Mugabe Out, Mnangagwa In, Inflation Down - Current Annual Rate 32%

Authored by Steve H. Hanke of the Johns Hopkins University. Follow him on Twitter @Steve_Hanke.

Robert Mugabe’s 27-year reign of lawlessness, corruption, and incompetence came to an end late November 2017, after a “soft coup” engineered by Emmerson Mnangagwa (aka “the Crocodile”) successfully unseated the aged dictator. Since then, inflation expectations in Zimbabwe have fallen sharply. In consequence, inflation has fallen like a stone. Indeed, before Mugabe’s resignation, Zimbabwe’s implied annual inflation soared to peak rate of 356% (10/26/17). But, following Mnangagwa’s assumption of power, the implied annual inflation rate has fallen to today’s rate of 32%.  

In 2008, Zimbabwe suffered the second most severe episode of hyperinflation in recorded history. The annual inflation rate peaked in November 2008, reaching 89.7 sextillion (10^23) percent (see table below).

At the peak of Zimbabwe’s hyperinflation episode in November 2008, Zimbabweans refused to use the Zimbabwe dollar. With that, the economy was spontaneously, and unofficially, dollarized. Eventually, the government faced this fait accompli in early 2009, when they dollarized the economy by accepting the dollar as the unit of account for government finances.

This year, Zimbabwe once again experienced a bout of hyperinflation, not due to dollarization, but because the Zimbabwean government is issuing, in effect, a new currency that is circulating parallel to the U.S. dollar. Currently (12/8/17), the annual inflation rate is at 32% (see chart below).

During Zimbabwe’s hyperinflation episode from 2007-2008, the Reserve Bank of Zimbabwe failed to report an accurate measure of inflation rates. When episodes of hyperinflation occur, the only feasible and reliable way to measure the inflation rate is via the application of Purchasing Power Parity (PPP). To do so, data on the exchange rate between the domestic currency and a stable international currency are required. This was not feasible in Zimbabwe. The Zimbabwe dollar was not traded on an organized exchange that reported exchange rates, and the use of black-market exchange rates was not feasible either.

However, the organized stock market in Harare did provide prices that allowed for the calculation of implied Zimbabwe dollar exchange rates. One stock, Old Mutual, was, and still is, listed on both the London Stock Exchange and the Zimbabwe Stock Exchange. Each share of Old Mutual commands the same claim on the company’s earnings and assets, irrespective of the market it is traded on. Therefore, given arbitrage and PPP, the ratio of the Old Mutual share price in Harare to that in London equaled the Zimbabwe dollar/sterling exchange rate.

To convert the resulting Zimbabwe dollar/sterling exchange rate to a Zimbabwe dollar/U.S. dollar rate, I multiplied the Zimbabwe dollar/sterling rate by the sterling/U.S. dollar rate, creating what is known as the Old Mutual Implied Rate (OMIR). By using the OMIR as an exchange rate between Zimbabwe dollars and USD, PPP was then applied as the final link necessary for calculating inflation rates.

When President Robert Mugabe’s party, ZANU-PF, regained control in Zimbabwe in 2013, government spending and public debt surged, resulting in economic instability. To finance its deficits, the government created a “New Zim dollar.” The New Zim dollar is issued at par to the U.S. dollar, but trades at a significant discount to the U.S. dollar. As a result of the issuance of the New Zim dollar, the money supply has exploded in Zimbabwe, and so has inflation.

Employing the same theory and method of measurement that was used to calculate Zimbabwe’s 2007-2008 hyperinflation episode, I was once again able to measure an accurate inflation rate, explained here in a detailed study. After doing so, I found that Zimbabwe experienced hyperinflation for the second time in less than ten years between September 2017 and early November 2017. 

Hyperinflation occurs when the monthly inflation rate reaches 50% per month and remains above that rate for at least 30 consecutive days. This initial threshold was breached on September 14, 2017, and the monthly inflation rate stayed above this rate until November 2, 2017. Currently, the monthly rate of inflation is -68% (see chart below).

De-Dollarization Continues: China, Iran To Eliminate Greenback From Bilateral Trade

The more Washington lashes out in anger at those who will not bow to the unipolar world order, the more the rest of the world fights back. As the launch of its Yuan/Gold-settled oil futures looms, China is escalating its de-dollarization scheme further by seeking a bilateral rial-yuan agreement with Iran.

As a reminder, nothing lasts forever...

The World Bank"s former chief economist wants to replace the US dollar with a single global super-currency, saying it will create a more stable global financial system.

"The dominance of the greenback is the root cause of global financial and economic crises," Justin Yifu Lin told Bruegel, a Brussels-based policy-research think tank.

 

"The solution to this is to replace the national currency with a global currency."

The writing is on the wall for dollar hegemony. As Russian President Vladimir Putin said almost two months ago during the BRICs summit in Xiamen,

“Russia shares the BRICS countries’ concerns over the unfairness of the global financial and economic architecture, which does not give due regard to the growing weight of the emerging economies. We are ready to work together with our partners to promote international financial regulation reforms and to overcome the excessive domination of the limited number of reserve currencies.”

As Pepe Escobar recently noted, "to overcome the excessive domination of the limited number of reserve currencies" is the politest way of stating what the BRICS have been discussing for years now; how to bypass the US dollar, as well as the petrodollar.

Beijing is ready to step up the game. Soon China will launch a crude oil futures contract priced in yuan, and now, as RT reports, Tehran and Beijing are determined to find ways to avoid using the US dollar as a settlement currency in trade, according to a report by Iranian economic daily Financial Tribune.

The topic of de-dollarization was raised at a meeting between leading Chinese government political adviser Chen Yuan and Iranian central bank officials in Tehran.

“Rial-yuan’s bilateral monetary agreement can have a significant role in increasing the volume of trade between the two countries and in this regard, we have conducted a series of negotiations with the central bank of the Republic of China’s president,”  said the Central Bank of Iran’s Governor Valiollah Seif.

Tehran has been pursuing the goal of eliminating the dollar in its trade, and has been trying to sign currency swap agreements with a few target countries.

Chen said that Iran and China should develop their banking links and also underlined the unfairness of the existing financial system, dominated by a few developed countries. He added, other nations would do better if the unfair system is eliminated.

“We could use the experiences of European countries in establishing the euro as a common currency between many countries, which is not exclusively controlled by a single country. But until then, we need to utilize the maximum available capacities to expand our banking relations,” he was quoted as saying by the Iranian daily.

As Federico Pieraccini previously noted, until a few decades ago, any idea of straying away from the petrodollar was seen as a direct threat to American global hegemony, requiring of a military response. In 2017, given the decline in US credibility as a result of triggering wars against smaller countries (leaving aside countries like Russia, China, and Iran that have military capabilities the likes of which the US has not faced for more than seventy years), a general recession from the dollar-based system is taking place in many countries.

In recent years, it has become clear to many nations opposing Washington that the only way to adequately contain the fallout from the collapsing US empire is to progressively abandon the dollar. This serves to limit Washington’s capacity for military spending by creating the necessary alternative tools in the financial and economic realms that will eliminate Washington"s dominance. This is essential in the Russo-Sino-Iranian strategy to unite Eurasia and thereby render the US irrelevant.

De-dollarization for Beijing, Moscow and Tehran has become a strategic priority. Eliminating the unlimited spending capacity of the Fed and the American economy means limiting US imperialist expansion and diminishing global destabilization. Without the usual US military power to strengthen and impose the use of US dollars, China, Russia and Iran have paved the way for important shifts in the global order.

The US shot itself in the foot by accelerating this process through their removal of Iran from the SWIFT system (paving the way for the Chinese alternative, known as CIPS) and imposing sanctions on countries like Russia, Iran and Venezuela. This also accelerated China and Russia’s mining and acquisition of physical gold, which is in direct contrast to the situation in the US, with rumors of the FED no longer possessing any more gold. It is no secret that Beijing and Moscow are aiming for a gold-backed currency if and when the dollar should collapse. This has pushed unyielding countries to start operating in a non-dollar environment and through alternative financial systems.

For China, Iran and Russia, as well as other countries, de-dollarization has become a pressing issue.

A Failing Empire, Part 2: De-Dollarisation - China and Russia's Plan From Petroyuan To Gold

Authored by Federico Pieraccini via The Strategic Culture Foundation,

As seen in my previous article, US military power is on the decline, and the effects are palpable. In a world full of conflicts brought on by Washington, the economic and financial shifts that are occurring are for many countries a long-awaited and welcome development.

If we were to identify what uniquely fuels American imperialism and its aspirations for global hegemony, the role of the US dollar would figure prominently.

An exploration of the depth of the dollar’s effects on the world economy is therefore necessary in order to understand the consequential geopolitical developments that have occurred over the last few decades.

The reason the dollar plays such an important role in the world economy is due to the following three major factors: the petrodollar; the dollar as world reserve currency; and Nixon"s decision in 1971 to no longer make the dollar convertible into gold. As is easy to guess, the petrodollar strongly influenced the composition of the SDR basket, making the dollar the world reserve currency, spelling grave implications for the global economy due to Nixon"s decision to eliminate the dollar’s convertibility into gold. Most of the problems for the rest of the world began from a combination of these three factors.

Dollar-Petrodollar-Gold

The largest geo-economic change in the last fifty years was arguably implemented in 1973 with the agreement between OPEC, Saudi Arabia and the United States to sell oil exclusively in dollars.

Specifically, Nixon arranged with Saudi King Faisal for Saudis to only accept dollars as a payment for oil and related investments, recycling billions of excess dollars into US treasury bills and other dollar-based financial resources. In exchange, Saudi Arabia and other OPEC countries came under American military protection. It reminds one of a mafia-style arrangement: the Saudis are obliged to conduct business in US dollars according to terms and conditions set by the US with little argument, and in exchange they receive generous protection.

The second factor, perhaps even more consequential for the global economy, is the dollar becoming the world reserve currency and maintaining a predominant role in the basket of international foreign-exchange reserves of the IMF ever since 1981. The role of the dollar, linked obviously to the petrodollar trade, has almost always maintained a share of more than 40% of the Special Drawing Right (SDR) basket, while the euro has maintained a stable share of 29-37% since 2001. In order to understand the economic change in progress, it is sufficient to observe that the yuan is now finally included in the SDR, with an initial 10% share that is immediately higher than the yen (8.3%) and sterling (8.09%) but significantly less than the dollar (41%) and euro (31%). Slowly but significantly Yuan currency is becoming more and more used in global trade.

The reason why the United States has been able to fuel this global demand for dollars is linked to the need for other countries to own dollars in order to be able to buy oil and other goods. For example, if a Bolivian company exports bananas to Norway, the payment method requires the use of dollars. Norway must therefore own US currency to pay and receive the goods purchased. Similarly, the dollars Bolivia receives will be used to buy other necessities like oil from Venezuela. It may seem unbelievable, but practically all countries until a few years ago used US dollars to trade amongst each other, even countries that were anti-American and against US imperialist policies.

This continued use of the dollar has had some devastating effects on the globe. First of all, the intense use of the American currency, coupled with Nixon’s decisions, created an economic standard based on the dollar that soon replaced precious metals like gold, which had been the standard for the global economy for years. This has led to major instability and to economic systems that have in the proceeding years created disastrous financial policies, as seen in 2000 and 2008, for example. The main source of economic reliability transferred from gold to dollars, specifically to US treasury bills. This major shift allowed the Federal Reserve to print dollars practically without limit (as seen in recent years with interests rates for borrowing money from the FED at around 0%), well aware that the demand for dollars would never cease, this also keeping alive huge sectors of private and public enterprises (such as the fracking industry). This set a course for a global economic system based on financial instruments like derivatives and other securities instead of real, tangible goods like gold. In doing this for its own benefit, the US has created the conditions for a new financial bubble that could even bring down the entire world economy when it bursts.

The United States found itself in the enviable position of being able to print pieces of paper (simply IOU’s) without any gold backing and then exchange them for real goods. This economic arrangement has allowed Washington to achieve an unparalleled strategic advantage over its geopolitical opponents (initially the USSR, now Russia and China), namely, a practically unlimited dollar-spending capacity even as it accumulates an astronomical public debt (about 21 trillion dollars). The destabilizing factor for the global economy has been Washington"s ability to accumulate enormous amounts of public debt without having to worry about the consequences or even of any possible mistrust international markets may have for the dollar. Countries simply needed dollars for trade and bought US treasures to diversify their financial assets.

The continued use of the dollar as a means of payment for almost everything, coupled with the nearly infinite capacity of the of FED to print money and the Treasury to issue bonds, has led the dollar to become the primary safe refuge for organizations, countries and individuals, legitimizing this perverse financial system that has affected global peace for decades.

Dollars and War: The End?

The problems for the United States began in the late 1990s, at a time of expansion for the US empire following the demise of the Soviet Union. The stated geopolitical goal was the achievement of global hegemony. With unlimited spending capacity and an ideology based on American exceptionalism, this attempt seemed to be within reach for the policymakers at the Pentagon and Wall Street. A key element for achieving global hegemony consisted of stopping China, Russia and Iran from creating a Eurasian area of integration. For many years, and for various reasons, these three countries continued to conduct large-scale trade in US dollars, bowing to the economic dictates of a fraudulent financial system created for the benefit of the United States. China needed to continue in its role of becoming the world"s factory, always having accepted dollar payments and buying hundreds of billions of US treasury bills. With Putin, Russia began almost immediately to de-dollarize, repaying foreign debts in dollars, trying to offload this economic pressure. Russia is today one of the countries in the world with the least amount of public and private debt denominated in dollars, and the recent prohibition on the use of US dollars in Russian seaports is the latest example. For Iran, the problem has always been represented by sanctions, creating great incentives to bypass the dollar and find alternative means of payment.

The decisive factor that changed the perception of countries like China and Russia was the 2008 financial crisis, as well as growing US aggression ever since the events in Yugoslavia in 1999. The Iraq war, along with other factors, prevented Saddam from starting an oil trade in euro, which threatened the dollar"s financial hegemony in the Middle East. War and the America’s continued presence in Afghanistan stressed Washington’s intentions to continue encircling China, Russia and Iran in order to prevent any Eurasian integration. Naturally, the more the dollar was used in the world, the more Washington had the power to spend on the military. For the US, paying a bill of 6 trillion dollars (this is the cost of the wars in Iraq and Afghanistan) has been effortless, and this constitutes an unparalleled advantage over countries like China and Russia whose military spending in comparison is a fifth and a tenth respectively.

The repeated failed attempts to conquer, subvert and control countries like Afghanistan, Georgia, Iraq, Libya, Syria, Donbass, North Korea, Egypt, Tunisia, Yemen and Venezuela, have had significant effects on the perception of US military power. In military terms, Washington faced numerous tactical and strategic defeats, with the Crimean peninsula returning to Russia without a shot fired and with the West unable to react. In Donbass, the resistance inflicted huge losses on the NATO-supported Ukrainian army. In North Africa, Egypt is now under the control of the army, following an attempt to turn the country into a state under the control of the Muslim Brotherhood. Libya, after being destroyed, is now divided into three entities, and like Egypt seems to be looking with favorable regard towards Moscow and Beijing. In the Middle East, Syria, Turkey, Iran and Iraq are increasingly cooperating in stabilizing regional conflicts, where needed they are backed by Russian military power and Chinese economic strength. And of course the DPRK continues to ignore US military threats and has fully developed its conventional and nuclear deterrent, effectively making those US threats null and void.

Color revolutions, hybrid warfare, economic terrorism, and proxy attempts to destabilize these countries have had devastating effects on Washington"s military credibility and effectiveness. The United States finds itself being considered by many countries to be a massive war apparatus that struggles to get what it wants, struggles to achieve coherent common goals, and even lacks the capability to control countries like Iraq and Afghanistan in spite of its overwhelming military superiority.

No One Fears You!

Until a few decades ago, any idea of straying away from the petrodollar was seen as a direct threat to American global hegemony, requiring of a military response. In 2017, given the decline in US credibility as a result of triggering wars against smaller countries (leaving aside countries like Russia, China, and Iran that have military capabilities the likes of which the US has not faced for more than seventy years), a general recession from the dollar-based system is taking place in many countries.

In recent years, it has become clear to many nations opposing Washington that the only way to adequately contain the fallout from the collapsing US empire is to progressively abandon the dollar. This serves to limit Washington’s capacity for military spending by creating the necessary alternative tools in the financial and economic realms that will eliminate Washington"s dominance. This is essential in the Russo-Sino-Iranian strategy to unite Eurasia and thereby render the US irrelevant.

De-dollarization for Beijing, Moscow and Tehran has become a strategic priority. Eliminating the unlimited spending capacity of the Fed and the American economy means limiting US imperialist expansion and diminishing global destabilization. Without the usual US military power to strengthen and impose the use of US dollars, China, Russia and Iran have paved the way for important shifts in the global order.

The US shot itself in the foot by accelerating this process through their removal of Iran from the SWIFT system (paving the way for the Chinese alternative, known as CIPS) and imposing sanctions on countries like Russia, Iran and Venezuela. This also accelerated China and Russia’s mining and acquisition of physical gold, which is in direct contrast to the situation in the US, with rumors of the FED no longer possessing any more gold. It is no secret that Beijing and Moscow are aiming for a gold-backed currency if and when the dollar should collapse. This has pushed unyielding countries to start operating in a non-dollar environment and through alternative financial systems.

A perfect example of how this is being achieved can be seen with Saudi Arabia, which has represented the crux of the petrodollar.

De-dollarize

Beijing has started putting strong pressure on Riyadh to start accepting yuan payments for oil instead of dollars, as are other countries such as the Russian Federation. For Riyadh, this is an almost existential issue. Riyadh is in a delicate situation, dedicated as it is to keeping the US dollar tied to oil, even though its main ally, the US, has pursued in the Middle East a contradictory strategy, as seen with the JCPOA agreement. Iran, the main regional enemy of Saudi Arabia, was able to have sanctions lifted (especially from Europeans countries) thanks to the JCPOA. In addition, Iran was able to pursue a historic victory with its allies in Syria, gaining a preeminent role in the region and aspiring to become a regional powerhouse. Riyadh is obliged to obey the US, an ally that does not care about its fate in the region (Iran is increasingly influential in Iraq, Syria and Lebanon) and is even competing in the oil market. To make matters worse for Washington, China is Riyadh’s largest customer; and considering the agreements with Nigeria and Russia, Beijing can safely stop buying oil from Saudi Arabia should Riyadh continue to insist on receiving payment only in dollars. This would badly hurt the petrodollar, a perverse system that damages China and Russia most of all.

For China, Iran and Russia, as well as other countries, de-dollarization has become a pressing issue.

The number of countries that are beginning to see the benefits of a decentralized system, as opposed to the US dollar system, is increasing.

 Iran and India, but also Iran and Russia, have often traded hydrocarbons in exchange for primary goods, thereby bypassing American sanctions.

Likewise, China"s economic power has allowed it to open a 10-billion-euro line of credit to Iran to circumvent recent sanctions.

Even the DPRK seems to use cryptocurrencies like bitcoin to buy oil from China and bypass US sanctions. 

Venezuela (with the largest oil reserves in the world) has just started a historic move to completely renounce selling oil in dollars, and has announced that it will start receiving money in a basket of currencies without US dollars. (This is not to mention the biggest change to have occurred in the last 40 years).

Beijing will buy gas and oil from Russia by paying in yuan, with Moscow being able to convert yuan into gold immediately thanks to the Shanghai International Energy Exchange.

This gas-yuan-gold mechanism signals a revolutionary economic change through the progressive abandonment of the dollar in trade.

In the next and last article, we will concentrate on how successful Russia, Iran and China have been in forging a multipolar world order with the goal of peacefully containing the fallout from the collapsing American empire, and how this alternative world order is opening up a new geopolitical landscape for America’s allies and other countries.

The World Is Creeping Toward De-Dollarization

The issue of when a global reserve currency begins or ends is not an exact science. There are no press releases announcing it, and neither are there big international conferences that end with the signing of treaties and a photo shoot. Nevertheless we can say with confidence that the reign of every world reserve currency has to come to and end at some point in time. During a changeover from one global currency to another, gold (and to a lesser extent silver) has always played a decisive role.

Central banks and governments have long been aware that the dollar has a sell-by date as a reserve currency. But it has taken until now for the subject to be discussed openly. The fact that the issue has been on the radar of a powerful bank like JP Morgan for at least five years, should give one pause. Questions regarding the global reserve currency are not exactly discussed on CNBC every day. Most mainstream economists avoid the topic like the plague. The issue is too politically charged. However, that doesn"t make it any less important for investors to look for answers.

On the contrary. The following questions need to be asked:

What indications are there that the world is turning its back on the US dollar?

And what are the clues that gold"s role could be strengthened in a new system?

The mechanism underlying today"s “dollar standard” is widely known and the term “petrodollar” describes it well. This system is based on an informal agreement the US and Saudi Arabia arrived at in the mid-1970s. The result of this deal: Oil, and consequently all other important commodities, is traded in US dollars — and only in US dollars. Oil producers then “recycle” these “petrodollars” into US treasuries. This circular flow of dollars has enabled the US to pile up a towering mountain of debt of nearly $20 trillion — without having to worry about its own financial stability. At least, until now.

For a long time the basis on which this global currency system rests was poorly documented. Finally, Bloomberg published a comprehensive article in May 2016, which provided detailed confirmation of the agreement that was hitherto only known as a rumor. The fact that this article is published now also represents a subtle clue that there are simmering shifts in the global currency system.

The trend becomes ever more tangible and can be described by the following term: de-dollarization. The world is looking for alternatives to the dollar — and finds them more and more often. At the same time the big oil producers and the largest exporters have stopped accumulating US debt securities. In one sentence: Since 1973 the dollar standard has been based on “usage demand” for dollars — they were needed. But when China and Russia find alternatives for their bilateral trading activity, they need fewer dollars. The same applies to European countries which have adopted the euro since 1999.

There have been many attempts by various nations to undermine the dollar"s preeminence in recent decades.

Some were nipped in the bud by US interventions — such as the plan of Iraq"s former dictator Saddam Hussein to sell oil for euros.

Or the rumored plan of Libya"s eccentric ruler Muammar al-Gaddafi to issue a pan-African gold currency.

Others are less well known, but are indeed continuing to “bubble” below the surface: For example, since 2008, an agreement exists between Saudi Arabia, Kuwait, Bahrain, and Qatar which provides for the creation of a monetary union. The planned new currency is nicknamed — rather unimaginatively — the “gulfo.” “The project is inspired by the European currency union, which is seen as a great success in the Arab world,” according to an article by Telegraph journalist Ambrose Evans-Pritchard. He inter alia quotes Nahed Taher, the CEO of Bahrain Gulf One Investment Bank: “The US dollar has failed. We need to delink from it.” However, it appears the plan has been put on hold in recent years. As recently as mid-2013 a statement was issued according to which the common currency was going to be put in place “by 2015 at the latest.” Today it is no longer even talked about. Moreover, other potential members such as the United Arab Emirates or Oman have so far failed to join the club. One should nevertheless keep an eye on developments in the Gulf.

A clear signal that something is afoot would be the abolition of the Saudi riyal"s peg to the US dollar. As recently as April of this year economist Nasser Saeedi advised Middle Eastern countries to prepare for a “new normal” — and specifically to review the dollar pegs of their currencies:

“By 2025 it is clear that the center of global economic geography is very much in Asia. What we’ve been living in over the past two decades is a very big shift in the political, economic, and financial geography.”

While the role of oil-producing countries (and particularly Saudi Arabia) shouldn"t be underestimated, at present the driving forces with regard to de-dollarization are primarily Moscow and Beijing. We want to take a closer look at this process.

There exist numerous political statements in this context which leave no room for doubt. The Russians and Chinese are quite open about their views regarding the role of gold in the current phase of the transition. Thus, Russian prime minister Dimitri Medvedev, at the time president of Russia, held a gold coin up to a camera on occasion of the 2008 G8 meeting in Aquila in Italy. Medvedev said that debates over the reserve currency question had become a permanent fixture of the meetings of government leaders.

Almost ten years later, the topic of currencies and gold is on the Sino-Russian agenda again. In March, Russia"s central bank opened its first office in Beijing. Russia is preparing to place its first renminbi-denominated government bond. Both sides have intensified efforts in recent years to settle bilateral trade not in US dollars, but in rubles and yuan. Gold is considered important by both countries.

The gradual move away from the USD to a multi-polar monetary order has several important effects, which only make sense when viewed through this lens. Contrary to what is asserted in most mainstream reports, oil-producing countries are not so much interested in a much higher oil price in USD terms, but rather in competition for market share. They are increasingly able to choose in which currencies they want to trade. The most important effect has become evident since 2014: two of the largest holders of US treasuries (China and Saudi Arabia) have abandoned their support of Washington. On the other hand, oil producers have no interest in recycling their revenues as “petrodollars.”

The process of moving away from the dollar - prepared by Europe and triggered by China and Russia - can no longer be stopped. And as a “supra-national” reserve asset, gold plays an important role in it.

America's Weapons: "The Dollar And The Drone"

Authored by Brian Maher via DailyReckoning.com,

It was said that “the guinea and the gallows” were the true instruments of British imperial power.

The guinea represented the coined wealth of Great Britain.

The gallows represented its… constabulary zeal in policing restless natives.

This is the 21st century of course… a time of enlightenment.

Today’s instruments of imperial power are no longer the guinea and the gallows.

No. Today’s instruments of imperial power are “the dollar and the drone.”

The dollar and the drone are America’s weapons.

Like the 19th-century pound (which replaced the guinea), today’s dollar is the world’s reserve currency.

Like the 19th-century pound, the dollar finances some two-thirds of global trade.

And the gallows?

Britain hanged its foreign trouble. America explodes its own in drone attacks.

Here is civilization; here is progress.

The sun eventually sank on the British Empire… the gallows came down… and the pound lost its global reserve status.

The U.S. will have its drones. But is its other weapon, the dollar, close to losing global reserve status?

Recent developments may tell…

The global oil trade has centered on the dollar since 1974, when Saudi Arabia agreed to enthrone the dollar as currency of the oil market.

If it was oil you wanted… it was dollars you needed.

But now China — world’s top oil importer — is preparing to create an oil market that bypasses the dollar entirely.

The plan would let China buy oil from Russia and Iran with its own currency, the yuan.

But the yuan is not a major reserve currency like the dollar.

Under this plan, Russia and Iran would be able to swap yuan for an asset far more desirable than Chinese scraps of paper — gold itself.

Perhaps that explains why China’s been hoarding so much gold in recent years?

Jim Rickards says this system marks the beginning of the end for the petrodollar:

China, Russia and Iran are coordinating a new international monetary order that does not involve U.S. dollars. It has several parts, which together spell dollar doom. The first part is that China will buy oil from Russia and Iran in exchange for yuan.

 

The yuan is not a major reserve currency, so it’s not an especially attractive asset for Russia or Iran to hold. China solves that problem by offering to convert yuan into gold on a spot basis on the Shanghai Gold Exchange…

 

This marks the beginning of the end of the petrodollar system that Henry Kissinger worked out with Saudi Arabia in 1974, after Nixon abandoned gold.

But it’s not only China, Russia and Iran that are out to dethrone King Dollar.

They’re joined by the rest of the “BRICS” nations — Brazil, India, South Africa.

Together they represent 25% of global economic output.

At last week’s annual BRICS summit in China, members announced full-throated support for China’s plan.

The message, clear as gin: The dollar’s days of “exorbitant privilege” must end.

And yesterday brought news that could further accelerate China’s de-dollarization plans…

Treasury Secretary Steve Mnuchin announced the U.S. would consider locking China out of the international dollar system if Beijing doesn’t cooperate with new sanctions against North Korea:

If China doesn’t follow these sanctions, we will put additional sanctions on them and prevent them from accessing the U.S. and international dollar system. And that’s quite meaningful.

“Meaningful” might be one word for it. “Menacing” would be another.

SWIFT (Society for Worldwide Interbank Financial Telecommunication) is a network that facilitates trillions of dollars in international money transfers each year.

It is the oil that lubricates the machinery of the international financial system — or as Jim Rickards styles it, “the oxygen supply that keeps the global financial system alive.”

And to cut off China’s oxygen?

“That is why China buys gold,” Jim Rickards tweeted this morning from London.

Our colleague Dave Gonigam of The 5 Min. Forecast half-jestingly wonders, “Is the Trump administration trying to kill off the U.S. dollar’s status as the globe’s reserve currency?”

Of course, the dollar will not lose reserve status tomorrow, next week, next year.

But the direction of travel seems clear enough.

Jim:

In 2000, dollar assets were about 70% of global reserves. Today, the comparable figure is about 62%. If this trend continues, one could easily see the dollar fall below 50% in the not-too-distant future.

How does one go bankrupt?

Slowly at first, said Hemingway — then all at once.

That’s how the dollar will likely lose its reserve status… slowly at first… then all at once…

How To Stop Venezuela's Fatal Inflation

During my testimony of March 28th before the U.S. House of Representatives Committee on Foreign Affairs, I stressed that, to establish stability and turn Venezuela’s economy around, runaway inflation must be stopped in its tracks. After all, stability might not be everything, but everything is nothing without stability.

To grasp the magnitude of Venezuela’s inflation problem, take a look at the chart below. It shows the annual inflation rates (yr/yr) for chicken. Venezuela’s current chicken-price inflation is running at a whopping 700% annual rate.

 

The New York Times editorial of March 30th, “Crisis Upon Crisis in Venezuela,” picked up on my “stop inflation first” elixir. As the Times put it: “the international community could propose specific macroeconomic reforms that could curb Venezuela’s runaway inflation and stabilize its currency.”

The Times failed to offer a specific inflation-killing strategy, however. There are only two sure-fire ways to kill Venezuela’s inflation and establish the stable conditions which are necessary to carry out much-needed economics reforms. One way would be to dump the bolivar and officially dollarize the economy, an option I covered in my March 30th Forbes piece, “On Venezuela’s Death Spiral.”

A second method would be to adopt a currency board system. In such a system, the bolivar would become a clone of a reliable anchor currency, such as the U.S. dollar.

Just what is a currency board? An orthodox currency board issues notes and coins convertible on demand into a foreign anchor currency at a fixed rate of exchange. As reserves, it holds low-risk, interest-bearing bonds denominated in the anchor currency. The reserve levels (both floors and ceilings) are set by law and are equal to 100%, or slightly more, of its monetary liabilities. A currency board generates profits from the difference between the interest it earns on its reserve assets and the expense of maintaining its liabilities.

A currency board’s operations are passive and automatic. The sole function of a currency board is to exchange the domestic currency it issues for an anchor currency at a fixed rate. In consequence, the quantity of domestic currency in circulation is determined solely by market forces, namely the demand for domestic currency. 

A currency board cannot issue credit. It cannot act as a lender of last resort or extend credit to the banking system. It also cannot make loans to the fiscal authorities and state-owned enterprises. In consequence, a currency board imposes a hard budget constraint and discipline on the economy.

A currency board requires no preconditions for monetary reform and can be installed rapidly. Government finances, state-owned enterprises, and trade need not be already reformed for a currency board to begin to issue currency.

Countries that have employed currency boards have maintained currency convertibility and delivered lower inflation rates, smaller fiscal deficits, lower debt levels relative to GDP, fewer banking crises, and higher real growth rates than comparable countries that have employed central banks.

It is important to mention that the currency board idea became engulfed in controversy – thanks to Argentina. What Argentina termed “Convertibility” was introduced in April 1991 to stop inflation, which it did. The system had certain features of a currency board: a fixed exchange rate, full convertibility, and a minimum reserve cover for the peso of 100% of its anchor currency, the U.S. dollar. However, it had two major features which disqualified it from being an orthodox currency board. It had no ceiling on the amount of foreign assets held at the central bank relative to the central bank’s monetary liabilities. So, the central bank could engage in sterilization and neutralization activities, which it did. In addition, it could hold and alter the level of domestic assets on its balance sheet. So, Argentina’s monetary authority could engage in discretionary monetary policy, and it did so aggressively. 

Because of these flaws, I penned an article which appeared in the October 25, 1991 edition of the Wall Street Journal. I concluded that, unless Argentina embraced orthodoxy and amended the Convertibility Law, the system would eventually collapse, which it did in 2002.

The collapse of Convertibility spawned a cottage industry of currency board critiques. But, since Argentina’s Convertibility System allowed for both monetary and exchange rate policies, it was not a currency board – something most economists failed to recognize. Indeed, a scholarly survey of almost 100 leading economists who commented on the Convertibility System found that almost 97% incorrectly identified it as a currency board system. So, those that used the collapse of Argentina’s Convertibility System to argue against currency boards literally didn’t know what they are talking about.

Just what can the international community do to shine a light on the currency board solution for Venezuela’s runaway inflation? For me, the answer harks back to 1992. That’s when I worked with the then-leader of the U.S. Senate, Bob Dole, and Senators Steve Symms and Phil Gramm, to draft U.S. legislation that would encourage countries with unstable currencies and runaway inflation to install currency boards. This legislation, (HR-5368, Law no. 102-391), was signed into law on October 6, 1992.

This piece was originally published on Forbes.

What Will Trump Do About The Central-Bank Cartel?

Submitted by Thorstein Polleit via The Mises Institute,

The US is by far the biggest economy in the world. Its financial markets — be it equity, bonds or derivatives markets — are the largest and most liquid. The Greenback is the most important transaction currency. Many currencies in the world — be it the euro, the Chinese renminbi, the British pound or the Swiss franc — have actually been built upon the US dollar.

The world is effectively on a US-dollar-standard, and the US Federal Reserve (Fed) has risen to the unofficial status of the world’s central bank. The rise of the Greenback has to a large extent been propelled by international banking, which has basically “dollarized” in terms of its lending and issuing activities.

The Fed Sets Global Policy

The Fed’s policy not only determines credit and liquidity conditions in the US, but does so in many financial markets around the world as well. For instance, movements of long-term US interest rates regularly have effects on credit and equity markets in, say, Europe and Asia. The Fed’s actions are the blueprint for monetary policymaking in many countries around the world.

The graph shows the Fed’s supply of newly created US dollar liquidity sent to other central banks around the world. It also shows the so-called “euro cross currency basis swap,” which can be interpreted as a “stress indicator”: If it drops into negative territory, it means that euro banks find it increasingly difficult to obtain US dollar credit in the free market place. The Fed’s injection of new US dollar balances into the financial system has helped to reduce the euro currency basis swap. Since late 2016, however, it has started to venture again into negative territory — potentially signaling that euro banks are again heading for trouble.

The financial and economic crisis 2008/2009 has increased further the dependency of the world’s financial system on the US dollar. As early as December 2008, the Fed provided so called “liquidity swap agreements.” Under the latter the Fed is prepared to lend newly created US dollars to other central banks around the globe.

For instance, the European Central Bank (ECB) can obtain US dollars from the Fed and lend the funds on to shaky domestic banks in need for US dollar funding. In other words: Liquidity swap agreements can easily replace foreign currency funding in the market place by foreign currency credit provided by central banks.

Meanwhile, all major central banks around the world — the European Central Bank, the Bank of Japan, the Chinese central bank, the Bank of England, and the Swiss National Bank — have joined the liquidity swap agreement club. They also have agreed to provide their own currencies to all other central banks — in actually unlimited amounts if needed.

It is no wonder, therefore, that credit default concerns in financial markets have declined substantially. Investors feel assured that big banks won’t default on their foreign currency liabilities — as such a credit event is considered politically undesirable, and central banks can simply avoid it by printing up new money.

Moving Toward a Worldwide Central Bank

The close cooperation and coordination among central banks under the Fed’s tutelage amounts to an international cartelization of central banking — paving the way toward a single world monetary policy run by a yet to be determined single world central bank. Such a development is, or course, in the very interest of those in favor of establishing a single world government.

How will President Donald J. Trump and his administration deal with the cartelization in central banking? Mr. Trump doesn’t seem to be an “internationalist,” seeking to build a new world order by political and military means. If that is so, he will sooner or later have to come to grips with the Fed’s policies — most notably with its liquidity swap agreements.

The Fed’s policy has made the world’s financial system addicted to ever greater amounts of US dollars, easily accessible and provided at fairly low interest rates. From this the US banks benefit greatly, while average Americans bear the brunt: they pay the price in terms of, for instance, boom and bust and an erosion of the purchasing power of the US dollar.

What Trump Should Do 

If the Trump administration really wishes to live up to its campaign promise “Make America great again,” there is no way of getting around addressing Fed policy. A first step in that direction is the idea to subject the US central bank to public scrutiny (“Audit the Fed”), bringing to public attention the scope of the Fed’s interventions into the world’s banking system.

Of course, the liquidity swap agreements in particular can be expected to be heavily defended by central bankers, bank representatives, big business lobbyists, and mainstream economists as being indispensable for financial system stability. And for sure, a sudden withdrawal from this practice would almost certainly deal a heavy blow to financial markets.

If push comes to shove, it could even make the worldwide credit pyramid, built on fiat money, come crashing down. However, the really important argument in this context is that the continuation of the practice of central bank cartelization will eventually result in a despotic regime: and that is a single world fiat currency regime.

Of course, change for the better doesn’t come from politics. It comes from better ideas. For it is ideas that determine human action. Whatever these ideas are and wherever they come from: They make humans act. For this reason the great Austrian economist Ludwig von Mises (1881 – 1973) advocates the idea of the “sound money principle”:

The sound-money principle has two aspects. It is affirmative in approving the market"s choice of a commonly used medium of exchange. It is negative in obstructing the government"s propensity to meddle with the currency system.

Mises also explains convincingly the importance of the sound money principle for each and every one of us:

It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of right.

Mises’s sound money principle calls for ending central banking once and for all and opening up a free market in money. Having brought to a halt political globalism for now, the new US administration has now also a once in a lifetime chance to make the world great again — simply by ending the state’s monopoly of money production.

If the US would move in that direction — ending legal tender laws and giving the freedom to the American people to use, say, gold, silver, or bitcoin as their preferred media of exchange — the rest of the world would most likely have to follow the example. That said, Mr. Trump could really make a real change, simply by embracing Mises’s sound money principle.