by Valentin KATASONOV
The war was not unleashed by frenzied Fuhrer who happened to be ruling Germany at the time. WWII is a project created by world oligarchy or Anglo-American “money owners”. Using such instruments as the US Federal Reserve System and the Bank of England they started to prepare for the next world conflict of global scale right after WWI. The USSR was the target.
The Dawes and Young Plans, the creation of Bank of International Settlements (BIS), the Germany’s suspension of reparations payments it had to pay according to Paris Peace Treaty and the acquiescence of Russia’s former allies in this decision, large-scale foreign investments into the economy of Third Reich, the militarization of German economy and the breaches of Paris Treaty provisions – they all were important milestones on the way of preparing the war.
There were key figures behind the plot: the Rockefellers, the Morgans, Lord Montagu Norman (the Governor of the Bank of England), HjalmarSchacht (President of the Reichsbank and Minister of Economics in the Hitler’s government).The strategic plan of Rockefellers and Morgans was to subjugate Europe economically, saturate Germany with foreign investments and credits and make it deliver a crushing blow against the Soviet Russia so that it would be returned into the world capitalist system as a colony.
Montagu Norman (1871 – 1950) played an important role of go-between to keep up a dialogue between American financial circles and Germany’s business leaders. HjalmarSchacht organized the revival of Germany’s defense sector of economy. The operation conducted by “money owners” was covered up by such politicians as Franklin Roosevelt, Neville Chamberlain and Winston Churchill. In Germany the plans were carried out by Hitler and HjalmarSchacht. Some historians say HjalmarSchacht played a more important role than Hitler. Simply Schacht kept away from spotlight.
The Dawes Plan was an attempt following World War I for the Triple Entente to compromise and collect war reparations debt from Germany. The Dawes Plan (as proposed by the Dawes Committee, chaired by Charles G. Dawes) was an attempt in 1924 to solve the reparations problem, which had bedeviled international politics following World War I and the Treaty of Versailles (France was reluctant to accept it got over 50% of reparations). In 1924-1929 Germany got $2, 5 billion from the United States and $ 1, 5 billion from Great Britain, according to Dawes Plan. In today’s prices the sum is huge, it is equal to $1 trillion of US dollars. HjalmarSchacht played an active role in the implementation of Dawes Plan. In 1929 he summed up the results, saying that in 5 years Germany got more foreign loans that the United States in the 40 years preceding WWI. As a result, in 1929 Germany became the world’s second largest industrial nation leaving Great Britain behind.
In the 1930s the process of feeding Germany with investments and credits continued. The Young Plan was a program for settling German reparations debts after World War I written in 1929 and formally adopted in 1930. It was presented by the committee headed (1929–30) by American industrialist Owen D. Young, creator and ex-first chairman of Radio Corporation of America (RCA), who, at the time, concurrently served at board of trustees of Rockefeller Foundation, and also had been one of representatives involved in previous war reparations restructuring arrangement – Dawes Plan of 1924. According to the plan, the Bank of International Settlements (BIS) was created in 1930 to make Germany pay reparations to victors. In reality the money flows went in quite a different direction – from the United States and Great Britain to Germany. The majority of strategically important German companies belonged to American capital or were partly under its control. Some of them belonged to British investors. German oil refinery and coal liquefaction sectors of economy belonged to Standard Oil (the Rockefellers). FarbenindustrieAG chemical industry major wasmoved under the control of the Morgan Group. 40% of telephone network and 30% of Focke Wulf shares belonged to American ITT. Radio and AEG, Siemens, Osram electrical industry majors moved under the control of American General Electric. ITT and General Electric were part of the Morgan’s empire. At least 100% of the Volkswagen shares belonged to American Ford. By the time Hitler came to power the US financial capital practically controlled all strategically important sectors of German industry: oil refining, synthetic fuel production, chemistry, car building, aviation, electrical engineering, radio industry, and a large part of machine-building (totally 278 companies). The leading German banks – Deutsche Bank, Dresdner Bank, Donat Bank and some others – were under US control.
On January 30, 1933 Hitler was named the Chancellor of Germany. Before that his candidacy had been thoroughly studied by American bankers. HjalmarSchacht went to the United States in the autumn of 1930 to discuss the nomination with American colleagues. The Hitler’s appointment was finally approved at a secret meeting of financiers in the United States. He spent the whole 1932 trying to convince the German bankers that Hitler was the right person for the position. He achieved the goal. In mid-November 1932 17 German largest bankers and industrialists sent a letter to President Hindenburg expressing their demand to make Hitler the Chancellor of Germany. The last working meeting of German financiers before the election was held on January 4, 1933 in Kölnat the home of banker Kurt von Schröder. After that the National Socialist Party came to power. As a result, the financial and economic ties of Germany with Anglo-Saxons elevated to a higher level.
Hitler immediately made an announcement that he refused to pay postwar reparations. It put into doubt the ability of England and France to pay off WWI debts to the United States. Washington did not object to the Hitler’s announcement. In May 1933 HjalmarSchacht paid another visit to the United States. There he met with President Franklin Roosevelt and big bankers to reach a $1 billion credit deal.In June the same year HjalmarSchacht visited London to hold talks with Montagu Norman. It all went down smoothly. The British agreed to grant a $2 billion loan. The British offered no objections related to the Germany’s decision to suspend debt payments.
Some historians say the American and British bankers were pliant because by 1932 the Soviet Union had fulfilled the 5-year economic development plan to make it achieve new heights as an industrial power. A few thousand enterprises were built, especially in the sector of heavy industry. The dependence of USSR on import of engineering production has greatly dwindled. The chances to strangle the Soviet Union economically were practically reduced to zero. They decided to rely on war and launched the runaway militarization of Germany.
It was easy for Germany to get American credits. By and large, Hitler came to power in his country at the same time as Franklin Roosevelt took office in the United States. The very same bankers who supported Hitler in 1931 supported Roosevelt at the presidential election. The newly elect President could not but endorse large credits to Germany. By the way, many noticed that there was a big similarity between the Roosevelt’s “New Deal Policy” and the economic policy of the German Third Reich. No wonder. The very same people worked out and consulted the both governments at the time. They mainly represented US financial circles.
The Roosevelt’s New Deal soon started to stumble on the way. In 1937 America plunged into the quagmire of economic crisis. In 1939 the US economy operated at 33% of its industrial capacity (it was 19% in the heat of the 1929-1933 crisis).
Rexford G. Tugwell, an economist who became part of Franklin Roosevelt’s first “Brain, a group of Columbia University academics who helped develop policy recommendations leading up to Roosevelt’s New Deal,wrote that in 1939 the government failed to reach any success.There was an open seatill the day Hitler invaded Poland.Only the mighty wind of war could dissipate the fog. Any other measures Roosevelt could take were doomed to failure. (1) Only the world war could save the US capitalism. In 1939 the money owners used all leverage at their disposal to put pressure of Hitler and make him unleash a big war in the east.
(To be continued)
(1) P.Tugwell, The Democratic Roosevelt, A Biography of Franklin D. Roosevelt, New York, 1957, p 477.
Over the centuries there have been many stories, some based on loose facts, others based on hearsay, conjecture, speculation and outright lies, about groups of people who “control the world.” Some of these are partially accurate, others are wildly hyperbolic, but when it comes to the historic record, nothing comes closer to the stereotypical, secretive group determining the fate of over 7 billion people, than the Bank of International Settlements, which hides in such plain sight, that few have ever paid much attention.
This is their story.
First unofficial meeting of the BIS Board of Directors in Basel, April 1930
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The following is an excerpt from TOWER OF BASEL: The Shadowy History of the Secret Bank that Runs the World by Adam LeBor. Reprinted with permission from PublicAffairs.
The world’s most exclusive club has eighteen members. They gather every other month on a Sunday evening at 7 p.m. in conference room E in a circular tower block whose tinted windows overlook the central Basel railway station. Their discussion lasts for one hour, perhaps an hour and a half. Some of those present bring a colleague with them, but the aides rarely speak during this most confidential of conclaves. The meeting closes, the aides leave, and those remaining retire for dinner in the dining room on the eighteenth floor, rightly confident that the food and the wine will be superb. The meal, which continues until 11 p.m. or midnight, is where the real work is done. The protocol and hospitality, honed for more than eight decades, are faultless. Anything said at the dining table, it is understood, is not to be repeated elsewhere.
Few, if any, of those enjoying their haute cuisine and grand cru wines— some of the best Switzerland can offer—would be recognized by passers-by, but they include a good number of the most powerful people in the world. These men—they are almost all men—are central bankers. They have come to Basel to attend the Economic Consultative Committee (ECC) of the Bank for International Settlements (BIS), which is the bank for central banks. Its current members [ZH: as of 2013] include Ben Bernanke, the chairman of the US Federal Reserve; Sir Mervyn King, the governor of the Bank of England; Mario Draghi, of the European Central Bank; Zhou Xiaochuan of the Bank of China; and the central bank governors of Germany, France, Italy, Sweden, Canada, India, and Brazil. Jaime Caruana, a former governor of the Bank of Spain, the BIS’s general manager, joins them.
In early 2013, when this book went to press, King, who is due to step down as governor of the Bank of England in June 2013, chaired the ECC. The ECC, which used to be known as the G-10 governors’ meeting, is the most influential of the BIS’s numerous gatherings, open only to a small, select group of central bankers from advanced economies. The ECC makes recommendations on the membership and organization of the three BIS committees that deal with the global financial system, payments systems, and international markets. The committee also prepares proposals for the Global Economy Meeting and guides its agenda.
That meeting starts at 9:30 a.m. on Monday morning, in room B and lasts for three hours. There King presides over the central bank governors of the thirty countries judged the most important to the global economy. In addition to those who were present at the Sunday evening dinner, Monday’s meeting will include representatives from, for example, Indonesia, Poland, South Africa, Spain, and Turkey. Governors from fifteen smaller countries, such as Hungary, Israel, and New Zealand are allowed to sit in as observers, but do not usually speak. Governors from the third tier of member banks, such as Macedonia and Slovakia, are not allowed to attend. Instead they must forage for scraps of information at coffee and meal breaks.
The governors of all sixty BIS member banks then enjoy a buffet lunch in the eighteenth-floor dining room. Designed by Herzog & de Meuron, the Swiss architectural firm which built the “Bird’s Nest” Stadium for the Beijing Olympics, the dining room has white walls, a black ceiling and spectacular views over three countries: Switzerland, France, and Germany. At 2 p.m. the central bankers and their aides return to room B for the governors’ meeting to discuss matters of interest, until the gathering ends at 5.
King takes a very different approach than his predecessor, Jean-Claude Trichet, the former president of the European Central Bank, in chairing the Global Economy Meeting. Trichet, according to one former central banker, was notably Gallic in his style: a stickler for protocol who called the central bankers to speak in order of importance, starting with the governors of the Federal Reserve, the Bank of England, and the Bundesbank, and then progressing down the hierarchy. King, in contrast, adopts a more thematic and egalitarian approach: throwing open the meetings for discussion and inviting contributions from all present.
The governors’ conclaves have played a crucial role in determining the world’s response to the global financial crisis. “The BIS has been a very important meeting point for central bankers during the crisis, and the rationale for its existence has expanded,” said King. “We have had to face challenges that we have never seen before. We had to work out what was going on, what instruments do we use when interest rates are close to zero, how do we communicate policy. We discuss this at home with our staff, but it is very valuable for the governors themselves to get together and talk among themselves.”
Those discussions, say central bankers, must be confidential. “When you are at the top in the number one post, it can be pretty lonely at times. It is helpful to be able to meet other number ones and say, ‘This is my problem, how do you deal with it?’” King continued. “Being able to talk informally and openly about our experiences has been immensely valuable. We are not speaking in a public forum. We can say what we really think and believe, and we can ask questions and benefit from others.”
The BIS management works hard to ensure that the atmosphere is friendly and clubbable throughout the weekend, and it seems they succeed. The bank arranges a fleet of limousines to pick up the governors at Zürich airport and bring them to Basel. Separate breakfasts, lunches, and dinners are organized for the governors of national banks who oversee different types and sizes of national economies, so no one feels excluded. “The central bankers were more at home and relaxed with their fellow central bankers than with their own governments,” recalled Paul Volcker, the former chairman of the US Federal Reserve, who at- tended the Basel weekends. The superb quality of the food and wine made for an easy camaraderie, said Peter Akos Bod, a former governor of the National Bank of Hungary. “The main topics of discussion were the quality of the wine and the stupidity of finance ministers. If you had no knowledge of wine you could not join in the conversation.”
And the conversation is usually stimulating and enjoyable, say central bankers. The contrast between the Federal Open Markets Committee at the US Federal Reserve, and the Sunday evening G-10 governors’ dinners was notable, recalled Laurence Meyer, who served as a member of the Board of Governors of the Federal Reserve from 1996 until 2002. The chairman of the Federal Reserve did not always represent the bank at the Basel meetings, so Meyer occasionally attended. The BIS discussions were always lively, focused and thought provoking. “At FMOC meetings, while I was at the Fed, almost all the Committee members read statements which had been prepared in advance. They very rarely referred to statements by other Committee members and there was almost never an exchange between two members or an ongoing discussion about the outlook or policy options. At BIS dinners people actually talk to each other and the discussions are always stimulating and interactive focused on the serious issues facing the global economy.”
All the governors present at the two-day gathering are assured of total confidentiality, discretion, and the highest levels of security. The meetings take place on several floors that are usually used only when the governors are in attendance. The governors are provided with a dedicated office and the necessary support and secretarial staff. The Swiss authorities have no juridisdiction over the BIS premises. Founded by an international treaty, and further protected by the 1987 Headquarters Agreement with the Swiss government, the BIS enjoys similar protections to those granted to the headquarters of the United Nations, the International Monetary Fund (IMF) and diplomatic embassies. The Swiss authorities need the permission of the BIS management to enter the bank’s buildings, which are described as “inviolable.”
The BIS has the right to communicate in code and to send and receive correspondence in bags covered by the same protection as embassies, meaning they cannot be opened. The BIS is exempt from Swiss taxes. Its employees do not have to pay income tax on their salaries, which are usually generous, designed to compete with the private sector. The general man- ager’s salary in 2011 was 763,930 Swiss francs, while head of departments were paid 587,640 per annum, plus generous allowances. The bank’s extraordinary legal privileges also extend to its staff and directors. Senior managers enjoy a special status, similar to that of diplomats, while carrying out their duties in Switzerland, which means their bags cannot be searched (unless there is evidence of a blatant criminal act), and their papers are inviolable. The central bank governors traveling to Basel for the bimonthly meetings enjoy the same status while in Switzerland. All bank officials are immune under Swiss law, for life, for all the acts carried out during the discharge of their duties. The bank is a popular place to work and not just because of the salaries. Around six hundred staff come from over fifty countries. The atmosphere is multi-national and cosmopolitan, albeit very Swiss, emphasizing the bank’s hierarchy. Like many of those working for the UN or the IMF, some of the staff of the BIS, especially senior management, are driven by a sense of mission, that they are working for a higher, even celestial purpose and so are immune from normal considerations of accountability and transparency.
The bank’s management has tried to plan for every eventuality so that the Swiss police need never be called. The BIS headquarters has high-tech sprinkler systems with multiple back-ups, in-house medical facilities, and its own bomb shelter in the event of a terrorist attack or armed conflagration. The BIS’s assets are not subject to civil claims under Swiss law and can never be seized.
The BIS strictly guards the bankers’ secrecy. The minutes, agenda, and actual attendance list of the Global Economy Meeting or the ECC are not released in any form. This is because no official minutes are taken, although the bankers sometimes scribble their own notes. Sometimes there will be a brief press conference or bland statement afterwards but never anything detailed. This tradition of privileged confidentiality reaches back to the bank’s foundation.
“The quietness of Basel and its absolutely nonpolitical character provide a perfect setting for those equally quiet and nonpolitical gatherings,” wrote one American official in 1935. “The regularity of the meetings and their al- most unbroken attendance by practically every member of the Board make them such they rarely attract any but the most meager notice in the press.”8 Forty years on, little had changed. Charles Coombs, a former foreign exchange chief of the New York Federal Reserve, attended governors’ meetings from 1960 to 1975. The bankers who were allowed inside the inner sanctum of the governors’ meetings trusted each other absolutely, he recalled in his memoirs. “However much money was involved, no agreements were ever signed nor memoranda of understanding ever initialized. The word of each official was sufficient, and there were never any disappointments.”
What, then, does this matter to the rest of us? Bankers have been gathering confidentially since money was first invented. Central bankers like to view themselves as the high priests of finance, as technocrats overseeing arcane monetary rituals and a financial liturgy understood only by a small, self-selecting elite.
But the governors who meet in Basel every other month are public servants. Their salaries, airplane tickets, hotel bills, and lucrative pensions when they retire are paid out of the public purse. The national reserves held by central banks are public money, the wealth of nations. The central bankers’ discussions at the BIS, the information that they share, the policies that are evaluated, the opinions that are exchanged, and the subsequent decisions that are taken, are profoundly political. Central bankers, whose independence is constitutionally protected, control monetary policy in the developed world. They manage the supply of money to national economies. They set interest rates, thus deciding the value of our savings and investments. They decide whether to focus on austerity or growth. Their decisions shape our lives.
The BIS’s tradition of secrecy reaches back through the decades. During the 1960s, for example, the bank hosted the London Gold Pool. Eight countries pledged to manipulate the gold market to keep the price at around thirty-five dollars per ounce, in line with the provisions of the Bretton Woods Accord that governed the post–World War II international financial system. Although the London Gold Pool no longer exists, its successor is the BIS Markets Committee, which meets every other month on the occasion of the governors’ meetings to discuss trends in the financial markets. Officials from twenty-one central banks attend. The committee releases occasional papers, but its agenda and discussions remain secret.
Nowadays the countries represented at the Global Economy Meetings together account for around four-fifths of global gross domestic product (GDP)— most of the produced wealth of the world—according to the BIS’s own statistics. Central bankers now “seem more powerful than politicians,” wrote The Economist newspaper, “holding the destiny of the global economy in their hands.” How did this happen? The BIS, the world’s most secretive global financial institution, can claim much of the credit. From its first day of existence, the BIS has dedicated itself to furthering the interests of central banks and building the new architecture of transnational finance. In doing so, it has spawned a new class of close-knit global technocrats whose members glide between highly-paid positions at the BIS, the IMF, and central and commercial banks.
The founder of the technocrats’ cabal was Per Jacobssen, the Swedish economist who served as the BIS’s economic adviser from 1931 to 1956. The bland title belied his power and reach. Enormously influential, well connected, and highly regarded by his peers, Jacobssen wrote the first BIS annual reports, which were—and remain—essential reading throughout the world’s treasuries. Jacobssen was an early supporter of European federalism. He argued relentlessly against inflation, excessive government spending, and state intervention in the economy. Jacobssen left the BIS in 1956 to take over the IMF. His legacy still shapes our world. The consequences of his mix of economic liberalism, price obsession, and dismantling of national sovereignty play out nightly in the European news bulletins on our television screens.
The BIS’s defenders deny that the organization is secretive. The bank’s archives are open and researchers may consult most documents that are more than thirty years old. The BIS archivists are indeed cordial, helpful, and professional. The bank’s website includes all its annual reports, which are downloadable, as well as numerous policy papers produced by the bank’s highly regarded research department. The BIS publishes detailed accounts of the securities and derivatives markets, and international banking statistics. But these are largely compilations and analyses of information already in the public domain. The details of the bank’s own core activities, including much of its banking operations for its customers, central banks, and international organizations, remain secret. The Global Economy Meetings and the other crucial financial gatherings that take place at Basel, such as the Markets Committee, remain closed to outsiders. Private individuals may not hold an account at BIS, unless they work for the bank. The bank’s opacity, lack of accountability, and ever-increasing influence raises profound questions— not just about monetary policy but transparency, accountability, and how power is exercised in our democracies.
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WHEN I EXPLAINED to friends and acquaintances that I was writing a book about the Bank for International Settlements, the usual response was a puzzled look, followed by a question: “The bank for what?” My interlocutors were intelligent people, who follow current affairs. Many had some interest in and understanding of the global economy and financial crisis. Yet only a handful had heard of the BIS. This was strange, as the BIS is the most important bank in the world and predates both the IMF and the World Bank. For decades it has stood at the center of a global network of money, power, and covert global influence.
The BIS was founded in 1930. It was ostensibly set up as part of the Young Plan to administer German reparations payments for the First World War. The bank’s key architects were Montagu Norman, who was the governor of the Bank of England, and Hjalmar Schacht, the president of the Reichsbank who described the BIS as “my” bank. The BIS’s founding members were the central banks of Britain, France, Germany, Italy, Belgium, and a consortium of Japanese banks. Shares were also offered to the Federal Reserve, but the United States, suspicious of anything that might infringe on its national sovereignty, refused its allocation. Instead a consortium of commercial banks took up the shares: J. P. Morgan, the First National Bank of New York, and the First National Bank of Chicago.
The real purpose of the BIS was detailed in its statutes: to “promote the cooperation of central banks and to provide additional facilities for international financial operations.” It was the culmination of the central bankers’ decades-old dream, to have their own bank—powerful, independent, and free from interfering politicians and nosy reporters. Most felicitous of all, the BIS was self-financing and would be in perpetuity. Its clients were its own founders and shareholders— the central banks. During the 1930s, the BIS was the central meeting place for a cabal of central bankers, dominated by Norman and Schacht. This group helped rebuild Germany. The New York Times described Schacht, widely acknowledged as the genius behind the resurgent German economy, as “The Iron-Willed Pilot of Nazi Finance.” During the war, the BIS became a de-facto arm of the Reichsbank, accepting looted Nazi gold and carrying out foreign exchange deals for Nazi Germany.
The bank’s alliance with Berlin was known in Washington, DC, and London. But the need for the BIS to keep functioning, to keep the new channels of transnational finance open, was about the only thing all sides agreed on. Basel was the perfect location, as it is perched on the northern edge of Switzerland and sits al- most on the French and German borders. A few miles away, Nazi and Allied soldiers were fighting and dying. None of that mattered at the BIS. Board meetings were suspended, but relations between the BIS staff of the belligerent nations remained cordial, professional, and productive. Nationalities were irrelevant. The overriding loyalty was to international finance. The president, Thomas McKittrick, was an American. Roger Auboin, the general manager, was French. Paul Hechler, the assistant general manager, was a member of the Nazi party and signed his correspondence “Heil Hitler.” Rafaelle Pilotti, the secretary general, was Italian. Per Jacobssen, the bank’s influential economic adviser, was Swedish. His and Pilotti’s deputies were British.
After 1945, five BIS directors, including Hjalmar Schacht, were charged with war crimes. Germany lost the war but won the economic peace, in large part thanks to the BIS. The international stage, contacts, banking networks, and legitimacy the BIS provided, first to the Reichsbank and then to its successor banks, has helped ensure the continuity of immensely powerful financial and economic interests from the Nazi era to the present day.
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FOR THE FIRST forty-seven years of its existence, from 1930 to 1977, the BIS was based in a former hotel, near the Basel central railway station. The bank’s entrance was tucked away by a chocolate shop, and only a small notice confirmed that the narrow doorway opened into the BIS. The bank’s managers believed that those who needed to know where the BIS was would find it, and the rest of the world certainly did not need to know. The inside of the building changed little over the decades, recalled Charles Coombs. The BIS provided the “the spartan accommodations of a former Victorian-style hotel whose single and double bedrooms had been transformed into offices simply by removing the beds and installing desks.”
The bank moved into its current headquarters, at 2, Centralbahnplatz, in 1977. It did not go far and now overlooks the Basel central station. Nowadays the BIS’s main mission, in its own words, is threefold: “to serve central banks in their pursuit of monetary and financial stability, to foster international cooperation in these areas, and to act as a bank for central banks.” The BIS also hosts much of the practical and technical infrastructure that the global network of central banks and their commercial counterparts need to function smoothly. It has two linked trading rooms: at the Basel headquarters and Hong Kong regional office. The BIS buys and sells gold and foreign exchange for its clients. It provides asset management and arranges short-term credit to central banks when needed.
The BIS is a unique institution: an international organization, an extremely profitable bank and a research institute founded, and protected, by international treaties. The BIS is accountable to its customers and shareholders—the central banks—but also guides their operations. The main tasks of a central bank, the BIS argues, are to control the flow of credit and the volume of currency in circulation, which will ensure a stable business climate, and to keep exchange rates within manageable bands to ensure the value of a currency and so smooth international trade and capital movements. This is crucial, especially in a globalized economy, where markets react in microseconds and perceptions of economic stability and value are almost as important as reality itself.
The BIS also helps to supervise commercial banks, although it has no legal powers over them. The Basel Committee on Banking Supervision, based at the BIS, regulates commercial banks’ capital and liquidity requirements. It requires banks to have a minimum capital of eight percent of risk-weighted assets when lending, meaning that if a bank has risk-weighted assets of $100 million it must maintain at least $8 million capital. The committee has no powers of enforcement, but it does have enormous moral authority. “This regulation is so powerful that the eight percent principle has been set into national laws,” said Peter Akos Bod. “It’s like voltage. Voltage has been set at 220. You may decide on ninety-five volts, but it would not work.” In theory, sensible housekeeping and mutual cooperation, overseen by the BIS, will keep the global financial system functioning smoothly. In theory.
The reality is that we have moved beyond recession into a deep structural crisis, one fueled by the banks’ greed and rapacity, which threatens all of our financial security. Just as in the 1930s, parts of Europe face economic collapse. The Bundesbank and the European Central Bank, two of the most powerful members of the BIS, have driven the mania for austerity that has already forced one European country, Greece, to the edge, aided by the venality and corruption of the country’s ruling class. Others may soon follow. The old order is creaking, its political and financial institutions corroding from within. From Oslo to Athens, the far right is resurgent, fed in part by soaring poverty and unemployment. Anger and cynicism are corroding citizens’ faith in democracy and the rule of law. Once again, the value of property and assets is vaporizing before their owners’ eyes. The European currency is threatened with breakdown, while those with money seek safe haven in Swiss francs or gold. The young, the talented, and the mobile are again fleeing their home countries for new lives abroad. The powerful forces of international capital that brought the BIS into being, and which granted the bank its power and influence, are again triumphant.
The BIS sits at the apex of an international financial system that is falling apart at the seams, but its officials argue that it does not have the power to act as an international financial regulator. Yet the BIS cannot escape its responsibility for the Euro-zone crisis. From the first agreements in the late 1940s on multilateral payments to the establishment of the Europe Central Bank in 1998, the BIS has been at the heart of the European integration project, providing technical expertise and the financial mechanisms for currency harmonization. During the 1950s, it managed the European Payments Union, which internationalized the continent’s payment system. The BIS hosted the Governors’ Committee of European Economic Community central bankers, set up in 1964, which coordinated trans-European monetary policy. During the 1970s, the BIS ran the “Snake,” the mechanism by which European currencies were held in exchange rate bands. During the 1980s the BIS hosted the Delors Committee, whose report in 1988 laid out the path to European Monetary Union and the adoption of a single currency. The BIS midwifed the European Monetary Institute (EMI), the precursor of the European Central Bank. The EMI’s president was Alexandre Lamfalussy, one of the world’s most influential economists, known as the “Father of the euro.” Before joining the EMI in 1994, Lamfalussy had worked at the BIS for seventeen years, first as economic adviser, then as the bank’s general manager.
For a staid, secretive organization, the BIS has proved surprisingly nimble. It survived the first global depression, the end of reparations payments and the gold standard (two of its main reasons for existence), the rise of Nazism, the Second World War, the Bretton Woods Accord, the Cold War, the financial crises of the 1980s and 1990s, the birth of the IMF and World Bank, and the end of Communism. As Malcolm Knight, manager from 2003–2008, noted, “It is encouraging to see that—by remaining small, flexible, and free from political interference—the Bank has, throughout its history, succeeded remarkably well in adapting itself to evolving circumstances.”
The bank has made itself a central pillar of the global financial system. As well as the Global Economy Meetings, the BIS hosts four of the most important international committees dealing with global banking: the Basel Committee on Banking Supervision, the Committee on the Global Financial System, the Committee on Payment and Settlement Systems, and the Irving Fisher Committee, which deals with central banking statistics. The bank also hosts three independent organizations: two groups dealing with insurance and the Financial Stability Board (FSB). The FSB, which coordinates national financial authorities and regulatory policies, is already being spoken of as the fourth pillar of the global financial system, after the BIS, the IMF and the commercial banks.
The BIS is now the world’s thirtieth-largest holder of gold reserves, with 119 metric tons—more than Qatar, Brazil, or Canada. Membership of the BIS remains a privilege rather than a right. The board of directors is responsible for admitting central banks judged to “make a substantial contribution to international monetary cooperation and to the Bank’s activities.” China, India, Russia, and Saudi Arabia joined only in 1996. The bank has opened offices in Mexico City and Hong Kong but remains very Eurocentric. Estonia, Latvia, Lithuania, Macedonia, Slovenia, and Slovakia (total population 16.2 million) have been admitted, while Pakistan (population 169 million) has not. Nor has Kazakhstan, which is a powerhouse of Central Asia. In Africa only Algeria and South Africa are members—Nigeria, which has the continent’s second-largest economy, has not been admitted. (The BIS’s defenders say that it demands high governance standards from new members and when the national banks of countries such as Nigeria and Pakistan reach those standards, they will be considered for membership.)
Considering the BIS’s pivotal role in the transnational economy, its low profile is remarkable. Back in 1930 a New York Times reporter noted that the culture of secrecy at the BIS was so strong that he was not permitted to look inside the boardroom, even after the directors had left. Little has changed. Journalists are not allowed inside the headquarters while the Global Economy Meeting is underway. BIS officials speak rarely on the record, and reluctantly, to members of the press. The strategy seems to work. The Occupy Wall Street movement, the anti-globalizers, the social network protesters have ignored the BIS. Centralbahnplatz 2, Basel, is quiet and tranquil. There are no demonstrators gathered outside the BIS’s headquarters, no protestors camped out in the nearby park, no lively reception committees for the world’s central bankers.
As the world’s economy lurches from crisis to crisis, financial institutions are scrutinized as never before. Legions of reporters, bloggers, and investigative journalists scour the banks’ every move. Yet somehow, apart from brief mentions on the financial pages, the BIS has largely managed to avoid critical scrutiny. Until now.
by Roger Blitz
A visitor to Mexico City’s Bellas Artes Museum walks between two Andy Warhol “Dollar Sign” paintings August 24. The two paintings are part of the first ever Andy Warhol exhibition in Latin America. Warhol’s art is back in fashion, according to museum director Agustin Arteaga, as similar retrospective exhibitions are being held this year in several cities around the world.
“Export growth has weakened,” said the central bank, in a veiled reference to how the sustained appreciation of the currency since last summer has weighed on the economy.
Although the Fed rarely chooses to discuss the currency, Janet Yellen, chairwoman, also referred to dollar strength during her press conference after the statement was published.
That one-two punch drove the dollar sharply lower on Wednesday, with the euro, which has depreciated 13 per cent since the start of the year, on track for its best weekly gain since October 2011.
A 25 per cent rise in the dollar over the past year may well give way to a period of far choppier trading that challenges investors, especially those betting on further gains for the greenback. With the US central bank voicing its worries about a strong dollar and signalling that this could delay monetary tightening, investors are likely to face a tougher trading environment in the currency market.
The strength of the dollar and ramifications for Fed policy have been bubbling away for a while. When ex-Fed chairman Ben Bernanke was guest of honour at a recent private investment forum hosted at Pimco, the bond fund management firm’s staff peppered him with questions about the central bank’s likely approach to the strengthening dollar.
Surging dollar appreciation globally has triggered growing unease among US equity investors as numerous multinational companies have revealed lower profits from their foreign operations.
That became apparent during this week’s Fed press conference. In addition to worries about exports, Ms Yellen said import prices had restrained inflation, and “in light of the recent appreciation of the dollar, will likely continue to do so in the months ahead”.
Rich Clarida, global strategic adviser at Pimco, says: “Until now, with markets romancing the idea of quantitative easing in Europe and Japan, you have had a one-way move in the dollar. The new element is that this is the first time the Fed, through its jawboning, has signalled that the currency move is on its radar.”
While the Fed statement and Ms Yellen played down the prospect of a rate rise in June, dollar bulls quickly capitalised on a knee-jerk bout of weakness.
After falling 2.5 per cent against the euro on Wednesday, the dollar roared back 24 hours later, reversing those losses. This whipsaw trading between the dollar and euro highlights how volatility is picking up across the currency market.
“You have to go back a long time to get to anything like that level of volatility,” says Simon Derrick, strategist at BNY Mellon. “To go from $1.06 to $1.10 [in one session] — that was ‘wow’.”
Marc Chandler, global currency strategist at Brown Brothers Harriman and a long-time dollar bull, says it was an opportunity that long-dollar advocates could not pass up.
“Long and medium-term dollar investors are still very dollar bullish,” he says. “Whether the Fed raises [rates] in June or September is not such a big deal.”
But some long-dollar traders have begun shifting their strategy and on Friday the euro was rising fast. Ugo Lancioni of asset manager Neuberger Berman says the group has been long on the dollar since last year but has become more neutral.
One reason, he says, is that divergence is now priced into the greenback. “Investors jumped on the dollar story on the back of expecting divergence, which is a powerful story, but which has played out,” he says.
“Given that the dollar is doing some of the tightening for the Fed, will that momentum of the divergence story continue?”
That view is shared by longstanding dollar-bull proponents at HSBC who say the dollar rally is nearing its end.
“Tell me something I don’t know,” says Daragh Maher of HSBC about the divergence argument. “There’s no one out there who isn’t aware the Fed wants to raise rates. We are in the autopilot phase.”
There are other reasons to believe that the dollar bull case has run its course, says HSBC.
The dollar has already moved a long way, more than in other historical dollar rallies; the dollar is the world’s second most overvalued currency (behind the Swiss franc); the markets are ignoring both disappointing US economic data and surprisingly good numbers from eurozone economies; positioning is so stretched that there appears no resistance to dollar bulls; and historically the dollar tends to fall after the US raises interest rates.
Mr Chandler disagrees. In dollar rallies of the 1980s and 1990s, the euro or its equivalent halved, he says.
History will repeat itself, he says. “It peaked at $1.60 back in 2008 and ever since that peak my technical models and fundamental views became much more dollar-bullish.
“It has been a long slog since then . . . but I’m convinced that the euro is going back down to test those historic lows at about half the value of its peak.”
by Charles Hugh-Smith
Borrowing in USD was risk-on; buying USD is risk-off.
There is a lively debate about the global demand for U.S. dollars:
Global finance faces $9 trillion stress test as dollar soars (Telegraph.co.uk)The Dollar Squeeze – How Problematic Is It? (Acting Man)The Global Dollar Funding Shortage Is Back With A Vengeance And “This Time It’s Different” (Zero Hedge), which references a Bank for International Settlements (BIS) paper: Global dollar credit: links to US monetary policy and leverage.
Thank you, Mark, for the detailed analysis. Here are my initial thoughts:
By Bill Holter
We have watched, even marveled at how the U.S. dollar has strengthened since last September. All sorts of theories have been put forth as to “why”. Some have proffered the dollar is the cleanest dirty shirt of the bunch. Others believe the interest rate differential is kicking in where dollars at least have a positive interest rate versus negative rates elsewhere.
Another theory and one which I have written about in the past and believe to be the main reason for dollar strength is the “margin call” aspect. In other words, the “carry trade” which was used to leverage all sorts of trades is unwinding and dollars are needed to pay back the loans. A synthetic dollar short being covered in other words.
Looking back to my writing yesterday regarding the impossibility in my mind of the Fed actually raising rates, the strong dollar also supports this argument. If the Fed were to raise rates, wouldn’t this exacerbate an already immense currency cross problem with (for) the rest of the world? Wouldn’t higher U.S. rates explode the dollar higher (short term) versus foreign currencies? The answer of course is yes, but with a stronger dollar comes other obvious problems.
The two biggest problems are
A. we still have a trade deficit of close to $500 billion per year, a stronger dollar will only exacerbate this AND destroy what little manufacturing we have left.
B. the very problems we just saw with a soaring Swiss franc will be seen in many multiples throughout the dollar lending market.
I might add, as the dollar moves higher and foreign currencies drop, more and much stronger inflation gets exported to foreign soil. High and rising inflation and its effects on living standards and the human psyche will create massive unrest across Europe and elsewhere.
This last point is an important one, foreigners who have borrowed in dollars have already seen their “loan balance” expand because the dollars cost more to pay back. Higher U.S. interest rates will only make matters worse. The strong dollar has had the effect of slowing the global economy as companies (and individuals) are cutting back (employment and consumption) to make ends meet.
The above is only half of the equation, the other half is described by Alan Greenspan himself. I personally watched Mr. Greenspan speak in New Orleans last October. He used the word “tinder” http://www.zerohedge.com/news/2015-03-09/alan-greenspan-warns-explosive-inflation-tinderbox-looking-spark for a coming inflation several times and spoke of the money supply and reserves of dollars that have been created and parked away on bank balance sheets. I could only think back to the Texas wildfire as he spoke of “tinder”. The amount of dollars created is like some nutcase piling dry leaves, branches and dead trees in a huge pile, then pouring gasoline on it …and thinking to himself, “this will keep me warm in winter”. In other words, the “fuel” is there and has already been created for a bonfire of inflation and the financial system blowing up on itself. But don’t worry, it will never catch fire?
Tying these two phenomena together, not enough dollars, yet too many, here is the likely scenario I can see unfolding.
The stronger dollar is putting pressure on the financial system all over the world, something (someone), somewhere is going to “fail”. Our financial system is so interconnected and over levered, it will only take one strategic institution’s failure to break the derivatives daisy chain.
Let’s call this the “spark”. This spark causes further failures which I am convinced will circle the globe in less than two days. The forest (economy and financial system) is very dry (weak, fragile), any spark (failure) will create an out of control forest fire which will not be put out until all the fuel is burned and blackened.
Please remember this, the dollar (and Treasuries) are now “backed” by the full faith and credit of the United States. This was not the case back in the 1930′s, dollars were backed by gold. The Treasury did not have enough gold to back all of the dollars but for a very large percentage of those outstanding. This is not even close to the case today. It remains to be seen if there is any gold at all left but, assuming the gold is left untouched, gold would need to be priced at $100,000+ per ounce to cover our debt and money supply. I bring this up because ”gold will still be gold” no matter what happens financially. Hold this thought, it ties in with the final logic.
The stronger dollar is beginning to cause stress both financially and economically. It is not “official” yet but even with bogus reporting, the West is already in recession while the East is markedly slowing down. This brings up a few questions. With a slowing or declining economy, will the Treasury have the tax revenues to pay total interest and support all of the other largesse?
Of course not, we will just borrow whatever is necessary to keep going on down the road.
What about higher interest rates, will this exacerbate the problem?
Of course. Tax revenues will drop, “benefits” or spending will rise as will the deficit…and now the federal debt is almost double what it was last time around in 2008. Do you see where this leads? Is the “issuer” of dollars stronger, or weaker than it was in 2008? It’s OK, you can admit it. Weaker. In this scenario where a higher dollar (the spark) puts so much pressure on financial counterparties who are short the dollar, what will be the Feds reaction to derivatives or other sovereign currency crises? Does the Fed have to quintuple their balance sheet again? Or the federal debt double again? Or will another secret $16 trillion or a multiple thereof be lent out all over the world by necessity?
Looking at this in the real world, there have already been many markets thrown into upheaval. The two most important being the FOREX crosses and the oil market. Oil without a doubt is the largest and most all encompassing market on the planet with the exception of dollars themselves. Oil has crashed well over 50% in less than 6 months, dollars have risen 25% over this time frame.
Do you think that these percentages when applied to $10′s of trillions might add up to a tad more than a tidy sum? Remember, derivatives is a zero sum game so anything “won” is also “lost”. I believe the spark has already created a fire behind the scenes and some have already been consumed and are dead, but hidden. Can I know this for sure? No, but common sense and the amounts involved tell me this is 100% dead on! And there you have it folks, there are too may dollars outstanding …which were created by too much borrowing of dollars … This pushed asset values higher until the world reached debt saturation and led to assets being sold to pay back the debt, asset prices dropped which is causing a global margin call…this synthetic short has created dollar demand to pay these dollars back. In essence creating a dollar shortage. Are you still with me after that long and horrible string of sentences?
If you are, then here we are …facing the global margin call which can ONLY be met by central banks printing more dollars, euros, yen etc. because liquidity is again drying up. The alternative of course is to let the margin call run its course and take all banks, brokers and insurance companies down. Oh yes, don’t forget the sovereign treasuries and central banks themselves. It is the solvency of these institution that will ultimately be challenged.
And no, I didn’t forget I told you to “hold that thought” for the end. What I have described to you is the world running around and fetching as much wood and pouring as much gasoline on the pile as possible. The thought is this, without a spark this is harmless right? Without going into static electricity, spontaneous combustion, a “gun” or even a BIC lighter for that matter, is it even sane? Gold and silver do not and will not burn.
Whether it be a wildfire, a derivatives core meltdown, or even a central bank (like the Fed) or a sovereign treasury going upside down, gold will remain money and remain the benchmark against which currencies are measured. Fiat currencies by definition are “terminal” at their inception. The “deflation/inflation” debate is a moot point unless argued in terms of real money.
Secret ‘Triangle’ Doc Strips NY Fed Power: “Reserve Bank Doesn’t Breathe without Asking Washington if It Can Inhale”
by Mac Slavo
A secret agreement that was enacted five years ago at the Federal Reserve has just come to light. Known as the ‘Triangle Document,’ it purports to take away regulatory power from the New York Fed branch – long known as the most important outpost for the private quasi-government institution – and put it in the hands of the Fed’s Board of Governors in Washington, D.C.
Until 2010, when the document was produced, the big banks essentially enjoyed self-regulation, with significant power over the board.
Class A and Class B NY Fed board members are elected directly by member banks, with Class C members in turn elected by the board (not much different, really). JPMorgan Chase CEO Jamie Dimon – intricately involved in the post-2008 bailout controversy – was the Class A director for the New York Fed board for six years until his term expired in 2013.
For Big Banks and the Federal Reserve, it was a sweetheart fox-guarding-the-henhouse arrangement that the public was never meant to fully understand.
The Wall Street Journal’s Jon Hilsenrath broke the story:
The Federal Reserve Bank of New York, once the most feared banking regulator on Wall Street, has lost power in a behind-the-scenes reorganization at the nation’s central bank.
The Fed’s center of regulatory authority is now a little-known committee run by Fed governor Daniel Tarullo , which is calling the shots in oversight of banking titans such as Goldman Sachs Group Inc. and Citigroup Inc.
The new structure was enshrined in a previously undisclosed paper written in 2010 known as the Triangle Document. Under the new system, Washington is at the center of bank supervision, exercising control over the Fed’s 12 reserve banks, much as the State Department exerts control over embassies….
The lengthy WSJ article details a rather dramatic power struggle between Wall Street’s top banking interests and Washington bureaucrats for control over the institution that has taken control of the world.
During discussions the same year over what became the Triangle Document, New York Fed bank examiners, led by supervisor William Rutledge, fought for more representation on committees but lost, according to people who took part. Mr. Rutledge, now at Promontory Financial Group, which advises firms on dealing with regulators, said he supported the reorganization…
Nine of the Federal Reserve Board’s members are on the 16-person committee; the New York Fed has three representatives, and they answer to Washington. Mr. Dudley isn’t on it.
“This reserve bank doesn’t breathe any more without asking Washington if it can inhale or exhale,” said one person prominent in the banking community.
The move, in theory, is one towards greater accountability towards the public, as the Fed’s Board of Governors in Washington are federal employees and subject to FOIA requests and greater scrutiny.
However, those gains are negated by the fact that the public didn’t even find out about this reorganization – set in 2010 – until five years later.
Nevertheless, the Triangle document reorients power Washington, likely a good thing for those who’ve been considered about the power granted the New York Fed, who have long established cozy ties with Wall Street.
This is partially a result of the Dodd-Frank Act and the creation of the Financial Stability Oversight Council.
As Naked Capitalism wrote:
This is a major win for Fed governor Dan Tarullo, who has emerged as one of the toughest critics of big financial firms at the Fed in the wake of the crisis. It is also a loss for the banks, since the New York Fed is widely recognized as close to Wall Street. Moreover, the Board of Governors is more accountable to citizens (its governors are Federal employees, the Board of Governors is subject to FOIA,
And while there is some good news in moving the power center directly away from Wall Street, it is obviously enough that Washington, D.C. hasn’t been much better for the interests of the people.
All in all, the significance of this move may be overstated – as it is now being made public – at a time when the Federal Reserve is trying to appear more accountable and transparent to the public, while also maintaining the appearance that life could not go on without its significant interventions.
Via Naked Capitalism:
Thus while this is generally a step in the right direction, the open question is whether these steps are adequate. As one can see from its monetary policy, which has worked out swell for the top 1%, the central bank is far too tied into orthodox, meaning elite, views of what its priorities should be. The Fed, for instance, appears to have no concern about the fact that the economy is overfinancialized and reducing the size and profitability of that sector should be a high priority. However, that point of view is anathema to the Board of Governors’ general counsel Scott Alvarez, who is unapologetic about how the deregulation over which he presided produced the financial crisis and continues to exercise outsized influence over regulatory policy.
As we’ve regularly argued, large banks get so much support from the state that they cannot properly be considered to be private entities. They now represent the worst form of socialism for the rich. They should be regulated like utilities. Having utility-like profits and pay would mean that real economy rather than casino economy jobs would look more attractive to ambitious, highly-educated candidates.
Thus the Board of Governors move, while salutary, is likely to turn out to be what the Japanese call “a height competition among peanuts,” where the changes look significant to insiders but are recognized as trivial to more objective observers.
Too little, too late is definitely a fair criticism. Will these regulatory changes amount to any significant reform?
by Patrick Barron
We refer to the dollar as a “reserve currency” when referring to its use by other countries when settling their international trade accounts. For example, if Canada buys goods from China, China may prefer to be paid in US dollars rather than Canadian dollars. The US dollar is the more “marketable” money internationally, meaning that most countries will accept it in payment, so China can use its dollars to buy goods from other countries, not solely the US. Such might not be the case with the Canadian dollar, and China would have to hold its Canadian dollars until it found something to buy from Canada. Multiply this scenario by all the countries of the world who print their own money and one can see that without a currency accepted widely in the world, international trade would slow down and become more expensive. In some ways, its effect would be similar to that of erecting trade barriers, such as the infamous Smoot-Hawley Tariff of 1930 that contributed to the Great Depression.
There are many who draw a link between the collapse of international trade and war. The great French economist Frédéric Bastiat said that “when goods do not cross borders, soldiers will.” No nation can achieve a decent standard of living with a completely autarkic economy, meaning completely self-sufficient in all things. If it cannot trade for the goods that it needs, it feels forced to invade its neighbors to steal them. Thus, a near-universally-accepted currency can be as vital to world peace as it is to world prosperity.
What “Reserve Currency” Really Means
However, the foundation from which the term “reserve currency” originated no longer exists. Originally, the term “reserve” referred to the promise that the currency was backed by and could be redeemed for a commodity, usually gold, at a promised exchange ratio. The first truly global reserve currency was the British pound sterling. Because the Pound was “good as gold,” many countries found it more convenient to hold pounds rather than gold itself during the age of the gold standard. The world’s great trading nations settled their trade in gold, but they might accept pounds rather than gold, with the confidence that the Bank of England would hand over the gold at a fixed exchange rate upon presentment. Toward the end of World War II, the US dollar was given this status by treaty following the Bretton Woods Agreement. The US accumulated the lion’s share of the world’s gold as the “arsenal of democracy” for the allies even before we entered the war. (The US still owns more gold than any other country by a wide margin, with 8,133.5 tons compared to number two Germany with 3,384.2 tons.)
The International Monetary Fund (IMF) was formed with the express purpose of monitoring the Federal Reserve’s commitment to Bretton Woods by ensuring that the Fed did not inflate the dollar and stood ready to exchange dollars for gold at $35 per ounce. Thusly, countries had confidence that their dollars held for trading purposes were as “good as gold,” as had been the British pound at one time.
The Advent of the Fiat Reserve Currency
However, the Fed did not maintain its commitment to the Bretton Woods Agreement and the IMF did not attempt to force it to hold enough gold to honor all its outstanding currency in gold at $35 per ounce. During the 1960s, the US funded the War in Vietnam and President Lyndon Johnson’s War on Poverty with printed money. The volume of outstanding dollars exceeded the US’s store of gold at $35 per ounce. The Fed was called to account in the late 1960s first by the Bank of France and then by others.
Central banks around the world, who had been content to hold dollars instead of gold, grew concerned that the US had sufficient gold reserves to honor its redemption promise. During the 1960s the run on the Fed, led by France, caused the US’s gold stock to shrink dramatically from over 20,000 tons in 1958 to just over 8,000 tons in 1970. At the accelerating rate that these redemptions were occurring, the US had no choice but to revalue the dollar at some higher exchange rate or abrogate its responsibilities to honor dollars for gold entirely. To its everlasting shame, the US chose the latter and “went off the gold standard” in September 1971. (I have calculated that in 1971 the US would have needed to devalue the dollar from $35 per ounce to $400 per ounce in order to have sufficient gold stock to redeem all its currency for gold.) Nevertheless, the dollar was still held by the great trading nations, because it still performed the useful function of settling international trading accounts. There was no other currency that could match the dollar, despite the fact that it was “delinked” from gold.
Why the Dollar Continued To Be a Reserve Currency
There are two characteristics of a currency that make it useful in international trade: one, it is issued by a large trading nation itself, and, two, the currency holds its value over time. These two factors create a demand for holding a currency in reserve. Although the dollar was being inflated by the Fed, thus losing its value vis-à-vis other commodities over time, there was no real competition. The German Deutsche mark held its value better, but the German economy and its trade was a fraction that of the US, meaning that holders of marks would find less to buy in Germany than holders of dollars would find in the US. So demand for the mark was lower than demand for the dollar. Of course, psychological factors entered the demand for dollars, too, since the US was the military protector of all the Western nations against the communist countries.
Today we are seeing the beginnings of a change. The Fed has been inflating the dollar massively, reducing its purchasing power and creating an opportunity for the world’s great trading nations to use other, better monies. This is important, because a loss of demand for holding the US dollar as a reserve currency would mean that trillions of dollars held overseas could flow back into the US, causing either inflation, recession, or both. For example, the US dollar global share of central bank holdings currently is 62 percent, mostly in the form of US Treasury debt. (Central banks hold interest-bearing Treasury debt rather than the dollars themselves.) Foreign holdings of US debt is currently $6.154 trillion. Compare this to the US monetary base of $3.839 trillion.
Should foreign demand to hold US dollar denominated assets diminish, the Treasury could fund their redemption in only three ways. One, the US could increase taxes in order to redeem its foreign held debt. Two, it could raise interest rates to refinance its foreign held debt. Or, three, it could simply print money. Of course, it could use all three to varying degrees. If the US refused to raise taxes or increase the interest rate and relied upon money printing (the most likely scenario, barring a complete repudiation of Keynesian doctrine and an embrace of Austrian economics), the monetary base would rise by the amount of the redemptions. For example, should demand to hold US dollar denominated assets fall by 50 percent ($3.077 trillion) the US monetary base would increase by 75 percent, which undoubtedly would lead to very high price inflation and dramatically hurt us here at home. Our standard of living is at stake here.
So we see that it is in the interest of many that the dollar remain in high demand around the world as a unit of trade settlement. It is necessary in order to prevent price inflation and to prevent American business from being saddled with increased costs that would come from being forced to settle their import/export accounts in a currency other than the dollar.
Threats To the Dollar as Reserve Currency
The causes of this threat to the dollar as a reserve currency are the policies of the Fed itself. There is no conspiracy to “attack” the dollar by other countries, in my opinion. There is, however, a rising realization by the rest of the world that the US is weakening the dollar through its ZIRP and QE programs. Consequently, other countries are aware that they may need to seek a better means of settling world trade accounts than using the US dollar. One factor that has helped the dollar retain its reserve currency demand in the short run, despite the Fed’s inflationist policies, is that the other currencies have been inflated, too.
For example, Japan has inflated the yen to a greater extent than the dollar in its foolish attempt to revive its stagnant economy by cheapening its currency. Now even the European Central Bank will proceed with a form of QE, apparently despite Germany’s objections. All the world’s central banks seem to subscribe to the fallacious belief that increasing the money supply will bring prosperity without the threat of inflation. This defies economic law and economic reality. They cannot print their way to recovery or prosperity. Increasing the money supply does not and cannot ever create prosperity for all. What is more, this mistaken belief compounds a second mistake; i.e., that savings is not the foundation of prosperity, but rather spending is the key. This mistake puts the cart before the horse.
A third mistake is believing that driving their currencies’ exchange rate lower vis-à-vis other currencies will lead to an export-driven recovery or some mysteriously generated shot in the arm that will lead to a sustainable recovery. Such is not the case. Without delving too deeply into Austrian economic and capital theory, just let me point out that money printing disrupts the structure of production by fraudulently changing the “price discovery process” of capitalism. When this happens, capital is allocated to projects that will never be profitably completed. Bubbles get created and collapse and businesses are suddenly damaged en masse, thus, destroying scarce capital.
Possible Future Scenarios
Because of this money-printing philosophy, the dollar is very susceptible to losing its vaunted reserve currency position to the first major trading country that stops inflating its currency. There is evidence that China understands what is at stake; it has increased its gold holdings and has instituted controls to prevent gold from leaving China. Should the world’s second largest economy and one of the world’s greatest trading nations tie its currency to gold, demand for the yuan would increase and demand for the dollar would decrease overnight.
Or, the long festering crisis in Europe may drive Germany to leave the eurozone and reinstate the Deutsch mark. I have long advocated that Germany do just this, which undoubtedly would reveal the rot embodied in the euro, the commonly held currency that has been plundered by half the nations of the continent to finance their unsustainable welfare states. The European continent outside the UK could become a mostly Deutsch mark zone, and the mark might eventually supplant the dollar as the world’s premier reserve currency.
The underlying problem, though, lies in the ability of all central banks to print fiat money; i.e., money that is backed by nothing other than the coercive power of the state via its legal tender laws. Central banks are really little more than legal counterfeiters of their own currencies. The pressure to print money comes from the political establishment that desires both warfare and welfare. Both are strictly capital consumption activities; they are not “investments” that can pay a return.
In a sound money environment, where the money supply cannot be inflated, the true nature of warfare and welfare spending is revealed, providing a natural check on the amount of funds a society is willing to devote to each. But in a fiat money environment both war and welfare spending can expand unchecked in the short run, because their adverse consequences are felt later and the link between consumptive spending and its harm to the economy is poorly understood. Thus, both can be expanded beyond the recuperative and sustainable powers of the economy.
The best antidote is to abolish central banks altogether and allow private institutions to engage in money production subject only to normal commercial law. Sound money would be backed 100 percent by commodities of intrinsic value — gold, silver, etc. Any money producer issuing money certificates or book entry accounts (checking accounts) in excess of their promised exchange ratio to the underlying commodity would be guilty of fraud and punished as such by both the commercial and criminal law, just as we currently punish counterfeiters. Legal tender laws, which prohibit the use (in many cases) of any currency other than the one endorsed by the state, would be abolished and competing currencies would be encouraged. The market would discover the better monies and drive out less marketable ones; i.e., better monies would drive out the bad or less-good monies.
We need to look at the concept of a reserve currency differently, because it is important. We need to look at it as a privilege and a responsibility and not as a weapon we can use against the rest of the world. If we abolish, or even lessen, legal tender laws and allow the process of price discovery to reveal the best sound money, if we allow our US dollar to become the best money it can — a truly sound money — then the chances of our personal and collective prosperity are greatly enhanced.