The dollar’s metamorphosis

The dollar’s metamorphosis

 Reuters news agency put up an interesting item a few days ago. We learn that the United Nations World Economic and Social Survey 2010 has concluded that the US dollar “…has proved not to be a stable store of value, which is a requisite for a stable reserve currency… The report supports replacing the dollar with the International Monetary Fund’s Special Drawing Rights (SDRs)”. (Section IV, pp. 128-129 of the UN report). Hmmm.

What exactly is an SDR you might ask, as I did. The International Monetary Fund explains them to be “…an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. Its value is based on a basket of four key international currencies, and SDRs can be exchanged for freely usable currencies”. Moreover, “The SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members.” (My italics)

You can buy things with them, exchange them for currency or sell them. They look like, behave like and you use them like, well, derivatives. Now that I think about it, they actually are derivatives! The downside of derivatives is that they don’t carry a primary obligation, the factors underlying them can be complex and some people, there’s no polite way of saying it, cheat in using them. Derivatives need confidence.

Anyway, everyone seems happy with SDRs at present and there are only USD 250 billion worth in existence, so does it matter? Well, maybe.

A a derivatives scam in all but name

Here’s the problem. Because the US economy and dollar are collapsing, no-one likes holding dollars any more. The Chinese have 2.5 trillion of them and would like something else. This Youtube clip is a bit out of date but the story is still the same. If the CBS report is correct, it’s the Chinese, probably with Saudi Arabia and the Gulf states, who are pressing for SDRs  so that they can unload their dollars, but it’s true – the dollar is finished as a reserve currency. But how would SDRs work? Two and a half trillion dollars, Chinese holdings alone, is a lot more than the current 250 billion dollars worth of SDRs in circulation now – 10 times more to be exact. Fred Bergsten, writing in the Financial Times gives the December 2007 figure of upwards of 20 trillion dollars held in world reserves. I can’t find a current figure but it must be above 25 trillion now.

Mr Bergsten says that the way to go about changing dollars for SDRs is for countries with “unwanted” dollars to deposit them with the IMF, which would exchange them for SDRs that they could use as money. The US would thus avoid high inflation and interest rates. It would also avoid huge exchange rate devaluation . Other countries, Mr Bergsten would persuade us, would benefit from getting the diversification in assets backing their reserves that they want instead of dollars and a new reserve currency in SDRs as well. The money markets would not notice. Everyone would be happy. Splendid.

What happens to the dollars that the IMF has? In Mr Bergsten’s scheme they are invested in United States securities, presumably treasury bonds. Now, the 25 trillion dollars that everyone else is holding is all US debt, whether dollar notes or treasury bonds. It’s all debt because if you take some of it to the US you can exchange it for any goods you like. Nearly, anyway. Not US ports as Dubai Ports World found, and probably nothing really worth having, but the US does owe physical stuff. So this 25 trillion could potentially end up in the IMF which reinvests it, not in anything tangible, but in US debt – again. In the meantime, everyone goes on using their SDRs that they were given by the IMF for their dollars. There’s something not quite right about this. It reminds me of, well, a derivatives scam.

We have vivid memories of the recent US derivatives scam on our banks. European taxpayers will be paying for it for a long time. These were the bundled mortgages that couldn’t be unbundled to tell who owed the money, most of whom had defaulted. There were clever items like credit default swaps (CDFs). A CDF is an insurance policy against default by someone who owes you money and you can use it as collateral. Actually, very useful. Unhappily, people like AIG liked getting the premiums and bonuses so much that they sold them to everyone who wanted them whether they were owed money or not. CDFs became a means of betting on whether a firm would fail, with the payoff if it failed. When firms began to default, AIG’s asset value was scrutinized, its credit dried up and it was allowed to crash (although other firms were saved by US taxpayer funds). These CDFs and numerous similar derivatives created at that time had been used as security or traded against other deals, generating a domino effect that still hasn’t unravelled.

Fred Bergsten and the Peterson Institute

Who is Fred Bergsten, anyway? He’s American – there’s a surprise. My life! You have to give credit (so to speak) where it’s due. Americans are brilliant at dreaming up these schemes! Fred is also the director of the Peterson Institute for International Economics. He was assistant secretary of the Treasury for International Affairs in 1977-81 and led the substitution account negotiations of dollars for SDRs for the US in 1980. In 1981 he set up and was the first director of the Peterson Institute, evidently to continue his good work. Fred will certainly understand the problem but one might well begin to think that this particular proposition might not be neutral to other countries’ interests. The idea has been around for a while, so there seems to be some international hesitation about buying it.

The Peterson Institute is a US establishment think-tank that has some very big international names on its Board of Directors. It is financed by the German Marshal Fund, which is a US-German government-financed propaganda and money channel that apparently exists to promote United States interests generally but probably particularly in Europe. So Fred is the regular guy who just dropped the idea into the Financial Times to get the City of London used to the thought of a little innocent change to the reserve currency of the world, while fronting for people who own three quarters of the wealth in existence.

“If we use the IMF scheme for substituting SDRs [Special Drawing Rights] for dollars, all that happens is that the dollars deposited with the IMF are continually recirculated back to America for more dollar debt.”

If we use the IMF scheme for substituting SDRs for dollars, all that happens is that the dollars deposited with the IMF are continually recirculated back to America for more dollar debt. America never pays off its debt which can still keep on growing with the IMF as America’s banker allegedly backed by the IMF’s members. SDRs no longer give any claim on America itself for payment or interest. Their real value equates to a pile of dollars within the IMF that are being kept off the currency markets for fear of what will happen. SDRs work as currency at the moment because the scheme is small scale and has no impact. Scaled up to reserve currency proportions it’s like everyone buying credit default swaps or printing money 24/7.

What I am curious about is the ultimate fate of this pile of dollars and their “special drawing rights”? Will the US redeem the debt one day? Will it continue to pay interest in dollars that are continually recycled by the IMF forever, using debt as collateral for more debt? This is called gearing; it can be useful but often gives magically wonderful results followed by unmitigated disaster. It was one of the factors involved in the banking crash. Will the IMF charge interest, reduce interest or even write it all off? Who is going to be left with the pile of worthless paper with big numbers on it when the scheme collapses?

You know, to digress for a moment, in 2008 when I first saw the proposal surface in the Financial Times for the British government to set up an insurance scheme for the banks’ unidentified but known to be massive future losses I couldn’t resist putting in a comment. I said that it was a stupid idea (but politely) because it would mean taxpayers making a gift of money to private sector banks. I thought that no British government and certainly not a Labour government would insure against private sector losses that were known to be there. The banks and their shareholders take their profits; they have to take their losses. I was wrong. The government did do it. That and handing over public capital to the banks without getting shares is the biggest financial betrayal of the British nation by its politicians since the government started using National Insurance contributions, that were supposed to be for future pensions, for general taxation. The guys who authored this rubbish, Laurence Kotlikoff and Perry Mehrling are American academics, conceivably friends of our incompetent ex-Prime Minister Gordon Brown who gave away our taxpayer funds to greedy and incompetent bankers. Kotlikoff and Mahrling’s students will have enormously successful careers in the US government where UK politicians look for guidance.

“Based on the US and British governments’ bank give-aways, the United States will never pay back its debt and probably not service its USD 500 billion annual interest while at the same time trying to avoid the devastating effects of defaulting.”

Well, here we go again. Based on the US and British governments’ bank give-aways, the United States will never pay back its debt and probably not service its USD 500 billion annual interest while at the same time trying to avoid the devastating effects of defaulting. The debt is being parked in the IMF forever until it is forgotten, depreciated by inflation or manipulated out of existence by some imaginative sleight of hand. All the major holders of US debt who are represented on the Peterson Institute Board probably want a temporary arrangement that will enable them to get their dollars into something solid like mining and agricultural leases before everyone dumps their holdings and the dollar finds its true level which is some value a little above zero.

Keep SDRs out of Europe

Let’s just keep SDRs out of Europe. And why should Europe or anyone else support them anyway? I don’t see why the US shouldn’t pay off its debt. Let’s see – it owns 261 million ounces of gold worth at USD 1,200/oz 313.8 billion. Perhaps not. They’re a bit short of 25 trillion by a factor of 80. It would do as a deposit, however, to show good faith and they could pay it off the way they made the UK pay off its lend-lease debt for equipment that they lent the UK to fight World War II. We paid it off four or five years ago, just in time to buy their toxic derivatives. I’m not bitter. I just think that that the US should pay its debts like everyone else, excepting the banks of course.

The IMF and the World Bank, that the US effectively controls, are very good at telling other countries to adopt sound financial and economic policies, so it is to this that they should apply their minds in the US case. Some austerity, some good economic management, bring all the troops home, close down the world-wide bases and the US is half-way there.

Fred Bergsten thinks that the IMF’s gold reserves of USD 80 billion would be enough to guarantee SDRs for all comers. I think not, Fred, but if the UK didn’t own some of it I’d say, “Toss it into the repayment pot”. Every little helps. Actually, I don’t think that the IMF has any physical gold. I suspect that what it calls its reserves are pledges from its members, that is, virtual reserves like the virtual currency of SDRs. The truth is that no country in the world is going to give up a gram of physical gold to back the US dollar.

Zhang Monan, a researcher in the Chinese government’s State Information Centre, writes:

Washington is focusing on financial rebuilding and attempts to restore its financial stability and competitiveness, and regain its absolute leadership in global financial matters…

On reforming the international financial system, the US is willing to accept only minor changes to international financial institutions, such as moderate tightening of financial oversight and symbolic increase in developing countries’ voting power in the IMF and the World Bank. The US has set two benchmarks on the issue – that no country be allowed to weaken its dominance over the international financial system and no reform should alter the dollar’s status as the world’s leading currency.

Interesting. But I wouldn’t call converting the world’s dollar reserves to derivatives a minor change. So what gives the US the confidence that it can maintain the status quo in its current situation with the world now deeply suspicious of US financial paper? Will they nuke us if we don’t lend them money? Stage Special Forces raids on Europe’s central banks? Torture our politicians? What else do they have? Would even our corrupt politicians dare to go for this SDR scheme?

A little time ago I predicted world economic meltdown due to the US’s desperate plans for getting out of its economic disaster by seizing the oil exporting regions of the Middle East. These SDR derivatives seem to be the financial part of the plan. Once I’d have said that it’s a stupid idea that is default by another name and destructive in the long run, but it seems that no US scheme, financial or otherwise, is too destructive – of someone else.

There’s a myth about, doubtless originating with some US think tank or other and propagated by the United Nations World Economic and Social Survey 2010 (Section V, p.114):

The current system requires that the country (or countries) providing the global currency run deficits to ensure sufficient liquidity to support the growth of global output and trade. The 2008-2009 global economic crisis demonstrates that the accumulation of deficits by the reserve-currency country, sustained by other countries because of their national policy objectives, is not self-correcting and leads to a crisis of global proportions whose costs are incurred by many innocent parties.

So, we are to believe that the US deficit is all self-sacrifice in service of the world’s greater good? I don’t think so. It’s economic, monetary and fiscal incompetence together with profligate spending, waste and wars by its military-industrial complex and parasitization of other countries and their resources. That probably covers it. If any Americans should by chance be reading this, I say: Hi guys! Bad news. A lot of people out there are thinking, “It’s payback time!”

Debt can’t be disappeared away like that unless, in the spirit of international goodwill and cooperation, China and the Saudis simply give back all their dollar reserves to the United States and write them off to friendship. It’s just another derivative scam and some people, sometime, are going to lose a lot of money if it’s implemented.

The international community doesn’t need the IMF to manipulate its affairs. Markets can set currency and interest rates perfectly well and individual countries are best placed to select a basket of currencies for their reserve needs based on their trading patterns rather than have the IMF do it for them. Markets and the institutions that use them do need responsible regulation, however. The current financial crisis is the result of inadequate and incompetent regulation. Governments also need to develop competent economic policies. If they don’t, they have to take their medicine as the IMF and World Bank have always said.

Christopher King is a retired consultant and lecturer in management and marketing. He lives in London, UK.

Source: Redress Information & Analysis ( Material published on Redress may be republished with full attribution to Redress Information & Analysis (