Emerging Markets Eye Insurance Against the US Dollar, Euro

Aside from the pledge to assist in the rescue of the EU, key emerging markets led by the BRICs and South Africa discussed insurance options that goes around the US dollar.

From the China Money Report,

The BRICS countries said on Monday that they’re considering setting up a foreign-exchange reserve pool and a currency-swap arrangement as financial problems threaten to spread across the global economy.Leaders of the five-member group —Brazil, Russia, India, China and South Africa— also said BRICS is “willing to make a contribution” to increase the International Monetary Fund’s ability to rescue troubled economies. President Hu Jintao joined his counterparts from other BRICS nations on Monday morning in the Mexican resort city Los Cabos ahead of the start of the G20 Summit.

According to the Chinese Foreign Ministry, the leaders discussed the currency swap and foreign-exchange reserve pool ideas and tasked their finance ministers and central bank chiefs to implement them, according to China’s Foreign Ministry.

Swap arrangements, which allow nations’ central banks to lend to each other money to keep markets liquid, and the pooling of foreign-exchange reserves are contingency measures aimed at containing crises such as the one roiling the eurozone, analysts said.

Zhang Yuyan, director of the Institute of World Economics and Politics affiliated with the Chinese Academy of Social Sciences, said the new mechanisms established by the emerging markets themselves, who “know their current conditions and demands
much better”.

Amid the global economic slowdown, the pooling of foreign-exchange reserves will help BRICS countries to fight the lack of market liquidity, beef up their immunity to financial crises and boost global confidence, Zhang said.

Contributions to this “virtual” bailout fund, as Brazil’s Finance Minister Guido Mantega put it, would be tied to the size of each BRICS member’s currency reserves, he said. The five leaders also discussed BRICS’ participation in replenishing the IMF’s lending capital. Hu said the G20 should encourage and support the eurozone countries’ adoption of fiscal controls and spending cuts as efforts to improve confidence in world markets. The leaders also urged the IMF to carry out promised reforms of its quota and governance systems. Mexico, which was hosting the G20 Summit on Monday and Tuesday, has said it will use the meeting to press the world’s largest economies to increase IMF resources and build the fund’s capacity to intervene in the European debt crisis.

While these may be constitute added signs that much of the world seem to be getting antsy with the unfolding events in the developed economies, swaps and foreign reserve pools won’t do much when the whole paper money system goes into flame.

The reason for this is that much of the world’s banking and financial system remains anchored on fiat currencies of the western world, where the US dollar and the euro constitute 90% of global reserve currencies (see chart from Wikipedia.org).

Besides, the monetary system of emerging markets operates from the same fractional reserve system as their developed peers, which means that like their developed peers, EM politicians will be seduced to used inflationism to achieve political goals.

Instead, what these economies should do would be to ramp on gold acquisition, and possibly consider a quasi-gold standard possibly through a gold based currency board (as proposed by Professor Steve Hanke) or a return to the gold standard or allow for currency competition with the private sector (free banking, free currency competition as proposed by Ron Paul and Professor Lawrence White).

Since any of the proposed monetary reforms would entail restriction in political actions and simultaneously require massive liberalization of respective economies, these won’t likely be palatable with incumbent political agents, who under such circumstances, lose much of their current privileges (Europe’s deepening crisis are manifestations of these).

Thus, it would likely take a deeper crisis (most likely a currency crisis) to force real reforms in the system.

Essays on Proposed Monetary Reforms

I am supposed to take my day off today.

But I stumbled upon a gem of collection of wonderful essays on proposed monetary reforms from my favorites: Ron Paul, James Grant, Gerald O’ Driscoll, George Selgin, Lawrence White, Judy Shelton, Roger Garrison, Kevin Dowd, Kurt Schuler and more.

Read them at Cato Institute Journal called Monetary Reform in the Wake of Crisis (Volume 32 Number 2), a forum which was held in November of last year.

Read some of the statements by Ron Paul, Ben Steill (CFR), Allan Meltzer (Carnegie Mellon University), Lawrence White (George Mason University), Gerald O’Driscoll (Cato Institute) and Robert Zoellick, Jr. (World Bank) at the forum here

Ron Paul: Federal Reserve System is the Epitome of Crony Capitalism

Here is the gist of US congressman Ron Paul’s courageous talk before the Committee on Financial Services, Subcommittee on Domestic Monetary Policy & Technology, United States House of Representatives, May 8, 2012 (From Lew Rockwell)

Much confusion exists over what the Federal Reserve System actually is. Some people claim that is a secret cabal of elite bankers, while others claim that it is part of the federal government. In reality it is a bit of both. The Federal Reserve Board is a government agency, while the Federal Reserve Banks are privately-run government-chartered institutions, and monetary policy decisions are made by the Federal Open Market Committee, which has members from both the Board and the Reserve Banks.

The Federal Reserve System is the epitome of crony capitalism. It exemplifies the collusion between big government and big business to profit at the expense of the taxpayers. The Fed's bailout of large banks during the financial crisis propped up poorly-run corporations that should have gone under, giving them an advantage that no other business in the United States would have received. The bailouts continue today, as banks maintain $1.5 trillion worth of excess reserves at the Fed, reserves which were created through the Fed's purchase of worthless securities from banks. The trillions of dollars that the Fed has injected into the system have the goal of forcing down interest rates. But the Fed fails to realize that interest rates are a price, the price of money and credit, and that forcing interest rates down will only create an even bigger bubble and an enormous economic depression when this entire house of cards comes falling down.

The Federal Reserve is statutorily required to focus on three aims when engaged in monetary policy: full employment, stables prices, and moderate long-term interest rates. In practice, only the first two have received any attention, the so-called "dual mandate." Some reformers have called for the full employment mandate to be repealed, in order to allow the Fed to focus solely on stable prices. But these critics ignore the fact that stable prices are not a desirable goal. After all, with increasing productivity and technological innovation, the natural trend for most goods is for prices to decrease. By calling for the prices of goods to remain stable, the Fed would have to inflate the money supply in order to counteract this trend towards price declines, pumping new money into the system and creating economic distortions. This is exactly what happened during the 1920s, as the Fed's monetary pumping was masked by rising productivity. The result was stable prices, but the malinvestment caused by the Fed's loose monetary policy became evident by 1929. There is no reason to expect that focusing on stable prices today would have a dissimilar outcome.

Other reformers have called for changes to the composition of the Federal Open Market Committee, the body which sets the Fed's monetary policy objectives. On Constitutional grounds, the FOMC is undoubtedly problematic, as government appointees and the heads of the private Federal Reserve Banks work together to set monetary policy objectives that directly impact the strength of the dollar. While all of the members of the FOMC ought to be confirmed by the Senate, debates about the size of the FOMC or whether Reserve Bank Presidents should make up a majority of the members or whether they should even serve at all are largely a sideshow. While the only dissent to monetary policy decisions in recent years has come from Reserve Bank Presidents, there is no reason to think that expanding the FOMC to include more Reserve Bank Presidents would lead to any greater dissent or to any substantive changes to the conduct of monetary policy.

Another proposal for reform is for outright nationalization of the Fed or its functions. No longer would the Fed create money; that function would be taken up by the Treasury, issuing as much money as it sees fit. No longer would the Treasury issue debt to cover fiscal deficits, it would just issue new money to cover budget shortfalls. If what the Fed does now is bad, allowing the Treasury to print and issue money at will would be even worse. These types of proposals hearken back to the days of the first greenbacks, which the U.S. government began issuing in 1863. A pure fiat paper currency, unbacked by silver or gold, the greenbacks were widely reviled. Only once the greenbacks were made redeemable in gold were they accepted by the American people. The current system of Federal Reserve Notes is even worse than the greenback era in that there is no hope that they will ever be redeemable for gold or silver. The only limiting factor is that the Federal Reserve System only creates new money when purchasing assets, normally debt securities. Allowing the federal government to print money without at least a nominal check on the amount issued would inevitably lead to a Weimar-like hyperinflation.

So what then is the solution? The Fed maintains that a paper standard can be adequately managed without causing malinvestment, inflation, or other economic distortions. If the Fed were omniscient and knew the wishes, desires, and future actions of all Americans, this might be possible. But the Fed cannot possibly aggregate or act on the information necessary to engage in monetary policy. The actions of hundreds of millions of individuals, all seeking to better their position in life, acting purposefully towards that aim, cannot possibly be compiled into aggregates or calculated through mathematical equations or econometric models. Neither a single person, nor the members and staff of the FOMC, nor millions of people with millions of computers working in a new Goskomtsen will ever be able to accumulate, analyze, and act upon the information required to create a centrally planned monetary system. Centrally planned fiat paper standards such as the one currently in place in this country are doomed to failure.

This brings us to the question of the gold standard. The era of the classical gold standard was undoubtedly one of the greatest eras in human history. For a period of several decades in the late 19^th century, largely uninterrupted by war, the West made enormous advances. Economic productivity increased, art and culture flourished, and living standards rose so that even the poorest citizens lived a life their forebears could have only dreamed of.

But the problem with the gold standard is that it was run by the government, which exercised a monopoly over monetary affairs. The temptation to suspend gold redemption, so often resorted to by governments throughout history, reared its head again with the outbreak of World War I. Once the tie to gold was severed and fiscal restraint thrown to the wind, undoing the damage would have required great fiscal austerity on the part of governments. Emancipated from the shackles of the gold standard, the Western world proceeded to set up a gold-exchange standard which lasted not even a decade before the easy money policies it enabled led to the Great Depression. While returning to the gold standard would certainly be far better than maintaining the current fiat paper system, as long as the government retains the power to go off gold we may end up repeating the same mistakes that occurred from 1934 to 1971 as the government went first off the gold coin standard and finally off the gold bullion exchange standard.

The only viable solution for monetary stability is to get government out of the money business permanently. The way to bring this about is through currency competition: allowing parallel currencies to circulate without any one currency receiving any special recognition or favor from the government. Fiat paper monetary standards throughout history have always collapsed due to their inflationary nature, and our current fiat paper standard will be no different. The Federal Reserve is currently sowing the seeds of its own destruction through its loose and reckless monetary policy. The day of reckoning may still be many years in the future, but given the lack of understanding on the part of the Federal Reserve's decision makers, it is quickly coming upon us.

Incidentally and ironically archrivals Ron Paul and Fed Chair Ben Bernanke had a face to face breakfast meeting the following day.

Here’s the Wall Street Journal Blog reporting on what transpired.

Still, Wednesday’s breakfast brought together two figures who publicly agree on very little. A longtime critic of paper currency and fan of the gold standard, Mr. Paul’s fiery Fed-bashing has enthused his campaign trail supporters, who often start rallies with loud chants of “end the Fed!”

Mr. Bernanke, meanwhile, dedicated a significant chunk of his first lecture at George Washington University in March to enumerating the flaws associated with a system in which the dollar is valued at a fixed price per unit of gold.

So did Wednesday’s meeting overturn any deep-set beliefs?

“He’s for the gold standard now,” joked Mr. Paul.

End the Fed. End Central Banking. End the politicization of money.

Vietnam Banks Pay Gold Owners for Storage

Here is an enlightening piece from Tim Staermose of the Sovereign Man.

Here’s something you don’t see every day: Banks in Vietnam will actually pay YOU to store your gold in one of their safe deposit boxes. I was pretty surprised to find this out for myself; neither Simon nor I have seen it anywhere else in the world except here.

This is actually how banking used to be. The original bankers were goldsmiths– big burly guys who worked with gold on a daily basis. They had the security systems already established, and, for a fee, they were willing to let you park your gold in their safes.

Eventually, goldsmiths got into the moneylending business; instead of charging a security fee, they would pay depositors a rate of interest for the right to loan out the gold at a higher rate of interest.

Goldsmiths’ reputations lived and died based on the quality of their loan portfolios, and their consistency of paying back depositor savings.

Today that’s all but a footnote in history. Except in Vietnam.

Read the rest here.

Interesting to note that despite technical political restrictions to do so by Vietnam’s authorities, whom sees gold as a constriction to their activities, paying fees to gold depositors seem to have become an ingrained practice by Vietnamese bankers. The simple reason for this is that gold ownership has been the main preference of the average Vietnamese over fiat money or the dong.

Yet perhaps, today’s exception will become the tomorrow’s norm. Stated differently, perhaps Vietnam’s banking ‘archaic’ banking system could become the banking system's paradigm of the future.

Add to this Malaysia’s desire for a gold standard, India’s cultural attachment to gold and the growing appetite for gold by the Chinese as evidenced by surging imports (see chart above from US Global Funds), I’d say that these evolving trends in Asia could serve as clues to the direction of the prospective reforms of the global monetary system.

Has Brazil Successfully Inflated Their Debt Away?

So claims popular analyst John Mauldin in his latest newsletter.

You don’t even have to go that far back to see hyperinflation and how brilliantly it works at eliminating debt. Let’s look at the example of Brazil, which is one of the world’s most recent examples of hyperinflation. This happened within our lifetimes. In the late 1980s and 1990s, it very successfully got rid of most of its debt.

Today, Brazil has very little debt, as it has all been inflated away. Its economy is booming, people trust the central bank, and the country is a success story. Much like the United States had high inflation in the 1970s and then got a diligent central banker like Paul Volcker, in Brazil a new government came in, beat inflation, produced strong real GDP growth, and set the stage for one of the greatest economic success stories of the past two decades. Indeed, the same could be said of other countries like Turkey that had hyperinflation, devaluation, and then found monetary and fiscal rectitude.

In 1993, Brazilian inflation was roughly 2,000 percent. Only four years later, in 1997 it was 7 percent. Almost as if by magic, the debt disappeared. Imagine if the United States increased its money supply, which is currently $900 billion, by a factor of 10,000 times, as Brazil did between 1991 and 1996. We would have 9 quadrillion U.S. dollars on the Fed’s balance sheet. That is a lot of zeros. It would also mean that our current debt of 13 trillion would be chump change. A critic of this strategy for getting rid of our debt could point out that no one would lend to us again if we did that. Hardly. Investors, sadly, have very short memories. Markets always forgive default and inflation. Just look at Brazil, Bolivia, and Russia today. Foreigners are delighted to invest in these countries.

Sometimes I feel like dispensing the role of snopes.com a popular website which serves as “the definitive Internet reference source for urban legends, folklore, myths, rumors, and misinformation.”

Well, here is the account of Brazil’s inflation-debt dynamics according to the Wikipedia.org, (bold highlights mine)

The stabilization program, called Plano Real had three stages: the introduction of an equilibrium budget mandated by the National Congress a process of general indexation (prices, wages, taxes, contracts, and financial assets); and the introduction of a new currency, the Brazilian real, pegged to the dollar. The legally enforced balanced budget would remove expectations regarding inflationary behavior by the public sector. By allowing a realignment of relative prices, general indexation would pave the way for monetary reform. Once this realignment was achieved, the new currency would be introduced, accompanied by appropriate policies (especially the control of expenditures through high interest rates and the liberalization of trade to increase competition and thus prevent speculative behavior).

By the end of the first quarter of 1994, the second stage of the stabilization plan was being implemented. Economists of different schools of thought considered the plan sound and technically consistent.

1994-present (Post "Real Plan" economy)

The Plano Real ("Real Plan"), instituted in the spring 1994, sought to break inflationary expectations by pegging the real to the U.S. dollar. Inflation was brought down to single digit annual figures, but not fast enough to avoid substantial real exchange rate appreciation during the transition phase of the Plano Real. This appreciation meant that Brazilian goods were now more expensive relative to goods from other countries, which contributed to large current account deficits. However, no shortage of foreign currency ensued because of the financial community's renewed interest in Brazilian markets as inflation rates stabilized and memories of the debt crisis of the 1980s faded.

The Real Plan successfully eliminated inflation, after many failed attempts to control it. Almost 25 million people turned into consumers.

The maintenance of large current account deficits via capital account surpluses became problematic as investors became more risk averse to emerging market exposure as a consequence of the Asian financial crisis in 1997 and the Russian bond default in August 1998. After crafting a fiscal adjustment program and pledging progress on structural reform, Brazil received a $41.5 billion IMF-led international support program in November 1998. In January 1999, the Brazilian Central Bank announced that the real would no longer be pegged to the U.S. dollar. This devaluation helped moderate the downturn in economic growth in 1999 that investors had expressed concerns about over the summer of 1998. Brazil's debt to GDP ratio of 48% for 1999 beat the IMF target and helped reassure investors that Brazil will maintain tight fiscal and monetary policy even with a floating currency.

In short, monetary reform via the dollar peg (first), fiscal austerity and the move towards greater economic freedom resulted to the reduction of Brazil’s debt.

Here is the account of the World Bank... (bold emphasis mine)

Brazil’s debt decomposition indicates that primary fiscal balances and real GDP growth have been the most significant debt-reducing factors between 1993 and 2003. Brazil’s primary fiscal balance, which has improved significantly in the recent past, has provided the largest debt-reducing contribution, in particular since 1999. Real GDP growth was responsible for a debt decline of 9.0 percent of GDP over the decade.

Apparently the World Bank says the same-fiscal side reforms functioned as the critical factor in Brazil’s debt reduction.

And here is a paper from the Inter-American Development Bank entitled The Structure of Public Sector Debt in Brazil

Afonso Sant’anna Bevilaqua, Dionísio Dias Carneiro, Márcio Gomes Pinto Garcia, Rogério Furquim Ladeira Werneck, Fernando Blanco, Patricia Pierotti, Marcelo Rezende, Tatiana Didier writes, (bold highlights mine, italics theirs)

Given Brazilian inflationary history, the domestic bonded debt market was recreated in the mid-1960s with the introduction of indexed bonds (ORTNs), which were then conceived as an antiinflationary tool. The idea was that only the money financing of the fiscal deficits was inflationary. In the period of more than thirty years since its creation, the Brazilian open market has evolved into a very sophisticated one. The gross bond debt held by the private sector is currently around one fourth of a trillion US dollars; the megainflation of the 1980s and early 1990s did not inflate away the Brazilian debt.

During the megainflation, most of the debt was placed with banks (and later, with mutual funds managed by the banks) which used the bonds as the asset counterpart of inflation protected deposits (the indexed money, or domestic currency substitute). With the Real Plan this situation is gradually changing. The debt maturity has been lengthened (with a few setbacks, as the recent Asian and Russian crises), and more agents interested in becoming final holders of long debt—as insurance companies and pension funds—are becoming more important in the financial arena.

A radical change in Brazil debt maturity profile and similarly a change in the classification of debt holders had also been a part of Brazil’s debt reduction dynamics. This paper even highlights: “the megainflation…did not inflate away the Brazilian debt”.

Bottom line: Beware of oversimplified misleading analysis.

World Bank Chief Robert Zoellig: Bring Gold Back As Part Of The New Monetary Order

I never imagined how quickly developments have been shaping in the direction of my perspectives.

Here is what I wrote last Sunday

Global Central banks appears to be rediscovering gold as possibly reclaiming its role as money in a new monetary order. A new monetary order is not question about an if, but a when…

Those who obstinately relish the bias that gold is nothing but a barbaric relic will likewise suffer from taking on the wrong positions. But they eventually will succumb to the shifting expectations as with many monetary authorities today. The reflexive process of having prices influence fundamentals has clearly been taking shape.

Here is from Monday’s news (Reuters)… [bold highlights mine]

The world's largest economies should consider gold as an indicator to help set foreign exchange rates, the head of the World Bank said on Monday in a proposal that threw open the acrimonious currency debate days before a summit of G20 nations.

Writing in the Financial Times, World Bank President Robert Zoellick called for a new monetary system to replace the floating rates adopted in 1971 known as Bretton Woods II…

The former U.S. trade representative, who served in several Republican administrations including Treasury, said the new system "is likely to need to involve the dollar, the euro, the yen, the pound and (a Chinese yuan) that moves towards internationalisation and then an open capital account".

"The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values," he added.

The geopolitical pressure for a monetary reform possibly anchored on gold appears to be mounting.