with this brilliant newfound wealth. pay off its huge pile of debts incurred during the reign of Louis XIV, the flamboyant “Sun King”. This was the famous Mississippi Company bubble, a financial pyramid that ultimately bursted, leaving the French regime in irreparable financial ruin. (One can argue that this, more than any other factor, was at the root for the eventual French Revolution in 1789.)

*See this incredible two-part video on Fiat Money Inflation in France here (Part 1) and here (Part 2).

Today’s QE bears eerie resemblance to the structural elements of the catastrophe of John Law’s exploits. First, fiat money was created to prevent a collapse of the financial sectors. Then, instead of the money being used for deleveraging and channelled into investments in the real economy, it effectively went into the financial speculative sectors (including shadow or “ghost” banking of speculative hedge funds) and propped up the nominal values of financial assets. Finally, this flow of money injection into the virtual financial sectors further widened the gap between the rich and the poor, with marginal demand for real goods and services (which is always more elastic in the hands of the poor and middle class) insufficient to grow the economy at a sustainable rate. Commodity prices all but collapsed. Nations began to play with their monetary policies and currency exchange rates out of desparation, only to adversely affect each other in a vicious cycle.

All of a sudden, capital markets the world over are coughing up values. More people are coming to the realisation that time is running out for a reform of the world’s money and international currency relations.

What A New Plaza Accord Would Take
The Plaza Accord, named after an agreement reached at the meeting of the G-5 nations back in 1985 at the Plaza Hotel in New York, was an attempt to deal with the global financial imbalance highlighted by heavily-lopsided trade and international payment imbalances between the United States and Japan, the major financial countries at the time.

An agreement was reached to allow the Japanese yen to appreciate against the US dollar. Over the course of the following years, the yen appreciated from 250 yen/USD to as high as 90 yen/USD. Japanese stocks and real estate went through the roof, Japanese companies went to the US to buy properties and businesses. Except that all these were financed with debt. When the financial bubble bursted, Japan went deeper into an economic slump and, to this day, has not recovered. Meanwhile, it began printing money as the only way to keep rolling over the debts (instead of capital restructuring) and introduced the world to the age of quantitative easing.

The global monetary imbalance today bears some resemblance to the scenario faced by the G-5 nations in 1985, but there are also vast differences in the economic and geopolitical realities. Once again, the overall monetary imbalance is between the US and an Asian country, this time China. But the world’s power structure is also vastly different this time. In short, how would an agreement be reached among a group of 20 diverse parties, instead of 5 who were substantially aligned?

First of all. China is not Japan, who at the end of the day was a US vassal at that time, for lack of military independence imposed by constitution. Secondly, US is heavily in debt this time, not just to foreign countries, but in the private sector at home as well. Thirdly, Europe is tacitly aligned more with China than the US, its supposed ally, on currency and financial regulatory issues. Fourthly, Britain just got the biggest chunk of bacon from China, being the primary banker of the emergent giant who lacks credit and funding market capabilities. Fifthly, Saudi Arabia, who is so important heretofore to US dollar hegemony by heading the OPEC consortium and undertaking the exclusive tie of oil to USD, has felt betrayed (“back-stabbed”, I was told) by Obama over Iran and Syria.

Most of all, how do China and America find a way to cooperate on such a high level when the US is so bent on picking a fight militarily with China in her front yard? That is why China’s foreign minister, Wang Yi , is making an urgent unscheduled trip to the US. The purpose? To draw the red line, in case the US think tanks and military are still oblivious to China’s core interests and determined will.

The future of war or peace in the world will rest with how the co-dependent partners in the US-China chain-gang work out ways to move forward. If they do, they would have to collectively remove the obstacles of the other independent variables in a complicated, polycentric world. If they do not, the world will go into a potentially unsettling journey, possibly nightmare.




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