How To Establish an International Currency

How To Establish an International Currency

July 6, 2009

(This originally appeared in the Daily Reckoning on June 30, 2009.)


Citizens can be easily coerced into using the government’s currency. Usually it is enough to demand that taxes be paid in that currency. Today, most governments make it illegal to use a foreign currency within their borders.

People in other countries are beyond such simple mechanisms of control. For an international currency, there must be reasons to use the currency voluntarily.

The best currency is the one that is most stable in value. Historically, the premier international currencies, whether the US dollar after World War II, the Dutch guilder in the seventeenth century, or the Athenian owl in the fourth century BC, were those reliably pegged to gold. Gold has been the superlative monetary standard for thousands of years.

Even after the US dollar left the gold standard in 1971, it remained the most stable currency in the world, which allowed it to maintain its prominence up to the present day. There was no better alternative.

During the 19th century, the US was considered an emerging market. The premier international currency was the British pound.

In 1914, the British pound had been pegged to gold (with brief lapses) for 233 years. However, the beginning of World War I tossed all the European powers into turmoil, including Britain. The pound’s link with gold was broken. People in Europe looked for a reliable store of their financial assets. They observed that the United States was untroubled by war and had by then a long history of gold-linked currencies and protection of property rights.

In the 1930s, all European governments devalued their currencies again. The United States did as well, in 1933, but the dollar remained pegged to gold afterwards while most European currencies (and the yen) floated. World War II cemented the transfer of financial prominence to the US To put it quite simply: the US Treasury bond – denominated in gold-linked dollars – was the most reliable store of value in the world.

Financial theorists divide the world of investments into two asset classes: the risk-free asset, and all other risky assets. With currencies mismanaged constantly by central banks, nothing today even approaches the ideal of a “risk-free asset.” In marketing-speak, a vast demand goes unsatisfied.

How could China establish an international currency? I predict it will happen when a person anywhere in the world is able to say: The Chinese government bond is the most reliable store of value in the world – the closest approximation to the “risk-free asset.”
Obviously, we are not there yet. How could the Chinese government promote this process?

The Chinese yuan would have to be reliably stable in value. In the past, this has always meant a gold standard. Fiat floating currencies managed by bureaucrats are never very reliable, and have a nasty tendency of disappearing altogether. In the past, the international currency was always the one that remained pegged to gold, while the alternatives sank into chaos and devaluation.

Chinese authorities may claim that their floating currency managers are better than the US or European floating currency managers, but nobody would believe them.

The yuan would have to be a reliably independent alternative to the dollar, euro or yen. Since 1950, the yuan has had one form or another of a dollar peg. It is completely pointless to use yuan instead of dollars, if the yuan is pegged (tightly or loosely) to the dollar. The desire for stable exchange rates is entirely reasonable. However, the Chinese government has not established any record of being able to manage an independent currency.

Simply having a floating currency is not enough. Both the euro and yen float, but they are not really independent of the dollar. Monetary policies at all three central banks are eerily similar. The Bank of Japan, in particular, seems to be subject to political pressure from the United States. If the dollar were to fall in value considerably, it is likely that the euro and yen would also be guided lower to avoid disadvantages to trade. They would all decline together, if not quite at the same speed.

To put it a slightly different way: Even though people are getting nervous about the reliability of the US Treasury bond, neither the German government bond nor the Japanese government bond are clearly better.

If China adopted a gold standard policy, this would establish true independence from the dollar. However, if the dollar fell in value considerably, then the yuan/dollar foreign exchange rates could change dramatically. Instead of about 7:1 today, perhaps it could go to 1:1 in the future. This would be due to a dollar fall, not a rise in the yuan.

Many countries could not tolerate such a situation. Switzerland tried, in the early 1970s, but the trade consequences were too great. It would be quite unpleasant for China as well. However, China already has significant trade advantages, so even large forex moves like this could be withstood.

The Gulf States – and Russia to some degree – have an even larger advantage in this regard. They have no real competition for their primary export, crude oil.

A credible military remains, unfortunately, an important component of political independence, and consequently currency independence. The US is not likely to hand over its mantle of world leadership without complaint. While hostilities are unlikely, certain political pressures by the US can be imposed upon governments who, in schoolyard terms, seem like they can be pushed around. Japanese leaders remember the military exercises the US Navy conducted in Tokyo Bay in 1989, a rather blatant reminder of the Black Ships of 1853. Russia is well aware of political incursions in the former Soviet republics, and even Germany still hosts enormous US military bases.
China is establishing itself as a military power. An alliance with Russia, and acquiescence among the other Asian states, would help establish real political independence.

There remains a little problem of exactly how to manage a gold standard system. This is not very difficult, but the Chinese monetary authorities apparently have not yet mastered the basic concepts involved. Fortunately, there is now a handbook on these subjects – Gold: the Once and Future Money (2007), which is available in a Chinese edition.

The US dollar is, quite frankly, not a very good currency. It would not be difficult to develop a better alternative – a currency pegged to gold. Once the Chinese authorities had demonstrated that they can manage such a system, people everywhere would flock to yuan-denominated assets. Lenders would demand that their loans be denominated in reliable, gold-linked yuan. Shanghai would become the financial capital of the world.
Nathan Lewis
for The Daily Reckoning

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It’s Goldman Sachs! Those guys really are scum. This article gets at maybe 0.1% of their nefarious activities.

The first thing you need to know about Goldman Sachs is that it’s everywhere. The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money. In fact, the history of the recent financial crisis, which doubles as a history of the rapid decline and fall of the suddenly swindled-dry American empire, reads like a Who’s Who of Goldman Sachs graduates.

More fingers are pointing at Goldman regarding their recent market-propping efforts.

This is a nice post by Karl Denninger, translating some ZeroHedge-speak into layman’s terms:

Denninger on ZeroHedge on Goldman

Joe Saluzzi of Themis Trading saying the same thing:

ZeroHedge: Joe Saluzzi

I’m sure you didn’t miss the kerfuffle on CNBC, where Rick Santelli, Larry Levin (trader), and guest host (???) Wilber Ross (???) discovered that they all agreed that the U.S. stock market is being propped up by official intervention.

Market intervention goes mainstream on CNBC

Some people think this particular event was meaningful: that it signaled, to the great masses of people who wait to be told what to think, that it was now OK to recognize official intervention in asset markets. I mean, would you rather side with Steve Liesman or Wilbur Ross?

Background info on High Frequency Trading from Themis Trading

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Tax hikes in 25 states: Paul Krugman wrote recently about fifty Herbert Hoovers. He says:

But even as Washington tries to rescue the economy, the nation will be reeling from the actions of 50 Herbert Hoovers — state governors who are slashing spending in a time of recession, often at the expense both of their most vulnerable constituents and of the nation’s economic future.

These state-level cutbacks range from small acts of cruelty to giant acts of panic — from cuts in South Carolina’s juvenile justice program, which will force young offenders out of group homes and into prison, to the decision by a committee that manages California state spending to halt all construction outlays for six months.

Of course this is baloney. Herbert Hoover was not a penny-pincher. He spent money like mad! Then — afterwards — he tried to “balance the budget” by increasing taxes. Roosevelt did the same thing, though not quite so dramatically. It’s the tax hiking that was Hoover’s big mistake. That tax-hiking was motivated by the deficits that appeared in large part due to the big spending, so in some sense the spending was a mistake too.

CS Monitor: Tax Hikes in 25 states

Apparently, the idea of a national VAT tax is getting more traction too. Hoowee that would suck. State and local sales taxes alone are over 10% in numerous places.

The funny thing is, I’m sure Paul Krugman knows all this. That’s why I say he’s a hack. A hack for the Keynesian Establishment, the Democratic Party, academic economists in general, and any other influential group that is in need of hacks.

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The Medical Scam: I think you have to live in another country to understand that the U.S. medical system is a scam. Fred Reed, who lives in Mexico — and is a regular columnist for the American Conservative — calls a spade a spade:

Ah! But in America, the means of production own the government. Inverted socialism it is. Here is a far better thing. If you are a means of production, anyway.

Example: Bausch & Lomb makes ophthalmic salt water, useful in treating corneal edema, under the trade name “Muro.” In the Yankee Capital, it costs $23 for 1.8 ounces; in Wincherster, Va., $19; in Farmacias Guadalajara, about $6. The identical product. The generic here, Hipoton, comes in at about $3.

You could call it price-fixing, but I prefer to think of it as governmental regulation of prices. It is perfectly legal, because Big Pharma owns the government.

I believe that Econ textbooks say that price controls haven’t worked from Diocletian on. Wrong. They work splendidly. Ask Bausch & Lomb. If you could make over twenty-two bucks on a dime’s worth of salt water, wouldn’t you be in favor of governmental interference in the economy?

Let me explain medicine briefly. It’s an unholy scam. Here in Mexico my wife occasionally gets ear infections. At any pharmacy, we pick up Amoxicillin, 250mg three times a day for ten days. Six bucks.

Recently we were staying in Maryland with friends, and she got an ear ache. Amoxicillin is by prescription only in the US, which means that doctors have a monopoly on ear aches. It was Friday evening. It was either agony until Monday or go to one of those mall-based walk-in clinics, which wanted $150 for the appointment and prescribed $78 in medicines.

It’s a scam, pure and simple. Above the level of county government, the US is as corrupt as Mexico could ever be, and it’s mostly legal. Yes, I know all the who-struck-John from doctors about engendering resistant bugs. Funny. Any pharmacist in Thailand will tell you the same thing a US doctor will—Amoxicillin, take all ten days’ worth, etc. Scam.