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    Default When Currency Becomes a Fiat for Oxygen

    When Currency Becomes a Fiat for Oxygen, All Breathing Must Leave the Room

    Something is afoot that, so far, skirts the ken of our most sprawling macro-economic theories. Like the ultimate exogeneity or game-changing black swan, the best evidence of a dawning paradigm is that few things make sense through the old glasses. As T. S. Eliot remarked of great poetry (and I paraphrase), its arrival is felt before its impact is understood. In this instance, we will regret mistaking a lack of understanding for a lack of arrival.

    Not surprisingly, America lies at the heart of the conundrum. There is a super-dimensional aspect to America's most-favored nation status as propagator of the world's reserve currency. When Zimbabwe prints money, hyper-inflation results – textbook stuff. Land reform programs (i.e., taking arable land from those with green thumbs and giving it to those with brown noses) will earn you 11,000,000% inflation.

    It's said the rich are different. So is the dollar. Indeed Mugabe must salivate at American alchemy. When America prints money, a flight to dollar safety ensues. Indeed there is a technical (read: temporary) complexion to the recent dollar run-up. (See Confusion reigns: A crisis-driven global rush to dollar liquidity is not deflation.) As the world shifts, panic-stricken, from one troubled asset class to the next, each swoon must pass through the dollar toll-booth. Thus we find wholesale panic bullish for the reserve currency. As Jesse’s Café Americain October 2 blog describes, European current demand for dollars is acute but really a short-term artificiality caused by “a currency imbalance [that] increases the cost of euro-dollar swaps”. Thus a strengthening dollar – vis a vis practically everything else – only mimics deflation; however, this effect is transitory, a trading event of discrete duration.

    Take no comfort my fellow Americans. This is the dollar as wounded eagle, a pigeon among sparrows. The highest man clinging to the mast of a sinking ship is in a position of relative safety to those below him. But the ship, the currency complex, is sinking.

    Beyond even these technical machinations, there is a ghost in the machinery of the currency complex that betrays a measure of irrationality, a non-quantifiable 'fealty' to dollars. Call it a force of habit. Other apt analogies? The Divine Right of Kings, Pax Romana. People are swimming – partly as an act of faith, partly from a half-century of ingrained habit – towards a lifeboat with a fatal leak. What's the alternative? Hugging a wave? For those who prefer casting aspersions with their last breath, they might shout, who didn't pack a second lifeboat? Perhaps it's not a lifeboat at all that will save us, but an island – gold. Perhaps there are better, more utilitarian, stores of intrinsic value: cigarettes, nylons and chocolate for example. Own a warehouse of ciggies and you may one day preside over a small mid-western town. (See Negative "Positive Feedback Loop" of Employment and Housing.)

    Money gets spent. However, belief systems linger beyond their era of efficacy. A belief system that has held sway for the better part of a half-century, Pax Americana, is bankrupt (literally), and risking hyper-inflation (after perhaps a brief deflationary interlude) as it strives mightily to forestall the inexorable process of its decline. History is littered with denialists (See iTulip Ka-Poom Theory, 1999). The bitter prospect of marking-to-market is an admission of lost might, a medicine far too hard to swallow. An empire collapses back to more manageable perimeters only with great reluctance. For one thing, retreat precipitates ugly feed-back loops. Other uppity frontier regions become emboldened. The empire buzzes with insurrection. The powers-that-be will embrace denial before they embrace retreat. We are about to learn just how dangerous a wounded Master of the Universe can be.

    One wonders, can the Pax Americana/Bretton Woods/Nixon Shock regime truly hand the baton to a new world order (lower case) without a resounding capitulation followed by an ensuing period of collapse? The Visigoths destroyed Rome. Centuries of darkness ensued before Pax Britannia re-ordered the world. But take solace, my broadband brethren. In the digital era, 'old time' centuries now conclude their business in mere decades if not years. Computers aren't going away.

    How can the world purge itself of dollars when it is awash in them? It pays to remember currencies are comparative, not intrinsic, stores of value. Thus purging oneself of a currency always involves binging on another. In an era of dwindling resources and looming peak oil, resource proxies are looking good – gold, oil. The euro might have served nicely as an orderly re-assembly point. But it's hard to imagine the long-term twin collapse of the dollar and the euro meaning anything less than the wholesale collapse of the currency regime. After all who are the pretenders to the currency throne? Certainly not the yen as it is too insular. Fiats have been done in by hubris. The loss of goodwill and trust in the power of paper, too hard to calibrate in the midst of the crisis, will no doubt be staggering.

    As for the Paulson Plan, it's an insult to band-aids everywhere. Apparently, the master plan is that all scorched parties must show up for future treasury auctions and pretend that their bandaged third-degree burns are mere flesh wounds. Isn't that the unspoken quid pro quo of the bail-out bill, uninterrupted Ponzi participation by foreign central banks? What dupe continues to show up for a Ponzi scheme after the pyramid's been revealed? The Plan reeks of global central bank fear. They will pretend on one another’s behalf in order to avoid the extinction of their species. Our currencies are their pawns.

    Up until very recently, gradualists had held out hope for a long-term dollar-to-euro migratory pattern. However, this trail has become washed-out in recent days as the euro proves itself more committee than currency. This is extremely bad news for a world desperately in need of economic bipolarity. One implication of a dollar-saturated world is that safe havens get repealed. Every kitchen sink becomes one-step removed from a dollar. Getting from point A to B requires a dollar. Of course it's easy to parochialize the debate around those damnable dollars. The larger point is that the world is drunk on fiats: currencies, derivatives, stocks, bonds.

    Structured finance always had a Faustian ring. Seeking to defy God's laws of gravity and commensurateness it is, as Ezra Pound warned in ‘With Usura’, contra natura. We've been misstating our income and levitating our wealth. The world's elite are loath to face just how poor we – and they – are. One consolation is that the rich, by practical necessity financial-asset-bound, have much further to fall than we do. That's why they want $700 billion – a completely arbitrary and almost certainly too-low number – from us to re-capitalize them. Furthermore as the erudite blogger London Banker points out in his October 2 entry, $700 million is only the diameter of the spigot – like an income statement, a mere snapshot at any given time: “Whether the final value of the legislation this week is $700 billion or $150 billion is irrelevant as long as the laundering operation can accommodate the throughput, as that number is only a cap on total extensions at any one time.”

    Meanwhile the Great American Unipole is sick and getting sicker by the day. Absolute power has indeed corrupted absolutely. Iraq is the same hubris in military guise. America succeeded beyond its wildest dreams, stuffing all gills with crappy Ponzi paper. The only solution available to the purveyors of paper is of course more paper; in short, a recipe for more disaster. Suddenly that industrial base looks like something more than a grimy anachronism. We make nothing.

    Even a well-anticipated freight train is unavoidable when you’re lashed to the track. The long-term answer must lie outside the fiat currency complex. But this is the Mount Everest of official denial. We will hyper-inflate back to a gold standard. No one in a position of power and authority will take us there. The currency will first be debauched until only a wheelbarrow full of it buys a cup of coffee. For one thing, influence purchased with sacks of gold is too susceptible to detection. Paper is the currency of epic-scale usury and malfeasance.

    As it is, the world finds itself (much to its chagrin) divided into two sprawling camps: Americans and Americans-by-proxy (or if you prefer 'foreign bag-holders'). In short, both camps only pretend at being two camps. Together, they will slide, daisy-chained, into the abyss.

    Europe's present turmoil marches the world one step closer to this abyss. Brazil and Argentina, God bless them, have announced bilateral trade will be conducted in their home currencies, no longer dollars. Of course they are less dollar-pregnant than Europe or China, economies who are frankly too big to bail --on the dollar. The euro was to be the world's second lifeboat. Hang on to your ciggies folks.

    ___

    **There are people up here on iTulip who've forgotten more about economics than I'll ever know, truly some keen minds. I've been enjoying my last few days here. There is probably no more compelling debate on the planet right now as what the hell is happening to us in a macroeconomic sense. Here's my stab, from the vantage of a writer primarily. --Norman Ball

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    Last edited by FRED; 10-10-08 at 10:04 AM.

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