As we have already stated, at the beginning of the paper (and nothing but paper) currency era in 1971, the US government had run up a funded debt of about $US 400 Billion. By the end of the 1970s, that debt was approaching the $US 1 TRILLION level and the world had gone through a decade of ever increasing monetary and financial chaos. Early in 1979 and fearing a possible collapse of the entire global currency system, the European Community (the forerunner of the European Union) decided to create the European Currency Unit or ECU. The ECU was never a currency in its own right. It was instead a basket of 12 European currencies - including the British Pound. Just over two-thirds of this "basket" was made up of three currencies, the German DMark, the French Franc and the British Pound. The ECU was, in essence, a European version of the Special Drawing Right or SDR concocted by the IMF in the late 1940s.
Over the course of the 20th century, the continental Europeans had been badly burned twice by sovereign debt repudiations. In 1931, the British government reneged on its promise to redeem its reserve currency - the Pound - in Gold. In 1971, the US government did the same thing with what had become the world's sole reserve currency - the US Dollar. In the late 1970s, the Europeans saw a distinct possibility that the world was entering a period of monetary chaos similar to what had happened in the 1930s. In late 1979, Fed Chairman Paul Volcker went to an emergency meeting in Belgrade. At that meeting, he was presented with a European ultimatum: "Take the lid of your interest rates so that they rise to reflect the true RISK of holding US Dollar denominated paper or we'll DUMP our Treasuries." Mr Volcker returned to the US and the rest is history. US interest rates soared and the US Dollar was "saved".
The Europeans were not convinced that it would stay "saved" so they concocted what they hoped would be an alternative reserve currency. The problem was that like the IMF's SDR, the ECU never became a circulating currency but remained as merely a "unit of account". As such, it posed no more of an alternative to the sole reserve currency status of the US Dollar than had the SDR. ECUs never traded on global currency markets, only European currencies did. By the end of the 1990s, its usefulness was done.
Enter The Euro:
In 1999, the ECU was replaced by the Euro. Unlike the ECU, the Euro is an actual currency which replaced the national currencies of the European Union members who agreed to use it. The Euro became an accounting currency in 1999 and a circulating cash currency at the beginning of 2002. As a circulating cash currency, it was a potential rival to the US Dollar as an international reserve currency. The problem was, and remains, that the Euro suffers from exactly the same fatal flaws that beset the US Dollar.
The biggest problem is that the Euro is a "fiat" currency. Just like the US Dollar, the Euro has nothing behind it except the full "faith and credit" of government. Just like the US Dollar, one Euro is redeemable in nothing - except another identical Euro. At its inception and to this day, the only difference between the Euro and the US Dollar is that Gold is recognised as an official "reserve" behind the Euro while it is NOT recognised as an official reserve behind the US Dollar. But the Euro is not REDEEMABLE in Gold - or anything else. It is nothing more or less than a promise to pay.
The other problem with the Euro, which is worse than the identical problem faced by the US Dollar, is the fact that the sovereign debt of government is the legal "reserve" behind the currency. The Euro's problem in this regard is worse than the US Dollar's because there is more than one government involved. In fact there are seventeen major European governments involved, all of which fiercely guard the right to set their own fiscal policies. This situation blew up in Europe's face in the aftermath of the 2008 Lehman crisis when the US and its "ratings agencies" adroitly switched the focus of the crisis across the Atlantic.
At the US Dollar's 2001 peak, it made up 71 percent of global exchange reserves. By 2009, the US Dollar's share had dropped to 62.1 percent while the Euro's share hit a high of 27.6 percent. Today, the US Dollar's share is flat at 62.2 percent while the Euro's share is down to 25.0 percent.
Winning On A Busted Flush:
On July 26, ECB head Mario Draghi made a statement reported all over the world. At a gathering in London to celebrate the opening of the Olympics on the following day, Mr Draghi let loose with this: "Within our mandate, the ECB is ready to do whatever it takes to preserve the Euro. And believe me, it will be enough." Nobody noticed that Mr Draghi had made no mention of WHEN the ECB was going to do whatever it was going to do and WHAT exactly it was that the ECB contemplated doing. When Mr Draghi fronted the press conference following the ECB meeting exactly a week later on August 2, the disappointment was palpable. The entire financial and investment world resembled nothing so much as a huge assemblage of young children pouting about opening their gaudily wrapped birthday presents only to find a pair of socks instead of the "neat stuff" they had been "promised".
Anybody who has ever played poker knows that the best hand does not necessarily win the pot. If everybody else at the table folds, the last player doesn't have to show his hand at all. In this regard, think about the "advice" that the European financial potentates have been getting from their US colleagues - notably Treasury Secretary Geithner - throughout the "crisis". Every time the Europeans proposed a new bailout fund, it was too small. As Mr Geithner never tires of telling them, if you hit them with a really huge pile of potential money, you will probably never have to spend it.
Running an economy with a fiat currency which can be created in "unlimited" quantities is, at its root, nothing more than a bluff of galactic proportions. You can keep pushing all your money into the middle of the table and as long as there is "enough" of it, everyone else will fold and you get it all back, and theirs' as well. That, in essence, is what monetary policy has come down to on both sides of the Atlantic.
The State Of The Game:
At his August 2 press conference, Mr Draghi assured the gathered throng that he could certainly "imagine a Eurobond". As an intelligent man, we have no doubt he speaks the truth. The average human being can imagine anything he or she wants to imagine, in great detail and in full colour. The problem for Mr Draghi and most of his colleagues tasked with running the European Union is that there are some people in Europe who they cannot bluff. A Eurobond would mean that every taxpayer in "Euro Europe" would be ultimately responsible for the debt run up by every government in "Euro Europe".
Late last year, a government think tank named State Budget Solutions calculated the cumulative debt of the 50 states in the US at about $US 4 TRILLION. According to their rankings, the least indebted state was Nebraska with a total of $21 per capita. At the other end of the scale, Connecticut stood with a state debt equivalent to $5,402 per capita. Imagine a scenario in which the taxpayers of Nebraska were asked to stand behind the debt incurred by the government of Connecticut (or California). If you can imagine their reaction then you have will have no trouble understanding the attitude of German, Dutch, Austrian and Finnish taxpayers to their Greek, Spanish, Portugese, Italian and French counterparts.
In the US, state governments get a large part of their "funding" from federal transfers and the federal government can still borrow money at historically low interest rates. That's why Connecticut doesn't pay more to borrow money than Nebraska does. In Europe, the state governments which use the Euro each tax, spend and borrow independently. That's why some of them are paying MUCH higher rates on their borrowings than others are. Since there is no common backstop on the debt of ALL the Euro states, some are in a much better position to bluff the markets than are others.
But EVERY state or nation which issues sovereign debt "backed" by a fiat currency - and every nation does just that - is in the same game. All of them are at the mercy of anyone who calls their bluff. Right now, the peripheral European nations are sitting at the table shame facedly with their cards face up. The rest of the players are still bluffing, but they haven't been forced to show their hands yet. They will. The only "solution" is to re-invent a very old game - one that is played with REAL money…
The oldest adage in the world of financial systems fuelled by and dependent on "credit" is those that live by the issuance of debt will perish by choking on that excess of debt. The second oldest adage is that the extent of their fall will be directly proportional to the degree to which genuine savings are hollowed out by the credit expansion. There is no way over, through or around these implacable truths. The only thing that can be done is to postpone the day of reckoning by ever deepening the pool of red ink. The only thing this accomplishes is to ensure that when the collapse DOES come, it will be deeper and more devastating than it would be if the credit creators had stopped earlier in the sequence.
A century ago, the US financial establishment claimed that they had ended the "business cycle" by instituting a central bank. Almost eighty years ago, they claimed that they had banished the threat of bank runs for all time by establishing the Federal Deposit Insurance Commission (FDIC). Today, the Fed has stripped the US Dollar of about 98 percent of its purchasing power while the danger of direct "bank runs" has been minimised by the non-existent interest rates on offer for savings deposited in banks. These situations are global, differing only in degree. The end results of terminal monetary profligacy are now being played out in Greece and are on the verge of being played out in Spain. From like inputs come like outputs. What is happening to Greece and Spain now will inexorably spread across the world later.
In the present market circumstances, the only way to preserve wealth and purchasing power is to make sure that it is not at the mercy of the financial "black hole" which government regulated "investment markets" have become. One of the small saving graces for Americans is that so many of them already have or now are abandoning the stock market. The real saving grace for Americans and everyone else will come to the extent that they realise that the financial system which rules them is set up to make genuine saving difficult to the extent of being all but impossible. But there always remains the alternative of precious metals, real goods and, for a while longer at least, cash or something as close to it as possible.
Investing in the future of debt creation is a sure path to penury. Nothing escapes from black holes.
.Ó 2009 – The Privateer
(reproduced with permission)
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