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<h3><span id="lblStoryTitle"><font size="5">Pass the Buck</font></span></h3>
<h4 class="MsoBodyText">by Grant M. NĂĽlle</h4>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">[Posted
December 2, 2004]</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2"><img alt src="http://www.mises.org/images3/chinacoin.gif" align="right" border="0" width="200" height="202">It
is a sign of the times when the Chinese government, which was just granted
market economy status by debt-laden Argentina, takes America to task over its
gaping budget and trade deficits.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">When</font> <font face="Verdana, Helvetica" size="2">interviewed</font>
<font face="Verdana, Helvetica" size="2">by the Financial Times,
published Nov. 22, Li Ruogu, deputy governor of the People's Bank of China,
admonished Washington not to blame outsiders for its disorderly accounts, but
instead put its own house in order."The problem is that they spend too
much and save too little," he says.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Similarly, when
Fed Chairman Alan Greenspan publicly acknowledged in Berlin that,"Given
the size of the current account deficit, a diminished appetite for adding to
dollar balances must occur at some point," something is afoot.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Markets indicate
that the fiat dollar era has arrived at an endgame. The greenback has fallen by
more than 35% against the euro and 21% against the yen this year, setting record
lows almost daily since spendthrift George W. Bush's re-election. As America's
current account and budget deficits continue to bleed red unabated, traders all
over the world are finally seeing red and dumping the dollar.</font>
<p class="MsoBodyText" align="center"><img alt src="http://www.mises.org/images3/NYBOT.gif" border="0" width="479" height="343">
<p class="MsoBodyText">
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">The precipitous
fall of the leading fiat currency in the absence of a functioning gold standard
is an inevitability predicted by adherents to the Austrian School at the outset
of the disastrous Bretton Woods system that French economist Jacques Reuff
referred to as,"a childish game in which, after each round, winners return
their marbles to the losers." </font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Bretton Woods
I & II</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">The post Second
World War monetary architecture crowned the dollar as the world's reserve
currency, tying it to gold at a fixed sum and all other currencies fixed against
each other. Under this pseudo gold standard, America's central bank would
convert dollars to gold on demand for foreigners. However, U.S. policy-makers
assumed that gold redemption would fail to materialize and the Fed could inflate
without sanction because foreign central banks would retain the dollars as
reserves on which to pyramid their own currencies.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">The system
worked fine, as far as America was concerned, until the 1960s when European
countries replaced an inflationary bent with hard money policies. Assailed by
rampant inflation, the Vietnam War, and staggering trade and budget deficits,
the U.S. hemorrhaged gold at an accelerated pace, prompting President Nixon to
close the gold window in 1973. The de facto declaration of national
bankruptcy heralded the advent of free-floating currencies and the present stage
of the dollar standard.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">No longer
constrained by even the nominal fetters of Bretton Wood's pseudo gold standard,
America has been able to purchase imports with fiat money churned out by the Fed
and uniquely finance its burgeoning indebtedness by issuing debt instruments in
dollars. On the other hand, foreigners, stuck with unconvertible greenbacks
since 1973, have had no choice but to adopt dollars, rather than gold, as the
world's reserve asset.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Consequently,
the dollar standard, in both the fixed and floating variants, has fostered an
unhealthy economic relationship whereby most major economies excessively rely on
exports to the U.S. and then funnel the greenback receipts back into America's
credit-hungry public and private sectors. Repatriated dollars seep into
America's financial system, furnishing banks a broader monetary base to pyramid
credit upon, which can fund more U.S. imports, thus perpetuating the world's
vicious economic cycle.</font><a id="_ednref1" title href="http://mises.org/fullstory.aspx?Id=1689#_edn1" name="_ednref1"><span class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2"></font></span></a>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Distortions
Galore</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Figures acutely
illustrate the scope of the distorted international monetary system. Since 1982,
the U.S. has run a current account deficit every year, save 1991. The IMF
expects the 2004 total to exceed $630bn, substantially larger than the $531bn
posted in 2003. Indeed, this year's expected current account deficit dwarfs the
GDP of all but nine of the world's countries.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">These persistent
and widening trade imbalances, payable in dollars and U.S. debt instruments,
have tremendously expanded the amount of the world's international reserves,
presently estimated at $3.368 trillion.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Between 1969 and
1999 total international reserves, primarily consisting of deposits, currency,
bonds, equities, and scarcely any gold, grew 20-fold,</font><a id="_ednref2" title href="http://mises.org/fullstory.aspx?Id=1689#_edn2" name="_ednref2"><span class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2">[ii]</font></span></a>
<font face="Verdana, Helvetica" size="2">standing at roundabout $1.6 trillion.
From January 2002 to July 2004 alone aggressive money creation by the Fed,
coupled with insidious fractional reserve and central banking the world over,
added a whopping $1.307 trillion to global currency reserves.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">American
indebtedness has burgeoned at a commensurately astounding clip. Total borrowing
per annum (government and private sector) has grown from $89bn in 1969 to $1.673
trillion in 2003 and cumulative outstanding debt stands at $22.394 trillion
compared to $1.332 trillion in 1969.</font><a id="_ednref3" title href="http://mises.org/fullstory.aspx?Id=1689#_edn3" name="_ednref3"><span class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2">[iii]</font></span></a>
<font face="Verdana, Helvetica" size="2">As one would guess, the U.S. household
savings rate declined from 10% in the 1980s to less than 1% today.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Put simply, the
U.S. requires about $2bn per day from foreigners to appease its insatiable
borrowing addiction.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">However, when
capital inflows begin to recede, because of diminished creditworthiness,"there
will be a crisis that will result in rapidly rising interest rates and a rapidly
depreciating dollar that will be very disruptive," said Robert McTeer,
president of the Dallas Fed.</font><a id="_ednref4" title href="http://mises.org/fullstory.aspx?Id=1689#_edn4" name="_ednref4"><span class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2">[iv]</font></span></a>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Fed and
administration officials like to spin the abysmal current account deficit as a
success story. The theory goes that foreign investors are keen to acquire
American assets and reap the higher returns offered by the country's impressive
productivity growth.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Conversely,
foreign demand for U.S. assets has been flagging. Last year America imported
twice as much capital a month as it needed to cover the trade deficit. The gap
has narrowed; $63.4bn of capital was imported in September compared with a
$51.6bn trade deficit that month. The abrupt upsurge in federal borrowing since
2001 has also quickened the gait of current account deterioration. As private
investment has dwindled and lenders are now financing government and household
consumption, rather than investment in productive ventures, foreign central
banks have picked up the slack.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Kings of the
East </font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Enter East Asian
central banks. China, Japan, and the Asian"tigers" have prospered by
gearing their economies toward exporting to America. Recurring trade surpluses
with the U.S. have been instrumental in boosting businesses, employment, and
government revenues in these countries. Moreover, surfeit dollar receipts, when
not plowed back into America, have financed the growing level of trade between
the nations of East Asia.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Little wonder
Asian governments have opted to use heavy purchases of dollar reserves to peg
their currencies to the greenback at undervalued rates. Mean currency values
keep Asia's exports competitive, supporting the rapid growth that underpins its
economic success.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">At the same
time, acquisitions of U.S. Treasury bonds reduce American interest rates, which
sustain spending and ensure that American consumers keep buying Asian wares.
Without currency intervention by Asian central banks, America would not be able
to finance its deficit without higher bond yields or a bigger fall in the dollar
than what has already occurred thus far.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">The downside of
this policy is that as Asian central banks purchase dollars and
dollar-denominated debt instruments in exchange for won, renminbi, yen, etc., it
expands each country's domestic money supply, precipitating their own boom and
bust sequences. Richard Duncan's book, [i]The Dollar Crisis, best
illustrates how asset price bubbles have burned Asian countries with sizable
dollar inflows during the 1980s and 1990s and helps explain the boom in credit
creation currently gripping China.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Presently, Asia
holds 65% of the world's foreign currency reserves, or about $2.183 trillion.</font><a id="_ednref5" title href="http://mises.org/fullstory.aspx?Id=1689#_edn5" name="_ednref5"><span class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2">[v]</font></span></a><font face="Verdana, Helvetica" size="2">Japan
and China hold $820bn and $514.5bn of foreign reserves—mostly dollars—respectively.
Asian countries have a delicate choice to make. Does each nation continue to
finance America's spendthrift ways, courting boom and bust cycles of their own,
or do they part with the dollar standard and permit their currencies to rise,
thereby kicking the last leg out from under the dollar? </font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Besides
incurring a diminution in export competitiveness, the latter option threatens to
wipe billions of dollars off Asian central bank balance sheets, as a declining
dollar rapidly erodes the value of their vast stores of U.S. debt instruments.
In effect, a steep greenback descent would constitute another de facto
default by America, albeit differently from 1973 in that the world's biggest
debtor will this time fail to pay on billions of central and fractional reserve
banking produced dollars and debts.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Already, there
are indications that Asian and other countries of the world are diversifying
their holdings away from greenbacks. The dollar fell to $1.32 against the euro
Nov. 23 when Russian central bank authorities hinted they might recalibrate the
ratio of greenbacks to the European currency held in the bank's portfolio from 3
to 1 to 1 to 1. Jittery currency markets were jolted a day later when a
respected Chinese economics professor and central bank committee member
reportedly told his students that the central bank had reduced U.S. debt
holdings.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">China is the
pivotal player in deciding the dollar's fate considering that Asia is almost, if
not already, subject to renminbi ascendancy, rather than dollars. Should the
Chinese government lose patience with the dollar and seek to move its foreign
reserves into another currency, the rest of Asia will follow suit, precipitating
a disorderly and calamitous rout of the greenback. The question is not if, but
when, Asia will discontinue financing America's staggering profligacy, even if
it entails a rise in the value of their currencies.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">To underscore
the voracity of the dollar's impending demise, the 27 November Edition of the Financial
Times furnishes a telling account published in its letter-to-the-editor
section. The writer, who just returned from a business trip to Vietnam, recalls
how when a 7-year-old street urchin asked him for money, the child refused</font>
<font face="Verdana, Helvetica" size="2">his offer of a dollar, instead
specifying euros.</font><a id="_ednref6" title href="http://mises.org/fullstory.aspx?Id=1689#_edn6" name="_ednref6"><span class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2">[vi]</font></span></a><font face="Verdana, Helvetica" size="2"> </font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">A 100% gold
standard, with its inherent price-specie-flow mechanism, would have precluded
the tremendous accumulation of debt and annual trade deficits by America as well
as the gross distortion of the international economy, whereby most major
countries orient production toward exporting goods to America. As 50 years of
the fiat dollar standard"boom" ends, the U.S. and the world will reap
what they have sown.</font>
<font face="Verdana, Helvetica" size="2">
<hr align="left" width="33%" SIZE="1">
<p class="MsoBodyText">Grant M. NĂĽlle is a Research Fellow with the Ludwig
von Mises Institute.[email] Post
comments on the blog.</font>
<p class="MsoBodyText">
<hr align="left" width="33%" SIZE="1">
<div class="MsoBodyText">
<div class="MsoBodyText" id="edn1">
<p class="MsoBodyText"><a id="_edn1" title href="http://mises.org/fullstory.aspx?Id=1689#_ednref1" name="_edn1"><span class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2"></font></span></a><font face="Verdana, Helvetica" size="2"><span lang="EN-GB">Duncan,
Richard. The Dollar Crisis: Causes, Consequences, Cures. 2003.</span></font>
</div>
<div class="MsoBodyText" id="edn2">
<p class="MsoBodyText"><a id="_edn2" title href="http://mises.org/fullstory.aspx?Id=1689#_ednref2" name="_edn2"><span class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2">[ii]</font></span></a><font face="Verdana, Helvetica" size="2"><span lang="EN-GB">Ibid.</span></font>
</div>
<div class="MsoBodyText" id="edn3">
<p class="MsoBodyText"><a id="_edn3" title href="http://mises.org/fullstory.aspx?Id=1689#_ednref3" name="_edn3"><span class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2">[iii]</font></span></a><font face="Verdana, Helvetica" size="2"><span lang="EN-GB">Federal
Reserve. [i]Flow of Funds Accounts of the United States. 4<sup>th</sup> Qtr.
2003.</span></font>
</div>
<div class="MsoBodyText" id="edn4">
<p class="MsoBodyText"><a id="_edn4" title href="http://mises.org/fullstory.aspx?Id=1689#_ednref4" name="_edn4"><span class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2">[iv]</font></span></a><font face="Verdana, Helvetica" size="2">"The
Wolf at the Door." The Economist. Oct. 28 2004.</font>
</div>
<div class="MsoBodyText" id="edn5">
<p class="MsoBodyText"><a id="_edn5" title href="http://mises.org/fullstory.aspx?Id=1689#_ednref5" name="_edn5"><span class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2">[v]</font></span></a><font face="Verdana, Helvetica" size="2">"Economies:
Imbalances Sweep Across the Pacific in Waves." Financial Times.
Nov. 19 2004.</font>
</div>
<div class="MsoBodyText" id="edn6">
<p class="MsoBodyText"><a id="_edn6" title href="http://mises.org/fullstory.aspx?Id=1689#_ednref6" name="_edn6"><span class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2">[vi]</font></span></a><font face="Verdana, Helvetica" size="2"><span lang="EN-GB">"Euro
Street Wisdom for Greenspan." Financial Times. Nov. 27
2004.
</span></font>
</div>
</div>
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