Edited for length. Entire article at: www.gold-eagle.com/editorials_99/sennholz121599.html

A Perilous Dollar Standard Hardly a year passes without a financial crisis. In 1998 the virtual collapse of the Russian economy led to serious losses on markets in Asia and Latin America. And the spectacular crack- up of a prestigious investment fund, Long-term Capital Management of Greenwich, CT, shook U.S. markets. The Federal Reserve felt compelled to move three times to stimulate economic activity by easing credit conditions to keep the U.S. economy from falling into a recession. The world monetary order which rests on the U.S. dollar as the most prominent reserve currency seems to be no stronger than the weakest link.

Last year's crisis passed, but the situation in many respects is more fragile today. There have been no fundamental reforms. The emerging countries are returning to their old free- spending ways and the United States, which for the last few years has been single-handedly sustaining the global system, may prove to be a shaky support. The downward pressure on the dollar  stemming from the fact that U.S. asset prices no longer are rising and capital inflows are drying up  highlights the fragility of the U.S. financial system and the vulnerability of the world economy. The dollar exchange rate is a barometer that may give early notice of the crises to come.

In 1997, finally, the world was caught in the grip of the most serious financial crisis since the 1978 and 1979 flight from the dollar. Starting in Thailand and spreading quickly to Indonesia, Malaysia, and the Phillippines as well as affecting South Korea, Hong Kong, and Singapore, it posed a direct threat to U.S. finance and the world dollar standard. By the end of 1997 the Asian currency depreciation averaged 50 percent against the U.S. dollar, contributing to Japan's slide into deep recession and causing the yen to plummet. A deep depression settled over parts of Asia, causing severe economic hardship and leading to social unrest and political upheavals.

The new Asian crises augured the bursting of various financial bubbles  just as the Japanese bubble had broken eight years earlier. It revealed huge malinvestments in industrial capacity and property and caused massive wealth destruction through the collapse of asset prices, creating mountains of bad loans and leaving behind an illiquid and vulnerable banking system. The crises affected other countries around the globe as liquid capital sought to escape the troubled areas and find safe havens in Europe and the United States. The influx of frightened foreign funds added more fuel to the U.S. bubble.

Since the beginning of this year (1999) the bubble has come under new pressure which is bound to increase in the future. Annoyed by the hegemony of the U.S. dollar in world markets and fearful of its precarious base of debts and deficits, many Europeans would like to withdraw from the world dollar standard by creating a currency system of their own. Eleven European countries launched a common currency, the euro, to replace their national currencies. In time it may create a continent-wide economy very much like that of the United States, and challenge the dollar as the world's primary currency. The Euroland of eleven is as large as the United States, conducting more trade with the rest of the world than the U.S., has larger foreign exchange reserves, and enjoys a much stronger foreign trade and finance position than the U.S. Europeans may soon finance their trade in euros rather than U.S. dollars, which may result in a huge shift from dollars to euros around the world. It would signal a shift from dollar hegemony or dollar standard to a bipolar monetary world. The transition may depress the exchange rate of the dollar, boost the prices of all imports, and generate an upward pressure on inflation and interest rates. It could trigger a dollar crisis, burst the Wall Street bubble, and usher in a deep recession.

The situation is not likely to change for the better given the global electronic infrastructure which will be at severe risk of collapse in the coming year. Commonly called The year 2000 (Y2K) Problem, it threatens most financial institutions especially on the international level. The computer omission of the century digits from dates has erected computational ambiguities that corrupt individual computer systems and then multiply to endanger inter-related systems. It is quite certain that many millions of computer systems around the globe will fail at the beginning of the new millenium, which will have a serious impact on the ability to conduct business. It is likely to deflate all financial bubbles.

Some Y2K analysts are convinced that hundreds of American communities with many millions of people will be without public utilities in January. They are warning that New York City, for instance, may experience major utility failures, which would play havoc with economic activity. The New York Stock Exchange surely would close and the banks would declare "holidays," just as they did in crisis situations in the past. There could be a financial panic leading to runs on the banks, which would quickly spread to other countries. It is equally possible that the bank runs may not begin in New York; they may start in Manila, Kuala Lampur, or Rio de Janeiro and spread to New York City. After all, the capital markets of the world are interdependent.

The American bubble is at extreme risk; it is the mainstay and supporter of all others. As the dominant reserve currency of the the world, the U.S. dollar is in world-wide demand, which has given the dollar authorities the ability and power to inflate and create credit at astonishing rates. The demand allows the U.S. to suffer huge trade deficits and export some of its excesses in the form of dollar loans to business and governments around the globe. The U.S. dollars held abroad then serve as an ever expanding basis on which foreign governments and central banks build their own bubbles. They are resting their credit pyramids on a dollar base which itself is a giant pyramid of leveraged credit and debt.

The visible marks of the U.S. bubble are not just egregious malinvestments, especially in the telecommunication and media industries, but also a great stock market boom. Taking advantage of the stock euphoria, investment bankers underwrite new stock and bond issues nearly every day. Corporate mergers and acquisitions proceed unabated, facilitated by lofty stock prices and easy credit. Feverish issuance of mortgage-backed and asset-backed securities bolsters a residential housing boom. Fannie Mae, the publicly owned and government-sponsored banking corporation, alone holds more than one trillion dollars of new mortgages. Syndicated bank lending exceeds even this amount. Outstanding credit card debt is growing at double-digit rates, while personal savings are declining. There is leverage upon leverage as never before, as securitization is vying with banking as the primary source of credit. Countless trillions of dollars worth of derivatives are supposed to sustain the lofty pyramid. Global outstanding interest rate swaps, currency swaps, and interest rate options alone now exceed $100 trillion. According to Alan Greenspan, the derivatives market carries some $80 trillion of most short-term debt, world- wide, with U.S. banks holding $33 trillion of this debt.

If some of the debtors should ever default because of an unexpected decline in financial markets or Y2K failures, the banks will be holding worthless IOUs, which would cast doubt on their solvency. Surely, the Federal Reserve will want to come to their rescue, but it is inconceivable that it can create trillion-dollar credits or print trillion-dollar notes. Any such attempt would seriously damage the U.S. dollar, lead to rampant price inflation, and irreparably ruin the world dollar standard. It is more likely instead that the federal government will declare bank holidays and impose a myriad of controls on the people. The controls in turn will generate a financial underground which will develop standards of its own.

The Federal Reserve still wields great power because part of the stock of money consists of bank deposits; and banks are forced to keep reserves at the central bank. But this Fed power may prove to be rather hollow because the evolution of electronic means of payment in recent years deprives the Fed as well as the member banks of all leverage. The proliferation of non-bank credit reduces the power of central banks because bank credit is steadily contracting as a proportion of total credit. Moreover, even where commercial banks still issue loans, these may be "securitized," which means that they are sold to non-bank investors who are not subject to reserve requirements. In short, the demand for bank money is eroding as is the Fed power to manipulate the people's money and credit.

In these waning days of the dollar standard and the exciting new world of electronic means of payment, it is difficult to foresee the shape and color of the coming financial order. We cannot say what the rate of inflation will be, nor can we know whether national authorities will find new ways of controlling the people's money. Most economists are convinced that we will have to return to the financial systems of the past. Surely, the monetary authorities of the world will want to reassert their position through new controls over their subjects and new international agreements and treaties. But it is difficult to see how political machinations can redirect the electronic national and international monetary flows.

In the end the standard of value in which international prices are quoted and contracts denominated will be neither the U.S. dol- lar nor the euro. It will not be measured in terms of a unit of account defined in terms of a basket of goods because the international authorities will never agree on the content of the basket. We are convinced that the future standard of value will be gold again, as it has been for more than 2,000 years throughout the Western world. The political authorities will fight it unrelentingly and mercilessly, but gold undoubtedly will prevail in the end.

The world monetary system is about to change again. It is difficult to foresee the form and structure of the coming order. Clinging to their powers, the monetary authorities of the world will want to repair the old order with restrictions and regulations. But their failure to prevent the numerous crises, which put nearly all countries in serious jeopardy, is casting serious doubt on their credibility and ability. The precarious condition of the very dollar base and chronic foreign account deficits of the United States at the expense of all creditor countries are discrediting the dollar authorities. This explains why governments and central banks throughout the world are becoming ever more reluctant to grant the U.S. government a permanent monopolistic position in matters of world money. In crisis and despair the world may choose gold.

Hans F. Sennholz 12/15/99

http://www.sennholz.com/index.html

-- Infidel (Barbarians@thegate.com), December 15, 1999

Answers

Link

-- Jack (jsprat@eld.~net), December 15, 1999.

The dollar falling or rising is always a crises based on ones particular mood or needs. When it is high we have an export crises, and when it is low we no longer have an abundance of cheaply priced but well made goodies.

It's been a little too high in my opinion. I am in CA which has a vast sprawl of wine makers to say the least. Some experts do tout some of them as the finest in the world. It would do a lot for the state if more people around the globe could afford CA domestic wines and other products. The stores right now are an endless slew and overload of Asian products due to the Asian crises. At the same time, for the Asian product prices to stabilize, would then prompt domestic consumers to purchase domestic products again.

My point being let us not worry about the "dollar falling" quite yet. A bit of a drop could do a lot of good not harm. "I have the highest dollar" doesn't make the king. I have the highest and lowest at the right times for my nation and people maketh the king.

-- Paula (chowbabe@pacbell.net), December 15, 1999.

Paula, the main point of the article, in my opinion, is that the dollar is historically cherished by many nations due to it's original status as the world's "reserve currency". The main reason for it's selection to this status was that, at the time, it was 100% backed by gold.

This changed in 1971, when the dollar became Just Another fiat currency like virtually all the rest. Traditions, however, die hard, thus the dollar is still considered a strong currency to this day.

However, both the Yen and the Euro (15% gold backing) are challengers, and tradition can only go so far. The dollar is indeed in a potentially perilous state.

-- Jack (jsprat@eld.~net), December 16, 1999.

I posted this in another thread - it's a recent quote from a Danish magazine. Personally, I don't understand ... but (as Ed Yourdon also said of himself), that's why I'm a moderately-paid systems analyst and not a rich player in the financial markets.

Y2K FLIGHT FROM THE EURO: Investors are expected to offload their Euro holdings and buy dollars, to secure themselves against all eventualities due to the Y2K rollover. They would rather be sitting with the old, familiar Dollar rather than the new-fangled Euro, if the finance markets are hit by chaos ... analysts estimate that trading will be 'irregular' in the coming weeks because of insecurity about what lies on the other side of Y2k (sic).

-- Risteard Mac Thomais (uachtaran@ireland.com), December 16, 1999.

"The main reason for it's selection to this status was that, at the time, it was 100% backed by gold".

JACK,

there is a lot I do not understand in this question of the dollar vs gold. Please help me here! In my present understanding there would not be enought gold to back every currency 100% worldwide and maintain any resemblance to the World ecomomy we now have.

What say yee?

-- Tommy Rogers (Been there@Just a Thought.com), December 16, 1999.

Tommy:

I am no expert on converting from a fiat currency to the gold standard, but can recommend http://www.fee.org/freeman/95/Greaves.html as a good explanation. You can also find a lot of similar editorials at www.gold-eagle.com in the Editorials; http://www.gold-eagle.com/editorials/waniski111897.html is a particularly good one.

If you think about it, the short answer is that really should not matter how much gold there is, or how many people there are in a true free market -- just as water seeks it's own level, so it should be with gold as money. If I measure a rug with a ruler delimited in millimeters versus a ruler delimited in inches, the rug is still the same size -- the fact that I have obtained two different numerical representations is does not alter this one whit.

15 days.

-- Jack (jsprat@eld.~net), December 16, 1999.

THANKS Jack...

I'm in the learning mode......

-- Tommy Rogers (Been there@Just a Thought.com), December 16, 1999.