USA Fire Sale, 2nd Meeting, June 2009: Political capital call - Eric Janszen

[flintlock]

you think she's writing about peter?

Ok mister Red Herring, that doesn't address whether Schiff was right or not.

[metalman]

Ok mister Red Herring, that doesn't address whether Schiff was right or not.

right about what? the dollar crashing last year? no.

about it crashing in the future? i doubt it.

this makes more sense to me... they support the dollar as needed with short term debt while diversifying out of dollars... use long term debt as collateral... set up currency swaps... etc...

what's the motto here... 'a process not an event'.

chart from part ii...



the dollar's been 'crashing' since 1971.

the pound sterling didn't 'crash' and lose reserve status overnight, either. process took decades, too...

[goadam1]

right about what? the dollar crashing last year? no.

about it crashing in the future? i doubt it.

this makes more sense to me... they support the dollar as needed with short term debt while diversifying out of dollars... use long term debt as collateral... set up currency swaps... etc...

what's the motto here... 'a process not an event'.

chart from part ii...



the dollar's been 'crashing' since 1971.

the pound sterling didn't 'crash' and lose reserve status overnight, either. process took decades, too...

The question is, should a British citizen with some savings, diversified out of holding denominated in pounds or would it not have mattered that much?

[metalman]

The question is, should a British citizen with some savings, diversified out of holding denominated in pounds or would it not have mattered that much?

$5 1941 to $2.50 in 1971... 50% in 30 yrs = dollar 110 in 2001 to 55 in 2031. itulip sees 79 to 60 in 5yrs.

my take... either way, slow or fast depreciation... you do not want a big exposure to a currency of a country that has another country trapped in that currency.

another the 'poom' scenario...

China’s Syndrome: The “dollar trap” in historical perspective

Olivier Accominotti 23 April 2009

China’s “dollar trap” has many analysts worried about its future resolution. This column discusses a similar situation in the 1920s when France held more than half the world’s foreign reserves. France’s “sterling trap” ended disastrously. Sterling suffered a major currency crisis, French authorities lost a lot of money, and subsequent policy reactions deepened the Great Depression.

China’s huge volume of dollar reserves is now at the centre of serious concerns about the future of the US currency. The origin of this situation dates back to the early 2000s, after the East Asian and Russian crises. At that time, accumulating foreign reserves was considered benign policy. Developing and emerging countries were encouraged in this way in order to insure against sudden reversals of capital inflows. China was pegging its currency against the dollar and, due to the US trade deficits, started acquiring US assets.

Ten years on, the People’s Bank of China (PBOC) has an extraordinary stock of dollars, and one pressing question: “What to do out of them?” Increasing political tensions have given rise to fears that it might get rid of this huge bulk of securities and precipitate a dollar crash. In August 2007, a Chinese official indeed reminded that Beijing was in a position to provoke a “mass depreciation” of the dollar if it decided to do so. Recent suggestion by Zhou Xiaochuan that China’s central bank might shift from the dollar has put the issue on newspapers’ headlines once again.

But bold statements are one thing, and actual policy another. Up to now, China’s authorities have shown few signs of attempting to weaken the dollar. The reason for this seems straightforward. After all, China is the world’s largest dollar investor, and no one else would have less interest in seeing the value of the US currency plummet. The PBOC might be the promptest to support the dollar, not least because it would suffer a huge capital loss in the event of a dollar depreciation. In a recent New York Times column, Paul Krugman argues that China has “driven itself into a dollar trap, and that it can neither get itself out nor change the policies that put it in that trap in the first place.”

This situation might appear unprecedented. But in truth, all this is not brand-new.

French foreign reserves policy during the Great Depression

Economic history offers one striking example of a country being trapped by the huge volume of its foreign reserves. This country was France, the period was the early 1930s, and the currency at stake the pound sterling. The episode ended up dramatically. Sterling suffered a major currency crisis, French authorities lost a lot of money, and their subsequent policy largely contributed to the Great Depression.

The origin of the problem lay in the government’s decision of 1926 to peg the franc to the sterling and dollar, two years before re-establishing the gold standard. Since the trade balance was in surplus and capital was flowing into the country, this goal was achieved through public purchases of foreign exchange. The Bank of France therefore accumulated a bulging portfolio of foreign holdings. At the end of the 1920s, the country held more than half of the world’s volume of foreign reserves.

French policy over subsequent years has been heavily criticized for being destabilizing. British contemporaries, like Paul Einzig, accused France of using its reserves in order to weaken the pound before the sterling crisis of September 1931. Others have noted that French conversions of foreign assets into gold after 1931, by imposing constraints on their money supplies, put intense deflationary pressures on other countries on the gold standard.

France’s Sterling Trap in 1931

Why did France engage in a policy that had such dramatic consequences? In a recent work, I explore the motivations behind the French reserves policy of this period. Spending time in the archives, I was able first to reconstitute the evolution of the reserves currency composition, and second, to identify the reasons invoked for the allocation decisions. Last, I have combined this information with market indicators of the perceived risk of reserves currencies.

France’s problems were similar to those of China today. The Bank of France was a private institution and its primary objective was to avoid capital losses. Its reserves were allocated between sterling and dollar. From 1929 to 1931, there were fears that the pound might be devalued and the Bank started shifting to the dollar (figures 1 and 2).

Figure 1. Bank of France’s Sterling Reserve (in millions of pounds sterling), 1928-1936


Figure 2. Bank of France’s Dollar Reserve (in millions of US dollars), 1928-1936

Source: Bank of France’s archives.

However, in implementing this policy, the Bank was also constrained by its position as a large player on the exchange market. So, as sterling’s weakness worsened at the end of 1930, the Bank was in a trap: it could not continue selling pounds without precipitating a sterling collapse and a huge exchange loss for itself. The only workable option left was to support the pound. French policy therefore suddenly turned cooperative. The Bank halted the sterling liquidations, and even intervened on the market in order to support the British currency.

When the pound eventually collapsed, the Bank of France was put into a state of technical bankruptcy. It was only able to survive thanks to a state’s rescue, obtained under tough conditions. Moreover, there were now rising fears over the dollar. The will to avoid further losses therefore led authorities to convert all their dollar assets into gold (figure 2), a policy that heavily contributed to the global monetary contraction of the 1930s.

Lessons for today?

What are the lessons for today? China’s objective function today certainly differs from those of France in the interwar years. But French experiences in the early 1930s are a reminder that when there is growing risk on reserves currencies, foreign reserves can be both a source of instability for the international monetary system, and a burden for large holders.

References

Accominotti, O., 2008, “The Sterling Trap: Foreign Reserves Management at the Bank of France, 1928-1936”, forthcoming European Review of Economic History.
Einzig, P., 1932, Behind the scenes of international finance, London: Macmillan.
Krugman, P., “China’s Dollar Trap”, New York Times, 2 April 2009
“China threatens nuclear option-of-dollar-sales”, Daily Telegraph, 10 August 2007

This article may be reproduced with appropriate attribution. See Copyright (below).

[ThePythonicCow]

China’s Syndrome: The “dollar trap” in historical perspective

Olivier Accominotti 23 April 2009

China’s “dollar trap” has many analysts worried about its future resolution. This column discusses a similar situation in the 1920s when France held more than half the world’s foreign reserves. France’s “sterling trap” ended disastrously. Sterling suffered a major currency crisis, French authorities lost a lot of money, and subsequent policy reactions deepened the Great Depression.

A 32 page PDF document The Sterling Trap Foreign reserves management at the Bank of France, 1928 – 1936, by Olivier Accominotti (November 2008), provides what seems to be more details in an earlier version of this study.

[touchring]

When the pound eventually collapsed, the Bank of France was put into a state of technical bankruptcy. It was only able to survive thanks to a state’s rescue, obtained under tough conditions. Moreover, there were now rising fears over the dollar. The will to avoid further losses therefore led authorities to convert all their dollar assets into gold (figure 2), a policy that heavily contributed to the global monetary contraction of the 1930s.

Why would converting dollar to gold cause monetary contraction?

[Munger]

Why would converting dollar to gold cause monetary contraction?

Because the dollar was tied to gold. Governments on the gold standard would convert their currency to gold at a fixed rate.

France was presumably getting its gold from other governments. The other government would give France some gold in exchange for its currency, which would take that currency out of circulation (unless it could find more gold on the market to buy and thus put the currency back into circulation).

[Charles Mackay]

China’s Syndrome: The “dollar trap” in historical perspective

Olivier Accominotti 23 April 2009

China’s “dollar trap” has many analysts worried about its future resolution. This column discusses a similar situation in the 1920s when France held more than half the world’s foreign reserves. France’s “sterling trap” ended disastrously.

Great article... thanks for posting it.. I wonder if France converted to gold before FDR's 69% devaluation? With China's latest 400 ton accumulation they maybe on this same path already.

[jk]

Great article... thanks for posting it.. I wonder if France converted to gold before FDR's 69% devaluation? With China's latest 400 ton accumulation they maybe on this same path already.

my understanding is that china accumulated this position from their own domestic production. what will be interesting is if the imf decides to sell its gold.

[c1ue]

I've seen this paper before - Yves on NakedCapitalism posted a link to it some time ago (1 month?).

The question I have is that this example may not apply due to a special circumstance. That circumstance is the French undervaluation of their currency just prior to a currency agreement - this is what led to their surplus to begin with.

Thus France did not have an ongong cost*productivity based advantage but rather a legal/political one.

The reason this might matter is that in a cost*producivity based advantage, past accumulations are added to by ongoing operations. In the legal/political one, what you've got is all you're going to get.

In more prosaic terms: fixed income vs. working income. In an inflationary period, those on fixed incomes can only try to exchange their capital (if possible) into some other form less affected by inflation whereas working incomes can be negotiated for higher pay increases as offsets.

[Chris Coles]

These nine warning signs alarm the savviest money managers in the world:

And that leaves the last but most important, the one no one talks about nowadays...... actually investing in the productive nation rather than keeping the money constantly flowing between their "friends" in all the other financial institutions.

Too much to think some of the savings should be actually invested in the citizens....... my oh my, whatever next?

[goadam1]

It seems to me that in the last dozen years, it doesn't matter if you invest in a productive economy. The nature of inflation is all the money chases returns. A productive economy is just as likely, if not more, to suffer from a market distortion as extra good returns create a positive feedback loop of smart investors. And then pop!