Brazil Slams the West’s Currency War

Mitt Romney is not the only global figure to unleash allegations of currency manipulation. In fact, most of the allegations are aimed at America and the West.

From Reuters:

Brazilian President Dilma Rousseff slammed rich nations on Thursday for unleashing a “tsunami” of cheap money that threatened to “cannibalize” poorer countries such as her own, forcing them to act to protect struggling local industries.

Rousseff’s words amounted to some of the highest-profile criticism to date of efforts by the European Central Bank, the Bank of Japan and others to spur their economies through low interest rates and cheap loans.

I just want to flag up Henry Kissinger’s words from his recent Foreign Affairs piece:

The current world order was built largely without Chinese participation, and hence China sometimes feels less bound than others by its rules. Where the order does not suit Chinese preferences, Beijing has set up alternative arrangements, such as in the separate currency channels being established with Brazil and Japan and other countries. If the pattern becomes routine and spreads into many spheres of activity, competing world orders could evolve. Absent common goals coupled with agreed rules of restraint, institutionalized rivalry is likely to escalate beyond the calculations and intentions of its advocates. In an era in which unprecedented offensive capabilities and intrusive technologies multiply, the penalties of such a course could be drastic and perhaps irrevocable.

Competing world orders could evolve? No; competing world orders are a reality, and it seems like Latin America — most obviously Argentina and Venezuela, but now also Brazil, and perhaps even Colombia and Mexico — are moving closer toward the emerging ASEAN bloc, and away from the West.

Ironically, the emerging currency war is as much as anything else a side-effect of Bernanke’s admitted preoccupation with fluffing and puffing up U.S. equities.

And it looks like he’s going to be getting a hand.

From Bloomberg:

The Bank of Israel will begin today a pilot program to invest a portion of its foreign currency reserves in U.S. equities.

The investment, which in the initial phase will amount to 2 percent of the $77 billion reserves, or about $1.5 billion, will be made through UBS AG and BlackRock Inc., Bank of Israel spokesman Yossi Saadon said in a telephone interview today. At a later stage, the investment is expected to increase to 10 percent of the reserves.

Zero Hedge prognosticates:

In other words, while the Fed’s charter forbids it from buying US equities outright, it certainly can promise that it will bail out such bosom friends as the Bank of Israel, the Swiss National Bank, and soon everyone else, if and when their investment in Apple should sour.

Luckily, this means that the exponential phase in risk is approaching as everyone will now scramble to frontrun central bank purchases no longer in bonds, but in stocks outright, leading to epic surges in everything risk related, then collapse and force the Fed to print tens of trillions to bail everyone out all over again, rinse repeat. We say luckily, because it means that the long overdue systemic reset is finally approaching.

Developing nations have a legitimate concern: Western central banks will throw liquidity around to no end to save the status quo. And that means that developing nations will themselves feel they have to compete in order to remain competitive. It’s messy.


Default & the Argentinosaurus

One thing is clear:

A huge mountain of interlocking, interconnected debt is a house of cards, and a monetary or financial system based upon such a thing is prone to collapse by default-cascade: one weak link in the chain breaks down the entire system.

But the next collapse of the debt-pyramid is a long-term trend that may be a long way — and a whole host of bailouts — away yet. A related but different problem is that of government spending. Here’s American government debt-to-GDP since the end of WW2:

After reducing the national debt to below 40% in the 70s and 80s America’s credit binges since that era have quickly piled on and on to the point that without a major war like World War 2, the national debt is above 100% of GDP, and therefore in a similar region to that period.

Simply, America’s government must find a way not only of balancing the budget, but of producing enough revenue to pay down the debt. This has inspired the current crop of Republican nominees to produce a slew of deficit-reduction plans, including Herman Cain’s hole-ridden 9-9-9 plan  which shifts a significant burden of taxation from the wealthy and onto the middle classes. Worse still, taxes on spending hurt the economy by discouraging spending. Want to expand your business with the purchase of new capital goods? 9% tax. Want to increase revenues through advertising? 9% tax. Want to spend your earnings on goods? 9% tax. That’s a hardly a policy that will encourage economic activity in an economy that is (for better or worse) led by consumption.

Whichever way the tax burden falls, the sad reality is that any plan that focuses on taxing-more-than-disbursing is just sucking productive capital out of the economy, constraining growth. The other “remedy” inflating the currency (to inflate away the debt), punishes savers, whose investment is necessary for productive growth.

Dean Baker shows a historical case of such an event. Argentina, crippled by its peg to the dollar, defaulted on its debt since 2001:

All the crushing weight of taking productive capital out of the economy crushed growth. Then Argentina defaulted on its debts, and rebounded, astonishingly. Of course, most of blogosphere is looking at Greece in this debate. I am not, because I recognise the Argentinosaurus in the room: America’s foreign-held debt load (payment for all those Nixonian free lunches) is undermining the dollar’s status as global reserve currency, a pattern of development that will ultimately force exporters — on whom America relies — out of exporting to America for worthless sacks of paper and digital. International trade has always been on a quid pro quo basis — and since 1971 that has worked fine for America — dollars have been a necessary prerequisite to acquire oil, other commodities and supplies and pay dollar-denominated debts.

So I think the time has come to explicitly advocate a radical solution to save the dollar — but just as importantly to save the middle classes, and productive capital from the punitive taxation (and welfare cuts) required by austerity.

America needs to balance its budget by gradually (and with negotiation) defaulting on its debts. The first prong of this is totally defaulting on the debt held by the Federal Reserve — this is simply just a circuitous way of cycling money from government to a private agency and back again to the government, while the private agency (the Fed) pays member banks 6% annual no-risk dividends. The second prong is to begin negotiations with international creditors to revalue American debt proportionate to what America can afford to pay in the long run.

Far from infuriating creditors, I think that the evidence shows that this move would benefit everyone. A strong American economy is important to Eurasian producers and exporters. An American-economy dragged down by debt-forced-austerity means a smaller market to sell to, and to gain investment from. The only significant counter-demand for such an arrangement might be a balanced-budget amendment, so that America could no longer borrow more than it can raise in revenues.

Of course, there are other avenues to explore: slashing military spending (and giving the money back to the taxpayer, or to the jobless, or to infrastructure programs) is one such avenue: as I have explained at length before, American military spending is subsidising a flat-market, and making non-American goods artificially competitive in America.

But the real issue today is that liberals mostly want to talk about higher taxes, and conservatives mostly want to talk about austerity. They’re missing the Argentinosaurus in the room: the transfer of wealth from the American public — and the productive American economy — to foreign (and domestic) creditors, and the downward pressure that this is exerting on American output.

Debts — even AAA-rates debt (or AAAAAAAAA as an Oracle once put it) — all carry risk: the risk that the debtor is getting into too much debt and won’t be able to pay back his obligations in a timely or honest fashion. Creditors are making a mistake to be ending money to a fiscal nightmare whose only economic refuge is money printing.

So will America continue to tread the bone-ridden road of austerity, high taxation and crushing economic contraction, leading to excessive money-printing, and ending in the death of the dollar and an inflationary firestorm? Or will it choose the sustainable route of negotiated default, low taxes, a return to productive, organic growth, and the opportunity to decrease reliance on foreign energy and goods?

What’s that sound? No, not the crashing Argentinosaurus.