March 2, 2008

We pay for America’s lunch

Posted in International Economy · 17 comments ·

In the 12th and 13th centuries, Venice was the centre of the trading world. Crusaders on their way to and from the Holy Land came through the great city, as did merchants of all sorts.

The streets were awash with coins from all over the world, of gold, silver and bronze. Thus the money changers of St Mark’s Square were pivotal characters in the commerce of the city – and, indeed, the globe. Every day, the money changers sat at their benches (called banca), coins piled high in front of them, shouting varying exchange rates as currency ebbed and flowed. If a Crusader ship docked, laden with coins from the Levant, the value of the Levantine coins would fall in response to the huge new supply, and vice versa.

When a money changer went broke, it was customary to smash his bench. The resulting broken bench or (banca rotta) was borrowed by Norman merchants on their way home from the Crusades to Ireland and England, giving us the word bankrupt.

Looking at the dollar as it plunges to record lows against the euro, the image of the Venetian money changers and their smashed benches comes to mind – not because America is anywhere near bankrupt, but because the dollar has always been a leading indicator of what is going on in the economy.

This weekend, much will have been written about the plunge of the greenback. A considerable amount of analysis will focus on Ben Bernanke’s speech last Wednesday, which hinted at bank failures in the US, an ongoing problem in the housing market and the Fed’s undertaking to cut rates at all costs. That was enough – on its own – to send the dollar packing.

There is more than enough bad news in the US at the moment to send the dollar southwards – take any indicator and you can read recession into it.

For conspiracy theorists, there is another reason which is tied to the electoral cycle. Followers of the relationship between the Fed and the White House will be mindful of the fact that George Bush Senior blamed Alan Greenspan for not cutting rates quickly enough in 1992 and thus handing the recession issue to Bill Clinton, who subsequently won the election on the economy. Bernanke might not want the same legacy with the Republican Party in the future.

Those with an attention span slightly longer than a foreign exchange trader will point to the simple fact that the Americans have not been saving. They have been using their houses as large ATMs, withdrawing equity and spending it to ‘‘keep up with the Joneses’’. Years of this carry-on has pushed the US trade deficit and current account deficit into delinquent territory.

This analysis suggests that the US has to stop spending, risk a recession and come out the far side with more savings. The reason savings are essential is that the gap between what it saves and what it invests has to be bridged by foreign borrowing – which is the current account deficit. The US does not want to countenance a fall in investment because investment is what keeps productivity high and keeps companies like Apple, Microsoft, Pixar and Goldman Sachs pre-eminent. So the choice America faces is to keep interest rates high to attract surplus foreign cash or allow its currency to fall so that American assets become so cheap that foreigners invest in the US because it is such good value.

Either way, America is for sale – to the lowest bidder! Whatever the proximate reason for the dollar’s fall last week, if we go back to our money changers in Venice with their broken benches, we see that something much more fundamental and long term is going on. Think about the expression ‘‘as good as gold’’. This comes from the idea that gold was always good and nothing could take the shine off this most exotic of metals.

Gold was an incorruptible store of wealth. Over the years, gold was corrupted and tampered with, leading to a fall in the value of certain currencies. The money changers were declared ‘‘banca rotta’’ or bankrupt if they constantly made the mistake of holding a currency that was falling in value and the major reason – then and now – for a currency falling in value, was that there was too much of it minted, or it was being constantly debased. In those days, gold coins were debased by kings who wanted to raise more money for wars, so they added baser metals to the coins in order to mint more of them. However, you can’t fool all the people all the time, and inevitably these debasers were exposed.

If we fast forward to our modern age, we see that the US, in particular, has been debasing its currency for years. Over the past century, the world has gone through periods of tying currencies to gold. Eventually, in 1968, the United States – facing mounting costs from the widening war in Vietnam – permanently took the dollar off the gold standard. Up till then, the amount of dollars in circulation had to be matched by the amount of gold in the Federal Reserve’s faults. If the US printed more dollars, the dollar/gold rate would fall. Since then, all governments have followed suit.

In the past four decades, we have seen the Fed increase the amount of money in circulation at a rate of between 5 and 10 per cent per year, while pretending that this is not happening. The US also persuaded other central banks that, instead of linking their ability to print money to gold, they should link it to US treasury bills. The world fell for this. So we have a situation where the US prints money to pay for its day-to-day spending and then borrows the cash from the rest of the world, issuing IOUs in this increasingly worthless currency as collateral for the loans. You’ve got to admire such chutzpah!

Not surprisingly, the dollar has been on a downward path for a few decades. Yes, there have been years when it bucks the trend, but ultimately the purchasing power of the average American Joe Soap has been embezzled relentlessly.

So far, there has been precious little questioning of this long-term debasement of the world’s biggest currency. Maybe the reason for this is that it is the right thing to do. If the rest of the world is stupid enough to give the US a free lunch, then why shouldn’t the Americans take it? If I were an American, I would certainly be content with that.

All the while, a US government, in denial, can adopt St Augustine’s line of ‘‘give me chastity and continency, but not yet’’. This was probably an expression the Venetian money changers were familiar with because, in their time, St Thomas Aquinas – a fan of St Augustine – preached about virtue and the next life, while they tried to turn a few quid and avoid bankruptcy in this one.

  1. John Q. Public

    It could be argued that unlike the 12th and 13th centuries, today we have emormous banks that lend out too much money and are aguably the cause of too much money in circulation. Did people in those days borrow from Peter to pay Paul like we do today? I doubt it. Mass hedonism and keeping up with the Joneses is the cause of so much foreign and domestic borrowing. USD$1.51 to the Euro, great for a shopping holiday in NY though!

  2. John Q. Public

    what is this annoying word ‘sub’ and what does it mean? For Christ’s sake say something intelligent.

  3. nick

    John Q,

    Who took the jam out of your doughnut today?? The reason I put in the word “sub” is in order to “subscribe” to the thread and have follow up comments emailed on to me.

    Quite simple and innocent and not worth getting your knickers in a twist over…

    Apologies for having made you spend approx half a second of your day having to read thru my constant “rant”.

    - yours etc,


  4. VincentH

    Not as far back. But in the 1830ish, N M, Rothschild and ten of his clerks went to the Bank of England with bank paper, where he demanded payment. He did this for a number of days, until he was invited by a usher to visit the boardroom, there he was asked why, his answer was that until the Bank accepted Rothschild paper he saw no reason why he should accept theirs.
    Fast-forward to a oil producers demand for the same payment and you can understand why the USA went off the standard.

  5. Paul

    While you would feel sorry for an individual who may be about to lose their home/job etc… the USA needs to feel the pain of a recession and wake up to some financial realities!!!

  6. John Q. Public

    The banks create the financial realities in the first place so maybe they need to be kept in check. They are like that the little devil on your shoulder that says ‘go on, you know you want to! spend, indulge in whatever you want, we’ll lend you the dough’. The angel on your other shoulder says ‘you better not’ but we give in to our desires. With proper regulations there would not be 1 million plus foreclosures, a credit crunch, a northern rock and debt at mamouth proportions. In fact we might not be having this conversation.

  7. AndrewGMooney

    No, Ireland won’t pay for America’s ‘free lunch’. America will. But the consequences for Ireland may be uncomfortable to witness.

    America has been able to dictate the terms of engagement to the rest of the world economically, culturally and militarily. Bretton-Woods. Disney/Pixar. Pax Americana. Etc. For how much longer?

    America has been on ‘The Mother Of All Spending Binges‘, whilst simultaneously funding ‘The Mother Of All Futile Battles’ in Iraq. Funded by writing I.O.U’s to the rest of the world. The assumption being that the incredible American success story of economic ingenuity would continue uninterrupted. Forever?

    But globalisation isn’t the one-way traffic of cheap Chinese goods to Wal-Mart. Now Americans realise that their collapsing home equity ATM’s no longer work and they have to get back to unfashionable ideas of thrift, hard-work and saving for a rainy day: Someone will have to take the blame. The rest of the world?

    U.S Protectionism will re-emerge. Not that it will work. The dreaded ‘decoupling’ looks increasingly feasible for the Eurozone and other markets.
    What then? The wounded pride and anger at the debauched Dollar will puncture the very confidence that America relies upon to continue.

    In a buoyant ruthless tooth and claw Capitalist society: There’s an acceptance of hire-and-fire laissez-faire. But when there’s no other jobs to go to? No safety net other than food stamps and night shelters? There’ll be as big a border problem with Canada as there now is with Mexico.

    Societies with ‘social safety nets’ are more likely to cope with major upheaval, not less. Look at Finland. As for those where the only alternative to the current job is not temporary assistance but living in your car….Hardly a stimulus for innovating anything other than new levels of serf-slave abject fear. Can the Knowledge Economy work on the same basis as the Industrial Economy? No.

    America is predicated on endless unstoppable economic success. But the inflated balloon must burst. It’s too late to deflate. Bernanke’s ‘stimulus package’ will not work. It can’t unless fundamental laws of economics have been re-written. You have to pay for goods and services consumed. Eventually. And you have to produce as well as consume. That’s the basis of trade.

    The ‘risk-enterprise’ that is The New York Port Authority cannot raise credit at anything other than extortionate rates. Warren Buffet declares “Recession! Shares too expensive! Wait till they fall much further before you buy!”

    What will happen to Eire? Intel move to Poland? The Euro cost-base is unsustainable now and will get worse. The Bundesbank (sorry ECB) will not rescue the collapsing Irish (and Spanish) property markets.

    And it’s all David’s fault!

    If only he hadn’t caused this ‘contagion’. Actually, Peter Schiff is the real culprit, predicting correctly the gold fever, the dollar and housing collapse, and numerous other bubble-popping scenarios. Hilarious archive footage of the ‘pariah’ on American media here:

    At least you lot don’t live in the U.K and haven’t had to put up with wall-to-wall footage of Brave Prince Harry till you smash your fist through the patio door.

    PS: Anyone feeling smug at America’s current misfortune deserves a smack in the gob. Marshall Plan. Cold War. Enough said.

  8. Fergal Treanor

    This is a very interesting article David.

    So: in your view, should Ireland seek to emulate Germany, France, and other succesful economies with a policy of slow, stable growth, a strong state invovement in the economy, and lots of public investment in education, health, infrastructure? Or should we continue to drive ourselves bankrupt with our orienttion towards US and British style “boom and bust” capitalism?

    Fergal Treanor

  9. Malcolm McClure

    What a lot of Weary Willies. Its no wonder that Economics is called the Dismal Science. At least Americans have a “Can do” attitude and more or less invented the term “Get up and Go”. As long as most Americans retain that fundamentally optimistic attitude, their economy will thrive again.

  10. Dan Hayes

    Speaking as an American, let me state that the “Get up and Go” has “Gone Off and Went.”

    America today, and for quite some time, has been populated by a bunch of narcissistic neer-do-wellers, who will curl up and die if they are ever subjected to a serious recession, never mind a 1929-type DEPRESSION!

    Don’t forget that in the 1930′s America was up for grabs, and Americans of that generation were a relatively tough, unspoiled lot!

  11. Jonathan

    Very interesting,
    I suppose the key message is that no matter how clever or complicated your financial trickery is, you can’t get away from the fundamentals.
    It’s looking like another bout of stagflation is about to hit the global economy and recession is imminent. Like previous episodes of stagflation, it all seems to stem from the sudden drop in spending, either public or private, which was originally fueled by unsustainable borrowing/bonds.
    Governments, by and large, try to keep their borrowing and spending at a reasonable level and this is accepted as good financial governance. However, allowing banks and financial institutions to dole out vast sums of borrowed money to the public, which is then spent, is equally as bad.
    Fundamentally, governments have abdicated responsibility for financial governance to banks and financial institutions with predictable results. Ultimately a new set of tools is needed to keep the banks in check.

  12. shtove

    I’m liking the Renaissance theme!

    News out of the US is very worrying – WTF are they trying to do to themselves?

  13. liberty dog

    Ron Paul has been speaking about this for years! But of course, the media ignores him and paints him as a lunatic. Google Ron Paul.

  14. Garry

    Very interesting, i commented on a previous article that the US were now starting a “War on Financial Probity” with their reactions to the credit crunch being effectively to try to reflate the bubble again. Its becoming clear the ECB aint going to join them on this; despite what the property shrills are saying here; …. they have resisted a lot of pressure to cut their rates.

    And it looks like OPEC aren’t buying the IOU’s either.
    If you think petrol has gotten expensive here, just check the USD prices for oil over the past few years… they are going up even faster than the USD is dropping against the euro. This could well be geology, i.e.; OPEC cant actually raise production but it could also be the start of their move to diversify from the dollar.

    Either way OPEC are sending a very powerful signal to the US that financial tricks like devaluation won’t get them a free energy lunch and while they might pay in $, they’ll be at least tracking the euro now… This will constrain the US’s room for manouvure probably just as much as the lack of cooperation from the ECB.

    Naomi Kliens latest book “The Shock Doctrine” gives numerous examples of how the world bank has exploited financial crises in many parts of the world over the years to further their own economic ideology. Its not that surprising that the medicine being dished out today is gentler now that a crisis is at home. But you can bet that this is being resented around the world.

    I’m not feeling at all smug at the US’s misfortune, far from it…. apart from our selfish interests the world needs a strong US, if you don’t think so, just imagine if china or russia were running the show.

    interesting times ahead…

  15. FreedomFighter

    The bad news – the next US president discussing economics. The most telling bit is the very last sentence. The candidate Ron Paul, is the only remaining challenger to McCain. Hence the media says it over, because the media does not want you to hear what Ron Paul has to say. Obama (the Hope Pope) and HillaryCare are about as knowledgeable as McCain. Even Cowen (with the words put in front of him by officials) is better than these three dunces…

  16. Rob

    very interesting. Would anyone offer their views as to whether a US collapse drag the EU with it or will it affect countries more like Ireland who have large american investments in ireland? Ultimately America needs to stop spending?

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