Posted on 07/31/2009 7:04:41 AM PDT by SeekAndFind
During the recent financial crisis, I didn’t meet anyone else who was invested in stocks and bonds. I guess I was the only one. Everyone else was holding “cash,” as they often quietly boasted. But even if your money is kept under a mattress, cash is best understood as a zero-coupon bond, in most cases drawn against an overdrawn nation-state.
Cash may be king, but the sovereign looks more temporary than a Romanov heir living in a rented villa in the south of France.
The risk comes about because, in order to be held in any amount, money has to be deposited in banks, of course, which during the crisis wiped away more investor capital than did Bernie Madoff. (At the end of 2006 Citigroup had a market cap of $273 billion; today it is $16 billion. And at least it stayed in business.)
Before getting into the ability of the Obama administration to spend and borrow further, and the wisdom of those who hoard cash, a bit of perspective:
Paper money had its origins as bills of acceptance. The bearer of the circulating note could present documents at a warehouse and collect (should no cash be on hand) bales of cotton or coffee.
Subsequently, governments decided that they, too, ought to be in the wealth creation game, and they began issuing national currencies. Literally and figuratively, depending on what was stirred into the vats of the paper companies, the deals amounted to money for old rope.
In some societies, bondholders (that is, all those with folding money in their wallets) demanded convertibility of currency into silver or gold. In countries off a gold or peg standard, however, money amounts to little more than an unsecured loan to a national government, which today is the best way to think of the American dollar.
During Reconstruction, the divide in the United States was between those that demanded a currency exchangeable into gold (Wall Street banking houses) and those that wanted convertibility into silver, if not wheat, corn, or sorghum (farmers).
Not surprisingly, despite the eloquence of William Jennings Bryan, the gold interests defeated the farm lobby, which made it impossible for loans to be repaid with cheap — that is, inflated — dollars.
The American money supply became a function of gold purchases and production, if not hostage to the fortunes of price fixes, corners, and oligopolists, who loved nothing more than to squeeze the economy into periods of recession. Deflation, when general prices fall, is a banker’s best friend, as it takes that much more “real” money or hard assets to repay a loan denominated in gold-backed dollars.
The strength of the American dollar was confirmed in the 1944 Bretton Woods conference in Washington, which both fixed the international price of gold and the supremacy of the greenback. Suddenly the dollar was as good as gold. Why mine or buy gold when you can print it?
Nothing other than the U.S. government’s promises restricted the amount of dollars that could be issued into world markets. No world central bank actually monitored the ratio of circulating currency and gold reserves, and few with dollars ever went to the Treasury to swap cash for gold ingots.
The costs of the Vietnam War and the Great Society forced the dollar off the gold standard in 1971. To pay for the guns and butter, Washington increased the money supply (printed dollars). The only monetary constraint was the supply of ink and paper.
For a while trade partners continued to accept payment in dollars, believing that the U.S. economy was stronger than any other. The dollar might have “floated” in relation to other currencies, but at least it wasn’t the Russian ruble or the Argentine peso.
The problem with floating currencies is that they are susceptible to runs should the issuing country run up budget or trade deficits. Why should anyone lend money to a bad business just because the enterprise is a country with a flag?
As U.S. deficits increased, global investors edged away from the dollar into the German mark, the Japanese yen, the Swiss franc, the Euro, and more recently baskets of Asian currencies.
Which brings us to today. Only goodwill (defined both as an accounting term and as political deference to military might) now supports the U.S. dollar as a reserve currency, which is what allows the United States to issue dollar-denominated bonds in world money markets.
It is this borrowing capacity that allows the Obama administration to bailout the banking industry, offer to pay for universal health care, fight colonial wars in the Middle East, stimulate the economy, send billions to Egypt and Israel, buy out General Motors, and subsidize every windmill start-up company in Nancy Pelosi’s home district. (Madoff’s problem was that he failed to set himself up as a country. He otherwise understood deficit spending.) But the shell game requires full faith in the dollar.
For those riding out financial storms by “sitting on cash,” here is what’s under your seat: in recent months U.S. federal debt has grown to $11.3 trillion, almost equivalent to gross domestic production. About one quarter of this indebtedness, or $2.8 trillion, is held abroad, and China and Japan hold just under half of those assets (liabilities to Uncle Sam).
Elsewhere on the American balance sheet is another $11.4 trillion in household debt, an annual trade deficit of about $725 billion, and a federal budget deficit that is estimated in 2009 to be approaching $1.8 trillion. That’s if the economy grows at 3 percent.
Off-balance sheet risks, what accountants call contingent liabilities, include about $10 trillion in new bailout guarantees (Fannie Mae, Bear Stearns, Countrywide, and whatever the administration launches as its New Deal of the Day). None of the above includes the unfunded liabilities of Social Security ($41 trillion), which, by comparison, make the shares of Lehman Brothers and AIG look like Scottish bonds held for widows and orphans.
The geese laying the golden eggs of U.S. financial stability are the printing presses of the U.S. Treasury, and, for now, those collecting them in their Easter baskets include a number of countries and regions perhaps tiring of American arrogance, if not of the drop in the dollar’s value. Who would blame such popular targets of moral abuse as China, Russia, Switzerland, Arabia, or Latin America for dumping their dollar-denominated assets?
All that lies between the U.S. dollar and a financial Armageddon is the Faustian house of credit cards under which Asian economies invest their trade surpluses in U.S. Treasury instruments — to keep the dollar strong, their own currencies weak, and purchases brisk between the likes of Wal-Mart and the Asian Greater Co-Prosperity Sphere.
Sooner than we think, China and Japan, like all nervous creditors, may send the United States a letter, suggesting that, henceforward, if Washington needs to borrow money, the bonds be issued in renmimbi, yen, or a basket of Asian currencies (a Pacific Euro).
Wall Street bankers did the same to the farm interests in the late nineteenth century, when they insisted that debt be based on a gold standard, as opposed to “free silver.” President Obama may be as eloquent as William Jennings Bryan. But at that point he will need to use all his oratory for the business of selling junk bonds.
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Matthew Stevenson was born in New York, but has lived in Switzerland since 1991. He is the author of, among other books, Letters of Transit: Essays on Travel, History, Politics, and Family Life Abroad. His most recent book is An April Across America.
Anyone care for California Dollars? Does the Constitution allow for state currencies?
whats the difference between Renminbi and yuan.
Would you lend this guy the money? Now... imagine you are the Chinese Minister of Finance and the bum is Uncle Sam...
Two words. Same currency. Its a cultural thing...
Why the hell would China ever buy US bonds. They should be investing in their own country.
RE: whats the difference between Renminbi and yuan.
It is the same. RMB is the abbreviation of Ren Min Bi, or the People’s Money. It is the official currency in China.
Yuan is the base unit for RMB - just as Dollar in USD. This is the currency system in China:
Fen = cent
Jiao = dime
Yuan = dollar
So Yuan and RMB is not always the same (as Yuan is just one of the currency units in RMB), but they can often be used interchangeably. 2500 RMB and 2500 Yuan is exactly the same amount of money.
I am not an economist, but have often wondered if the dollar's strength is tied to our military might. The writer seems to confirm this idea.
So, if we cut our military and continue to spend .....?
I’ve read elsewhere that one is a domestic currency, while the other is used in foreign trade.
It provides the Chinese authorities with more levers to manipulate, AFAIK.
The author states that floating currencies act as a check on government gone wild. How is this a bad thing?
Sooner than we think, China and Japan, like all nervous creditors, may send the United States a letter,
Bingo, someone is getting it.
And all those Nobel economists, with few of them having a clue.
The Suntrade Institute says that recession, depression, inflation, are two forms of the same thing: the failure of the subject nation to produce. Either there is no money, because nothing is produced for return (depression), or there is worthless money, printed blatantly in spite of nothing being produced for return (inflation).
In the long run, and that is indeed "sooner than we think," the only way out of the spiraling abyss is conservatism; that is each individual facing the truth about one's self, one's worth, and one's responsibilities. Communism, Leftism, Socialism, is exactly the opposite: you are not to blame but rather others, the government (others) shall take care of you.
The whole success of America was based on the character of the individual. And that character was built through the imposing world of human freedom.
Johnny Suntrade
Let the world markets crast 25% again and we’ll see how quickly money flocks back into US Treasuries.
Because if they stopped doing it the Dollar would fall to a degree that china couldn’t sell goods in the us anymore. They started doing it because they wanted to have some influence on the exchange rates and they had to put the dollars they where payed for somewhere.
at that yield noone will really want to buy them - they will rather invest into infrastructure, commodities or companies.
Old Chinese Proverb: "Never lend money to people who can't pay it back."
Actually, I did rather well in Swiss Francs last time!
It's a bit more nefarious than that. A sovereign's promise to repay principal and interest is an implicit claim -- a presumption -- on a portion of the productive labor of current and future generations.
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