Wednesday, 8 December 2010

If the Dollar fails, how can the Euro not fail along with it?

Inquisitive minds are wondering how anyone could possibly think the € might survive if (when) the $ fails — surely it must be taken down with the ship, along with everyone else, right?

I thought it might be interesting to play a quick game of 'pass the bomb'... here are the rules of this game, as I see them:


  1. National Central Bank (NCB) holds mostly US$ in its international forex reserves, a little other currencies perhaps, and some amount of gold.
  2. NCB wishes to find a way to dispose of excessive holding of US$, without simplistic sell-US$/buy-own-currency trades on forex markets. Excessive strength in its own currency would kill its exports, helping to sink the local economy.
  3. European Central Bank (ECB) holds gold and some foreign currencies including US$. It issues its own currency, the euro, which is backed by these aforementioned reserves. The gold component percentage of the reserves expands as the market price of gold rises (and falls if the market price drops), as witnessed quarterly in its accounts on the website.
  4. ECB can issue new euros to buy gold from NCB. Euro supply is increased (euro value decreases), but there is an offsetting increase in ECB gold reserves to balance that dilution (euro value increases again). Confidence is fully maintained in the ECB's currency, in spite of the increased number of euros, through the also increased gold reserves.
  5. NCB has more euros in its reserves, lower percentage of currency reserves are in US$ now. But NCB's gold reserves are also lower... hmm... bummer!
  6. NCB is free to sell US$ and buy gold. Even lower percentage of currency reserves are in US$ now, and restored holding of gold in NCB reserves again. Yay!
  7. Eurozone total ECB+NCB's gold reserves net increased, exposure to US$ reserves net decreased. Euro retains valuation against gold.
  8. Supply/demand balance of US$/gold now out of whack, US$ valuation against gold declines as a result of this supply/demand dynamic. Ergo, $:€ exchange rate declines too. Euro is by this stage net stronger, against Dollar. NCB is net up on the deal.
  9. If NCB was able to obtain gold from the market OK, keep going back to (2), otherwise...
  10. Boom! Strong Dollar Policy game over. Freegold reset.


Please try our new blockbuster game, Strong Euro Policy.

52 comments:

Fauvi said...

Monsieur le Baron,
…..and if an ounce of gold now is represented with 1000 euro after Freegold it might be … How much?
If the euro stays strong keeping his “high” value then it might be better to sell one’s gold before Freegold reset. Where/what did I get that wrong? What about the European liabilities, our ruined SS systems, where do they get their stuff to pay back from?

DP said...

Hi Fauvi - welcome! :-)

Don't get me wrong, the euro will also be printed into oblivion. I am just saying what I understand to be the current rules of the Dollar dance game at the ECB, according to their own documentation. This is the mechanism for how they will make an orderly retreat from holding US$ reserves among the Eurozone NCBs, while gold is still flowing in the COMEX/LBMA market. When it stops flowing, the game changes.

Ultimately, they'll print the shit out of the euro, to cover all those expenses and liabilities you referred to, and more besides. Deflation in just about anything, in nominal terms, feels very unlikely to me. They'll convert failing loans into ready cash (or "excess reserves" at the banks, if you prefer to be accurate :-) ). But they will still be able to do this at the ECB, because they will still have a lot of gold to back their currency.

Other parties will have had to sell their gold in defence of their currencies, and their paper gold market systems. Until they run out of gold that is, or they decide they cannot continue to sustain the outflow of gold. The Strong Dollar Policy just means "you can actually get cheap gold". When you can't get it any more, the Strong Dollar Policy goes dark like someone turned out the lights. Confidence will vanish. As FOFOA said, it will be like someone turned off the $IMFS Matrix and exposed the Real World hidden behind the glow.

I wonder why Gordon Brown decided to sell half the UK's gold reserves at the turn of the century? I'm pretty sure he didn't use the proceeds to pay off the UK's national debt! ;-D

In the ECB's case, the sole target is stability in terms of Eurozone-wide consumer goods prices. Their target is not stability in terms of the gold price. A deflationary depression will see to it that consumer demand, and therefore prices all along the supply chain, of ALL goods and services will drop significantly. The euro will be printed such that it will drop down with those demand-led prices on consumer items in the basket, to roughly maintain the price of those items in nominal terms. They will also take euros back out of the system, should consumer prices start to rise again. This is in order to smooth the demand rates, keeping the economy functioning to a greater extent than elsewhere, as people continue to be employed and buy goods and services from each other. The maintenance of stability.

As I said to you the other day over at FOFOA's place, in the Eurozone you will get there early, but you will get good seats and enjoy the end of the show a lot better than some others. At this point I would have liked to end with a smiley, but you will appreciate it is difficult in my situation. Maybe you will smile for me instead?

Fauvi said...

DP,
very hospitable home you have, indeed.
As I am still a newbie and I see what a fabulous traction FOFOAs blog got, please feel so free as to forward this explanation to his blog. It’s not easy to follow his mental gyrations and ppl need answers like yours and fairly quickly!
And please go to Gent and Antwerp with your wife, she’ll love both!!! Fashion better than France, nice architecture rather than pompous monotonous French one, chocolate, well, not so great cheese… but we would smile together!

Blondie said...

"Other parties will have had to sell their gold in defence of their currencies, and their paper gold market systems."

As they all know the score (gold's true value), I can't see any nation actually doing this. That would be naive. You don't use your actual insurance policy to fight the fire you are insured against.

Anecdotal evidence suggests the physical market is getting pretty tight.
Sooner or later paper and physical will part company, and that will be the end. Punctuated equilibrium. The entire monetary system rests on gold being available at the paper price. It's the "lynchpin", if you like.

DP said...

Hi Blondie.

While I can certainly see your point, and at some point in the process surely any government must see the writing on the wall and have to accept it must admit defeat.

I am having difficulty believing the Brown Bottom was not related to some kind of delivery difficulty at the LBMA, and that he had to choose between sell half our gold reserves, or breakdown of the LBMA market and with it the credibility of the Pound. If people stop believing London is a place you can come to the fair with cash and realistically expect to walk home with gold and not scrip, then that's a very large part of our offering to the world gone. Paper and physical gold would definitely part company at that point, because London is a very important gold fair.

Hopefully our new crowd are a bit smarter than Brown's gang though. Which seems to me like it wouldn't be very difficult, but we perhaps shouldn't take it as a given.

DP said...

Fauvi: As I am still a newbie

Me too -- I have only been a citizen of FOFOAland for approx a couple of months. We are all of us perpetual students, I think. (With perhaps the exception of FOFOA, of course... :) )


It’s not easy to follow his mental gyrations and ppl need answers like yours and fairly quickly!

I agree, there is definitely a market for simplistic clarity. However, the brand of simplistic clarity that I hope I am successful in attempting to bring on occasion, isn't in the longer term as good for the readers as the more cryptic and well-rounded nature of FOFOA's messages, along with some of the more seasoned commenters. I think it helps the reader to Think Long And Hard (smile), and better understand the wider picture as a result. But yes, I also see as you do, that not everyone is a Strategic Thinker, and perhaps it is useful to many people to have some Starters For Ten Points, to help them along the road a little... :-)

Patrick said...

Even if the Chinese hit 15 % as gold reserve , they could join the euro....

DP said...

Well yes that's right. In theory they could, Patrick. :-)

And the Russians. The Turks. The the the...

The British?

But certainly not the US. In fact, anyone except the US could join. Technically.

It would be interesting to have things happening like the Chinese domestically using "the European currency". And there is no good technical reason why they couldn't join, that I can see. Political reasons, sure. But technical ones... someone tell me if you spot one, because I am interested.

Personally, I think they should have called it something other than "euro". It is a slightly deceptive name; maybe they just thought it would be accepted more easily with a European sounding name(?).

However, I think it's perhaps more likely the Chinese will form a regional monetary union of their own, similar to the Eurozone? The SCO seems like a pretty good springboard to that. Given they are already founder members of the SCO, maybe Russia goes that way with China, rather than join the Eurozone? They are spoiled for choice really aren't they...

What do you think, anyone?

DP said...

It was remiss of me not to include a link to the SCO wiki, for those that haven't heard of it. Bad Baron!

Wiki:SCO

Patrick said...

http://www.difc.ae/press-centre/press-archive/2010/09-december-2010/

DP said...

DP Likes Patricks link

Martijn said...

ECB can issue new euros to buy gold from NCB. Euro supply is increased (euro value decreases), but there is an offsetting increase in ECB gold reserves to balance that dilution (euro value increases again). Confidence is fully maintained in the ECB's currency, in spite of the increased number of euros, through the also increased gold reserves.

This is not an infinite dynamic, is it?

It is not that because the ECB marks its limited gold supply to the market that they can endlessly print money.

They may be smart, but they're not alchemists. Printing money in unlimited supply will render the currency worthless even if the printers own a little gold.

Fauvi said...

In a multipolar world I think they can have several currencies sans needing to “join” the one or the other. I believe Russia has historically and economically quite some ties to Europe/Germany/France and I don’t think these two big powers, China and Russia, want to be exactly in the same boat.
What I don’t understand is the working ways of the SDRs and their gold content. These SDRs have long been discussed by Sinclair. But even if they have a high gold %age, should they be very suspect to the world, rigged by IMF? The paper currency in them can be highly manipulated, exactly as the gold in them.

Fauvi said...

edit: should they not be...

Dimmed aurum said...

Hi guys,
All your comments fit freegold nicely.
A question~ Why is so large a percentage of Germany`s gold outside German borders. Will they ever demand it back? What`s your opinion on the matter?.
D. a

DP said...

Hi Martijn, and welcome :-)

Yes, you are right. This is not an indefinitely sustainable solution. I don't believe it was ever meant to be. However, it does provide a method for the NCBs to extricate themselves fairly painlessly from their accumulated holdings of US$ in their reserves, by switching to predominantly end up holding gold plus a locally usable, and controlled, currency. The aim being to get out from under the monetary policies asserted by the US, as issuer of the global reserve currency. This mechanism described above is a means to an end, not the end itself. The end is to transition away from the US$ being the global wealth reserve, to return to gold once more.

The ECB doesn't aim for their currency to be stable against gold; their aim is for their currency to be broadly stable (falling at a 2% per year rate, ideally) against a basket of consumer product prices as measured by the HICP. This is in order to maintain a functional economy, with people continuing to buy goods and services from each other, and thereby keeping each other other in work (and the governments receiving their taxes, not paying welfare!).

Everything is relative. As all the previously issued $ wash back up on US shores, I wonder how likely it is that the economy there will remain stable in terms of consumer prices, and therefore how predictable employment and tax revenues will be. Also in other regions/nations, where $ remains the primary reserve asset.

Gold is the global barometer of 'value', against which all currencies are being judged. That is why the ECB marks their gold reserves to market -- so that others can keep score over their performance.

The euro is going to fall (and at times rise, if consumer prices dictate it should happen) in valuation, when measured against this golden benchmark. By design (look to the ECBs single mandate for proof). I believe it will do so more predictably than other currencies, and this stability in demand for consumer goods and raw commodities will be a desirable feature for international investors and suppliers. Until the day the euro, too, is brought properly into question and faces its own demise of course. Nothing is forever. But I would say that is a less immediate issue than escaping the dollar trap.

If you really want to maintain your long term buying power in terms of gold, I guess the simplest answer is to buy gold while you still can, and be done with it... :)

Cheers!

DP said...

@Fauvi: I agree, the SDR idea - even with gold in the basket - is still paper.

Russia have tipped their hand that they wish to join the Eurozone. Or maybe they don't, who knows. They hold a few cards, don't they.

DP said...

Hi Dimmed aurum - welcome! :-)

The most short and honest answers is:
I dunno! :)

My guessing hat is telling me that it's just a fact of the international settlement system, which has the repositories in the US, London and Switzerland.

What are your thoughts?

Dimmed aurum said...

@DP,
It is a matter of who is in charge of the system, I think.
But if I was them, I would have wanted out, out, OUT NOWNOWNOW!
And here are my thought on the BMW (or real estate per se)
1. You can work your a** off to get a BMW (/house) or an oz of gold (moreover in freegold situation). Creating let`s say five times the value added for your company share holders, managers whatever destroying your health in the process.
2. You could just buy that damned BMW drive to the nearest gold-bearing river and sift through 20-2000tons of dirt panning for gold to redeem that lost oz and still havin` the wheels. But that may be on the fringes of what is allowed by law and still it is work by the ton.
3. You may just say “what the heck” and go “all out” robbing a jewelers shop thus getting an oz or to; or a piece of lead instead, smile.
That’s my asymmetric approach anyway. Watch out for any asymmetric game-changing plan form the banksters to “fix” the eCONomic system their way!
Dimmed.

DP said...

@D.a I can see that perhaps a country might choose to have some part of its assets held outside of its national borders, in case it was ever invaded. Pirates can't steal what is not there! :-D

The Dork of Cork said...

Excellent blog , but we must realize that if the dollar fails America will not disappear.
I am still getting my head around the free gold concept and generally accept this is happening in Europe but how will the US react to a epic great game failure - will it be a passive submissive or will it react as Germany did in the 30s - I fear that if the US is not given a get out mechanism that can preserve its dignity it will react in a very violent manner.
Canada will be in the height of shit also.
Given the massive silver resourses shared between Mexico , US and Canada a moving silver standard shared amongest these countries which are so interlinked may provide a lifeboat of stability for people - if not God knows how they will react.

DP said...

Welcome, TDoC. Thank you for the kind words, which are always appreciated but certainly never expected. ;)

It will be very interesting to witness how this does pan out. It could go any of many ways couldn't it? It does seem lately there is a dawning realisation, or public admittance perhaps, that any solution must revolve around gold if it is to be taken seriously and not collapse again in a few years. (See recent Zoellick and Hoenig statements for example.)

At the end of the day, the US does have a buttload of gold. They just don't choose to count it on their balance sheet and let people measure their Dollar. They could do this and it will put a floor under this by now long-toothed currency, but when one looks at the number of them in existence around the world today, in terms of the comparison to the level of gold reserves, it's going to measure up a long way short of the ECBs comparable metric.

Interesting times.

I can see that the US will not be keen to give up their exorbitant privilege without a struggle. But really, other than the controls to the Dollar printing press, what gives the US these days any objective right to be ahead of the rest of the world? They have run up the biggest pile of debts in the history of man, bigger than everyone else in the world put together, they're not exactly a manufacturing export juggernaut any more; how can they seriously expect to come out of this the richest kids on the block still...

The Dork of Cork said...

Yes the US has a large amount of Gold but their deficit is so large that they would lose this in short order.
They essentially need this to pay for items outside their immediate sphere of influence - especially if they cannot afford to station troops in the Gulf.(although this flows mainly to Europe and Asia)
A moving silver standard for a time may reduce the shock to the system as they re localise in their own continent.
PS check out W. buiter comments on FT Alphaville where he talks about increasing the ECB liabilities in areas such as short term deposits etc.
What will this do for assets if the ECB increases their liabilities by 1 to 2 trillion ?

http://ftalphaville.ft.com/blog/2011/01/07/452096/buiters-e2000bn-solution-for-the-eurozone/

DP said...

I think, if the rest of the world decides that it is going to use gold as its monetary standard, then anyone deciding to use silver (or anything else for that matter) is going to have a mountain to climb.

I refer you at this point to a germane recent article of FOFOA's, Focal Point:Gold, in case you didn't already read it. It contains a very pertient section about this very subject (among others) that covers this in more detail that I am about to attempt here in this one brief comment.

Yes, I can see that there is a whole lot of silver kicking around under the dirt of the US/Mexico/Canada patch... (there is also a half decent amount of gold too). However, there are a LOT of people elsewhere in the world which will come and sell every bit of silver they have, to buy gold with the proceeds, and the US/Mexico/Canada will kill themselves attempting to fight that tide. The rest of the world will want gold to buy oil with, or to put in reserves to maintain confidence behind their currencies.

Sadly, the world is a big place, and the economy is now globalised. Unless you want to cut right off like Iran or North Korea maybe. Maybe the North American Alliance feels that it doesn't need the rest of the world. It might be interesting I suppose. But unless they want to do that, nobody can think about economics in the goldfish bowl of their own local economies any more, because the economies are all open.

That is the summary of why silver is a bad idea. The decision regarding what will be the global monetary metal has already been made by the most significant players. If you don't have gold, you don't have the confidence of the people you want to buy oil from.

DP said...

Moving on to the other side of your comment now, about the ECB issuing further Euros.

There is a way you can know what the ECB will do in terms of how many Euros they will issue. They have a single mandate, unlike other Central Banks, and it is to maintain consumer prices (measured by HICP) at as close as possible to 2% per year. They will do this by monitoring prices, and adjusting the amount of Euros in circulation either up or down as appropriate, so that consumer demand for money and goods remain in the kind of balance where prices gently inflate at this target rate over time.

There will be a tail wind to their efforts, if other countries keep more and more of the Euros in their foreign exchange reserves. While they're locked up in there, they're not chasing consumer goods and forcing up the prices faster. They will need to create more Euros to maintain the consumer demand to keep prices rising slowly. So, the more the Euro becomes the dominant reserve currency of choice, the more Euros the ECB can print without causing any problems.

My understanding is oil and China both like Euros better than Dollars today.

DP said...

By the way TDoC, I reckon you can count the UK in on the whole "being in shit" thing alongside the US and Canada. Ironic that we should have been lending you good folks some "money" recently, eh? (I hope you guys will feel just as charitable when the roles are reversed later! :->)

In fact, a whole lot of places will be in deep trouble if the Dollar takes a beating. Everywhere that still has the US Dollar as its primary reserve asset. Japan springs to mind most immediately and significantly, but by no means exclusively.

I reckon the UK can look forward to the Euro in its future. I don't know whether we give in while we still can get a decent deal out of it, or we do it when we have no choice. [sigh]

The Dork of Cork said...

@DP
I think the surprise in the Euro system may be the ejection of Ireland from the Euro.
This may actually reduce the Euro liabilities in the longer term although the ECB may take a huge hit on the mortgage collateral that I beleive they hold on their assets side as there has been a significant amount of dark matter present in Dublin.- therefore Eurogold might correct downwards after a period of time reinforcing the illusion of the take no shit Euro

A significant development has been the rejection of Irish paper by the Swiss central bank on the 21st of December.
I think Ireland is being set up for a reintegration withen the BOE direct sphere of influence again.

however good luck collecting the 200 billion+ loaned to Ireland - outside a small amount of sovergin debt it looks unrecoverable as most of these "investments" have no real yield.

Check out the excellent corner turned blog for a good view of Irish financial affairs

blog.cornerturned.com/2011/01/04/the-man-from-zurich

The Dork of Cork said...

Again the moving silver standard is a ad hoc arrangement to internalise the North American economy as all it needs after maybe 20 years of reindustrialization is outside oil that it can pay for in Gold via the indirect transfers that bankers have a ability to arrange.

Also while its industrial base has been ravaged by the global petrodollar system it still has elements of skills in various high technology areas that other countrys never quite achieve to the same standard.
However this skill base may go the way of the British boffin culture of the 1960s which was annihilated by the new monetarists.
Who really knows what the future may bring.

DP said...

@TDoC (RE: W.Buiter @ FT Alphaville, commented here above and also I now see at FOFOA's place):

Apologies for not responding earlier to this question you placed, I have only just got around to reading the artlce you provided the link for.)

The national sovereigns cannot print Euro to pay their debts. Investors are scared they will get a default, rather than repayment through inflation as they might receive elsewhere. They demand an elevated interest rate for buying the bonds of those sovereigns that are of concern.

The ECB are the only people that can issue Euros. They can issue as many as they see fit, and the idea they might outright default on a Euro obligation is a non-issue (although stealth default via inflation is still always a potential issue, and that is why interest rates were invented). Because the ECB will, like the US Fed, never default, any entity that is officially backed by the ECB will have an exemplary AAA credit rating assigned to it because it should be unthinkable it would default. Such an entity would get plenty of offers from investors, at the lowest of interest rates (based on the outlook of future restraint at the ECB).

The way I see this heading is the sovereigns will be bailed out whole by the ESF, when it is necessary to do so. When the interest rate demanded of them becomes intolerable (over 7% perhaps being a current threshold to begin discussions?) the ESF will offer to buy the debts that must be rolled over, for a "reasonable rate of interest" (about 5%-6% looks "reasonable" currently I guess, based on the Greek and Irish deals worked out lately?). The ESF will either receive the necessary cash from international investors in exchange for bonds that it issues, or failing that the ECB can step in to buy the ESF's bonds if investors for some reason are losing confidence even in the ESF! The ESF will then have the bond, and the previously issued bonds of the national sovereign will be settled at expiration with this "bail out" cash. The cash was already spent into the economy when the now-expired bonds were issued, long ago - there are no new Euros that are going to enter the economy and bid up prices because this new cash is going to the buyer of the previous bond; it is non-inflationary (it is also non-DEFLATIONARY, unlike the alternative default).

The national sovereign gets to live on and fight another day. It didn't get out of jail free, because it still has to pay that "reasonable rate of interest", but it has now played its "get out of jail for reasonable amount of bail" card. The country in question is still going to have to pull in its horns and get its fiscal house in order -- because they don't have another card, I suspect(? At least IMO they shouldn't).

For global investors, better to invest in an economic block that is humming along with a mild inflation but most people are still in a job rather than draining cash from their government in welfare payments, than in some other economy that is in a chaotic deflation or hyperinflation due to a debt crisis that wasn't resolved in a similarly controlled manner. If they can invest in a way that has the backing of the entire block, rather than a single nation within it, this has to be preferable to them.

If the ESF managed to sell bonds at a good rate of interest to international investors, I think it's job done and the remainder of the comment here will be irrelevant. So reading beyond here let's assume that for some reason the international investors could not be coaxed to earn a secure but small return on ESF bonds... the ECB had no choice but to issue new Euros to give to the ESF in order for the ESF to buy the bonds of the national sovereign. This is really the disaster scenario, basically the wheels really must be seen to be coming off for it to come to this, surely?

Cont'd...

DP said...

...

The ECB doesn't have to worry about HICP consumer price inflation taking off, because no net-new Euros are going to enter the wider economy. However, you will be thinking "but there are more Euros in the system now though, and there isn't more gold or foreign hard currency added to the reserves? The Euro will go down on the forex markets because the ECB reports will show that it has been diluted", and you will be right to think that. The Euro goes down a little against the US$ [but... the Fed are printing too, no? :) ]. The ECB won't care about this, all they are concerned about is HICP consumer price inflation, which as I said above should not materially change as a result of this "bail out", because no new cash is going to enter the economy and circulate to push up prices. The ECB don't care directly about the exchange value of their currency, only about demonstrating responsibility and transparency in issuance to maintain confidence, and
of course that single mandate of ~2% HICP consumer price inflation per year that is their only goal.

But won't the Germans be up in arms about this? They remember the Weimar experience painfully well, and they do not want to see inflation. Again, no new cash is going to enter the economy and circulate to push up prices, and confidence in the ECB's restraint isn't about to be smashed and bring on a hyperinflation either I think. All that has happened is the old bond has expired and the debt has been moved from one party to another. A currency deflation and crisis of confidence through default has been avoided. In fact, Germany loves this steady and planned dilution -- they get a nice tail wind to their export-led economy, because they become more competitive on world markets the lower their currency is against others. The rest of Europe being economically weak is exactly what Germany gets out of the currency union. Without the profligate states elsewhere on the patch, the Deutschmark would have put paid to any plans of a continued export-led success for Germany, and their local economy would have atrophied long ago. They would have massive numbers on the dole, and who would pay for that?

So, in short, I see the ECB printing Euros out the wazzoo in order to ensure there are no significant defaults, and everyone coming to think it's a good thing.

DP said...

@TDoC: (RE: your comment about the Swiss rejection of Irish debt)

Do you think the Swiss might prefer to buy ESF debt, backed by the whole Eurozone and the ECB, rather than that of individual nations? Just a thought.

DP said...

As if by magic, this afternoon sees an article at the Telegraph, telling us Germany may agree to expand €750bn bail-out fund, as ECB buys bonds.

By my estimation, the ECB currently have little choice but to directly monetise. If the ESF were instituted and was able to attract international capital via bond issuance, this would in all likelihood avoid the need for the ECB to issue the Euros to paper over the problems, as I was saying earlier. So really, it would seem to me that the better course of action for the Eurozone as a whole, might be to setup the officially-supported notion of the ESF and to enable it to achieve the desired result of shoring up the PIIGS debt without having to resort to printing Euro. It would have the ECB backing though, in case it would need to come to that (thereby providing the impeccable credit rating that is required in order to obtain the low interest rates and high demand from international investors).

Merkel doesn't yet appear to see it is necessary, or in my view in fact desirable, unfortunately. Somehow, I think before long it might come out that in fact, she does after all.

The Dork of Cork said...

@DP
Given that the commercial banks are reducing their credit production especially in over banked Iberia and Ireland the ECB should create high powered money - although Buiter seems to favour covering checking account liabilities on the ECB balance sheets rather then goverment debt.
This is unfortunate as with the exception of Greece Goverment spending has been well managed - the overspending of goverments in Iberia and Ireland was due to the almost hyperinflationary environment in housing created by private credit - this forced these Governments to pay excessive wages to Goverment employees so that they could live withen 50 miles of their job.
The ratio of goverment debt relative to the ponzi was low until the ponzi became apparent.
The refusal of the ECB to recognize this obvious flaw is maddening although I suspect they knew full well what was going on and used the crisis to accomplish their long term goals in the freegold sphere - redirecting reserve dollars into Gold.

As for the Swiss they are a enigma wrapped up in a cuckoo clock - I have no idea what there bottom line is other then the bottom line.

DP said...

Japan aren't happy to buy individual Eurozone PIIGS sovereign debts, but are comfortable with the idea of buying bonds of ESF.

http://www.bbc.co.uk/news/business-12159399

DP said...

If Merkel doesn't come around soon, France and Germany will be paying through the nose as well and the problem will then be out of control.

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/8251389/EMU-debt-crisis-edges-ever-closer-to-the-core.html

DP said...

@TDoC: The housing boom was caused by creation of high-powered money in combination with lax oversight of the fractional reserve banking system, allowing the broad money supplies to massively expand (monetary inflation, of the kind where the new cash WILL enter the economy and circulate to push up prices). The governments were complicit in encouraging both sides of this, clearly. If they hadn't allowed that party to get out of control, their workers wouldn't have needed the pay rises that were unaffordable once the housing boom party music inevitably stopped. The problem here is the governments were greedy soft money debtors, and they couldn't (or wouldn't) see beyond the next election that they hoped to win by promising people things that weren't sustainably affordable, especially in a hard money system like the Euro.

Buiter is paid by Citigroup. He would therefore naturally prefer the bank deposits were being backstopped directly, rather than via government bonds. If the cash goes to the governments, the banks will still have to beg for it again from the governments, to paper over their private problems. That is how Ireland was broken, backstopping private banking problems with public money (albeit they stupidly did that before getting the money from the Central Bank, which was utter insanity but I guess they hadn't realised that things had changed, monetarily...). Better for the banks that the money comes direct from the CB and they only have to beg the once. Not better for anyone else though.

The best thing for everyone but the banks and politicians, would have been if there was never the bubble in the first place. This would have been avoided if either of the following things (and ideally both) had been the case:

1) Fractional Reserve Banking wasn't in place, or at least there was a much more conservative ratio enforced and idiotic holes like not requiring reserves on non-demand deposit accounts, allowing demand-deposit accounts to be swept into non-demand accounts overnight, bundling together groups of crap into tradable securities and rating them AAA -- aka "casino banking", or perhaps "financial Russian roulette" would be more apt a name.

2) Governments hadn't gone on a spree with the easy debt, paying their public sector workers too much and helping to stoke up the demand for high priced housing. If the public sector unionised workers had been left behind early on, they would have been up in arms and the politicians would have had to draw a line under the thing.

Hopefully, some governments and voting publics will have learned a valuable lesson from all of this. Taking on debt is like holding a stick of dynamite while someone else holds the detonator.

The Dork of Cork said...

I disagree - housing bubbles are almost always the result of credit money created withen the walls of commercial banks.
Yes politicans are cretins but that is partially a result of their subservience to the current money system - they willnot and cannot be rational senators and congressmen when the populace with a vote are monetory heroin addicts.

I have grave problems with the freegold mechanism as all power derives from a possibly fictional balance sheet.
We must always strive for balance in systems between the Hamiltonian and Jeffersonian views - I fear the freegold mechanism gives far too much power to the monetory priesthood.

DP said...

It seems like in the end we agree -- Fractional Reserve Banking ( creation of credit money within the walls of commercial banks, multiplying high powered money issued by the Central Bank) is the root of all evil. :-)

If the Central Banks of this world showed more restraint in issuing this high powered money, that the banks then multiply by issuing credit, rather than turning a blind eye to the bubbles and enjoying the tax rewards that come from then, we would have a better world. The issuance of Euros by the ECB is outside of the control of national politics, and this makes it a superior mechanism in this regard, IMO.

DP said...

Confirmation Germany thrives on a currency with reduced exchange value, keeping export demand high and unemployment low.

http://www.telegraph.co.uk/finance/economics/8254644/German-economy-grows-at-fastest-pace-since-reunification.html

DP said...

Oooh, well lookie here. A very well-bid (understatement of the year to date) sale of bonds from the ESF takes place. Asia and the Middle East can't get enough of this idea. Eurobonds are go.

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/8282038/Asian-investors-lead-massive-demand-for-first-Euro-bail-out-bond.html

DP said...

Reuters: Analysis - Euro fund sale shows there's a way, if there's a will

The ease with which the euro zone's financial stability fund raised super-cheap borrowing this week may mark an inflection point in the bloc's debt crisis -- it shows financing presents no bar to solving the problem.

...

DP said...

So... they will raise funds in the ESF by selling AAA rated bonds to investors in China/Japan/MiddleEast/etc, then using the funds to loan to troubled Eurozone states, so that those states can then buy back their previously-issued bonds, which are trading at a discount to face value at the moment.

Pretty slick solution, no? The states can afford the below-market interest rates charged by the ESF, the investors are happy with the risk/reward profile of these new bonds, and the states will pay those lower rates on a smaller principal because the market has already discounted the risk of the old state-specific bonds. In a little more time, the old bonds will drift back up to near par, I would expect. How much better could this be for all concerned?

All eyes to start turning to the other big debtors shortly now methinks.

DP said...

So... they will raise funds in the ESF by selling AAA rated bonds to investors in China/Japan/MiddleEast/etc, then using the funds to loan to troubled Eurozone states, so that those states can then buy back their previously-issued bonds, which are trading at a discount to face value at the moment.

Pretty slick solution, no? The states can afford the below-market interest rates charged by the ESF, the investors are happy with the risk/reward profile of these new bonds, and the states will pay those lower rates on a smaller principal because the market has already discounted the risk of the old state-specific bonds. In a little more time, the old bonds will drift back up to near par, I would expect. How much better could this be for all concerned?

All eyes to start turning to the other big debtors shortly now methinks.

DP said...

It seems like in the end we agree -- Fractional Reserve Banking ( creation of credit money within the walls of commercial banks, multiplying high powered money issued by the Central Bank) is the root of all evil. :-)

If the Central Banks of this world showed more restraint in issuing this high powered money, that the banks then multiply by issuing credit, rather than turning a blind eye to the bubbles and enjoying the tax rewards that come from then, we would have a better world. The issuance of Euros by the ECB is outside of the control of national politics, and this makes it a superior mechanism in this regard, IMO.

DP said...

Japan aren't happy to buy individual Eurozone PIIGS sovereign debts, but are comfortable with the idea of buying bonds of ESF.

http://www.bbc.co.uk/news/business-12159399

DP said...

...

The ECB doesn't have to worry about HICP consumer price inflation taking off, because no net-new Euros are going to enter the wider economy. However, you will be thinking "but there are more Euros in the system now though, and there isn't more gold or foreign hard currency added to the reserves? The Euro will go down on the forex markets because the ECB reports will show that it has been diluted", and you will be right to think that. The Euro goes down a little against the US$ [but... the Fed are printing too, no? :) ]. The ECB won't care about this, all they are concerned about is HICP consumer price inflation, which as I said above should not materially change as a result of this "bail out", because no new cash is going to enter the economy and circulate to push up prices. The ECB don't care directly about the exchange value of their currency, only about demonstrating responsibility and transparency in issuance to maintain confidence, and
of course that single mandate of ~2% HICP consumer price inflation per year that is their only goal.

But won't the Germans be up in arms about this? They remember the Weimar experience painfully well, and they do not want to see inflation. Again, no new cash is going to enter the economy and circulate to push up prices, and confidence in the ECB's restraint isn't about to be smashed and bring on a hyperinflation either I think. All that has happened is the old bond has expired and the debt has been moved from one party to another. A currency deflation and crisis of confidence through default has been avoided. In fact, Germany loves this steady and planned dilution -- they get a nice tail wind to their export-led economy, because they become more competitive on world markets the lower their currency is against others. The rest of Europe being economically weak is exactly what Germany gets out of the currency union. Without the profligate states elsewhere on the patch, the Deutschmark would have put paid to any plans of a continued export-led success for Germany, and their local economy would have atrophied long ago. They would have massive numbers on the dole, and who would pay for that?

So, in short, I see the ECB printing Euros out the wazzoo in order to ensure there are no significant defaults, and everyone coming to think it's a good thing.

DP said...

By the way TDoC, I reckon you can count the UK in on the whole "being in shit" thing alongside the US and Canada. Ironic that we should have been lending you good folks some "money" recently, eh? (I hope you guys will feel just as charitable when the roles are reversed later! :->)

In fact, a whole lot of places will be in deep trouble if the Dollar takes a beating. Everywhere that still has the US Dollar as its primary reserve asset. Japan springs to mind most immediately and significantly, but by no means exclusively.

I reckon the UK can look forward to the Euro in its future. I don't know whether we give in while we still can get a decent deal out of it, or we do it when we have no choice. [sigh]

DP said...

Welcome, TDoC. Thank you for the kind words, which are always appreciated but certainly never expected. ;)

It will be very interesting to witness how this does pan out. It could go any of many ways couldn't it? It does seem lately there is a dawning realisation, or public admittance perhaps, that any solution must revolve around gold if it is to be taken seriously and not collapse again in a few years. (See recent Zoellick and Hoenig statements for example.)

At the end of the day, the US does have a buttload of gold. They just don't choose to count it on their balance sheet and let people measure their Dollar. They could do this and it will put a floor under this by now long-toothed currency, but when one looks at the number of them in existence around the world today, in terms of the comparison to the level of gold reserves, it's going to measure up a long way short of the ECBs comparable metric.

Interesting times.

I can see that the US will not be keen to give up their exorbitant privilege without a struggle. But really, other than the controls to the Dollar printing press, what gives the US these days any objective right to be ahead of the rest of the world? They have run up the biggest pile of debts in the history of man, bigger than everyone else in the world put together, they're not exactly a manufacturing export juggernaut any more; how can they seriously expect to come out of this the richest kids on the block still...

DP said...

DP Likes Patricks link

DP said...

It was remiss of me not to include a link to the SCO wiki, for those that haven't heard of it. Bad Baron!

Wiki:SCO

DP said...

Fauvi: As I am still a newbie

Me too -- I have only been a citizen of FOFOAland for approx a couple of months. We are all of us perpetual students, I think. (With perhaps the exception of FOFOA, of course... :) )


It’s not easy to follow his mental gyrations and ppl need answers like yours and fairly quickly!

I agree, there is definitely a market for simplistic clarity. However, the brand of simplistic clarity that I hope I am successful in attempting to bring on occasion, isn't in the longer term as good for the readers as the more cryptic and well-rounded nature of FOFOA's messages, along with some of the more seasoned commenters. I think it helps the reader to Think Long And Hard (smile), and better understand the wider picture as a result. But yes, I also see as you do, that not everyone is a Strategic Thinker, and perhaps it is useful to many people to have some Starters For Ten Points, to help them along the road a little... :-)

Blondie said...

"Other parties will have had to sell their gold in defence of their currencies, and their paper gold market systems."

As they all know the score (gold's true value), I can't see any nation actually doing this. That would be naive. You don't use your actual insurance policy to fight the fire you are insured against.

Anecdotal evidence suggests the physical market is getting pretty tight.
Sooner or later paper and physical will part company, and that will be the end. Punctuated equilibrium. The entire monetary system rests on gold being available at the paper price. It's the "lynchpin", if you like.

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