Monday, September 9, 2013

Salinas-Price On the Changing Tempo and Tenor of the Growth of International Reserves

by Jesse

My friend Hugo Salinas-Price has shared some uniquely interesting observations on the growth of international paper reserves, which have been largely constituted of claims on debt, often pinned to the US dollar because of its international reach. And with all such fertile and insightful thinking it provokes more thought in others.
In this article he observes that the appetite for sovereign Treasury debt, and other forms of private debt such as mortgages and consumer credit, may not be keeping pace with the issuance of these forms of debt.
I think that with respect to price that this is a foregone conclusion in light of the Fed's QE III. The whole point of this exercise is to ensure that the current pricing is not sustainable without a non-market priced subsidy from the Fed, hopefully until some point that the markets reach some sort of self-sustaining equilibrium.
One of my key theses has long been that this equilibrium cannot occur without major systemic reforms.  The factors that created the problem were not incidental, but fundamental to changes that occurred during the 1990's in particular, with deeper roots back to 1980.  There was a decade long effort to overturn the New Deal Reforms that had allowed for the long stability that the financial world largely enjoyed in the post-WW II era.  These reforms were overturned by greed and corruption of power, and so here we are today.  We cannot go forward without returning to more transparent, honest markets that operate with a bias towards justice, and not bowing to right as defined and sanctified by might.
Modern monetary theorists would postulate that none of this is a problem, because the issuance of money based on debt is not necessary in the first place. All the debt can be repurchased through the direct issuance of money by a sovereign at any time. The proposal of the 'trillion dollar platinum coin' illustrates that principle in action.
But while technically true, there are two important facts that impinge on the wonders of such a brave new monetary world, besides the obvious problem of the ability of concentrated power to corrupt such Utopian arrangements from their inception.  I keep asking, 'where is the flywheel' meaning where is the check and balance on the monetary issuance?
The first obstacle is that such money issuance system of almost unrestrained fiat works best where all the market participants are forced to operate according to the centralized rules. They will accept the money at stated value because they simply have no other choice, no other options.  Given Gresham's Law, if you think about this for a while, it becomes very apparent that this is the case. Fiat of this level of discretion must have the absolute force of law, without viable competition or substitute.

Money is what we say it is, and is worth our stated official price.
I think we have enough historical examples of how well this works in practice. I saw it up close in both Russia and Czechoslovakia before and during the final collapse of the Soviet System.
In the world as it is, there is really no one world currency, issued by a centralized all-powerful entity, that essentially creates money from nothing, distributes it as it pleases, and dictates its value to all.  At least there is no such system yet, although it is certainly the objective of more groups than you might care to imagine.
In the case of a non-self-sufficient economy, there is the inescapable issue of trade and travel with other economies, that are not under the control of the central authority.
So the second great problem is that in the world as we have it today, oil and natural gas and certain essential commodities are significant factors when considering the international currency regime. In quite a literal sense, the US dollar is the petro-dollar, and control of the world's currency regime requires a strong influence over the world's oil and gas supply first and foremost.
If the US was truly energy self-sufficient, then the issue of trade and tariffs and money would be much simpler.  This would not be the case for some other entities without its geographic reach and the rich variety of its resources.
The other imported products are much more discretionary, and the domestic economy would most likely even prosper under a greater emphasis on self-sufficient production. Although the issue of reform would still remain because of the broken system of wealth distribution along lines of unequal power and influence over law.
It would have repercussions on international relations no doubt, but that is economic power by other means and would be dealt with through the usual alliances and cooperative ventures that could be denominated in other than a domestic currency.   This arrangement calls for the growth of large areas of common interest, or spheres of interest if you will,  that are able to achieve resource self-sufficiency. 
The sophists will seek to dismiss what I am saying here as a paean to the gold standard. I wish to state again, categorically, that it is not. I am not proposing any solution, merely attempting to draw up some outlines around the problem, what might be termed a systems analysis.
Gold does have some remarkable qualities that make it quite suitable for use as money. No one can create it, it is enduring, and relatively stable in terms of growth. As an external standard it is almost ideal. And yet it does have some drawbacks, in that gold cannot enforce honesty on a corrupt system.
If there is any key point I wish you to take and hold in your minds and hearts it is that there is no such thing as a perfect, self-regulating monetary system. There could only be such an ideal model if men and women were angels, perfectly rational and reliably virtuous.
And like wealth the distribution of reason and virtue is very uneven, and so all systems must rely on a continuing effort and bias towards justice for all. And this has inescapable requirements for the design of the system.  Among these are transparency and the rule of law.   And the assumption that there will always be those who will be actively attempting to subvert the system, some bluntly, and some quite cleverly.
Money is power, and power corrupts.  So no system can succeed by its own design if it's reins are held in the hands of people, with all their weaknesses and failings.
It will be fascinating to see how this evolves. Will we see the creation of an SDR like monetary instrument based on a basket of items and currencies not under the control of a single power bloc?

Will the world evolve into three or four powerful trading blocs, each with their own currency arrangements? Will the current dollar hegemony continue on until the collapses, and the what could have been an evolution will be a more sudden monetary revolution in which great wealth is destroyed, transferred and created anew?
We do live in interesting times.  And inescapably, these questions are now being addressed in what some have called the currency wars.

06 September 2013

Stalling growth of international reserves

Hugo Salinas Price

I have kept track of International Reserves (excluding gold) for many years, with data helpfully provided every week by Doug Noland, at, who obtained the information from Bloomberg.
Here is the graph I have elaborated with data since 1948, when there was still a modicum of reason operating in the financial world.

Lately, I worked out a graph showing in more detail the growth of these reserves in the period from August 2005 to August 30, 2013.

I draw your attention to the slump in reserves which took place during the year 2008-2009. It was an ugly period, financially.
Then, notice the slowdown in growth of reserves during the past two years (24 months).
Finally, notice that growth in reserves has stalled in the last few months of this year. Growth appears to be topping-out. Since April 13, when reserves passed the $11 Trillion mark at $11.082 Trillion, in the four months to August 30, they have only increased by $86 billion – 0.78%
If the growth in reserves registered from August 2009 to August 2011, which averaged $1.5 Trillion yearly, had continued from August 2011 to August 2013, international reserves would now be over $13 Trillion; as it is, they are stalled at just over $11 Trillion. $2 Trillion are missing!
International reserves have two sources of growth:

  1. Accumulation of Bonds (mainly Euro and Dollar Bonds) in central banks of the exporting nations, which come about due to export surpluses with which the exporters purchase bonds issued by the importing countries.
  2. Accumulation of interest earned on the bonds, re-invested in bonds.

The international reserves are thus a measure of the credit which the exporters are willing and able to grant the purchasers of their exports.
If international reserves are not growing, but stalling out, this means that the exporting countries are not extending further credit, for whatever reasons, to the importing countries, mainly the US and the Euro Zone.
Born of the liberation of the world’s money from the shackles which tied it to gold under Bretton Woods, the world’s great credit-expanding machine is slowing down. $2 Trillion in international reserves have not been generated in the last 24 months. The cause must be a decline in international trade, through which enormous export surpluses of the East were sold to the West on credit, and the East received bonds for the extended credit. The market for government bonds of the West has been the eastern exporting countries, which have used their vast export surpluses to invest in western bonds.
If the exporting countries – the East – are slowing down on bond purchases, it most likely means they have less surplus left with which to purchase the bonds. Of course, they might have generated surpluses and used them to invest in the “Emerging Markets” – another name for what used to be called the Third World. Perhaps they are buying up the underdeveloped and chronically deficit-ridden Third World? That may be, but such a policy could hardly account for a $2 Trillion slow-down in growth of international reserves.
A $2 Trillion market for bonds has not materialized in the last two years; it is no wonder that the Fed has stepped in with QE to purchase the bonds which must be sold to keep the US Government in operation, not to mention to stave off utter collapse if the word were to spread that “There is no market for US and Euro Bonds at the volumes that the sellers require!”
The US and the Euro Zone are finding that they cannot float further credit in the exporting countries. This is a serious condition; the West depends on a market which will accommodate its expansion of credit – a market for its government bonds – for without that continual expansion the whole house of financial cards comes crashing down.
There appears to be no further market where the US and the Euro Zone can float their bonds. The only recourse is to monetize their government debt (QE) and that means monetary inflation.
The consequence of monetizing debt will have to be rising interest rates.
If the government debt were not monetized, US and Euro Zone bonds would have to be thrown on the world market, but – who would purchase them? Interest rates would skyrocket, even if there were possible buyers, which is doubtful.
As it is, the US can only continue to monetize government debt. Higher dollar interest rates are inevitable and will cause further government deficits; the debt overhang in both the US and Euro Zone is so great that a rise of a few points in interest rates will explode the deficits, and so on and so forth.
Bottom line: Stalling growth in International Reserves tells me that a world financial collapse is in the offing.
Please draw your own conclusions.

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