Currency Wars: The Making of the Next Global Crisis

by James Rickards

  What is most important is that the systems of immediate concern—currencies, capital markets and derivatives—are social inventions and therefore can be changed by society. The worst-case dynamics are daunting, but they are not inevitable. It is not too late to step back from the brink of collapse and restore some margin of safety in the global dollar-based monetary system. Unfortunately, the deck is stacked against commonsense solutions by the elites who control the system and feed at the trough of complexity. Diminishing marginal returns are bad for society, but they feel great for those on the receiving end of the inputs—at least until the inputs run dry. Today, the financial resources being extracted from society and directed toward elites take the form of taxes, bailout costs, mortgage frauds, usurious consumer rates and fees, deceptive derivatives and bonuses. As citizens are crushed under the weight of this rent extraction, collapse grows more likely. Finance must be returned to its proper role as the facilitator of commerce rather than a grotesque end in itself. Complexity theory points the way to safety through simplified and smaller-sized institutions. Incredibly, Treasury Secretary Geithner and the White House are actively facilitating a larger-scale and more concentrated banking industry, including a protoglobal central bank housed at the IMF. Any success in this endeavor will simply hasten the dollar’s dénouement.

  CHAPTER 11

  Endgame—Paper, Gold or Chaos?

  “I just want to make it clear to everybody that our policy has been and will always be . . . that a strong dollar is in our interest as a country, and we will never embrace a strategy of trying to weaken our currency to gain economic advantage at the expense of our trading partners.”

  U.S. Treasury Secretary Timothy F. Geithner, April 26, 2011

  “No, they cannot touch me for coining, I am the king himself.”

  William Shakespeare, King Lear

  Few economists or policy makers at the IMF or global central banks would subscribe to the complexity-based, money-as-energy model outlined in the previous chapter. Although the physics and behavioral science are well founded, mainstream economists do not greet interdisciplinary approaches warmly. Central bankers do not have a sudden dollar collapse in their models. Yet mainstream economists and central bankers alike are well aware of dollar weakness and the risks to international monetary stability from the new currency wars. Taking a range of views from the conventional to the cutting-edge, we can foresee four outcomes in prospect for the dollar—call them The Four Horsemen of the Dollar Apocalypse. In order of disruptive potential from smallest to greatest, they are: multiple reserve currencies, special drawing rights, gold and chaos.

  Multiple Reserve Currencies

  A country’s reserves are something like an individual’s savings account. An individual can have current income from a job and have various forms of debt, yet still maintain some savings for future use or a rainy day. These savings can be invested in stocks and commodities or just left in the bank. A country has the same choices with its reserves. It can use a sovereign wealth fund to invest in stocks or other asset classes, or it can keep a portion in liquid instruments or gold. The liquid instruments can involve bonds denominated in a number of different currencies, each called a reserve currency, because countries use them to invest and diversify their reserves.

  Since Bretton Woods in 1944, the dollar has been by far the leading reserve currency; however, it has never been the sole reserve currency. The IMF maintains a global database showing the composition of official reserves, including U.S. dollars, euros, pounds sterling, yen and Swiss francs. Recent data show the U.S. dollar comprising just over 61 percent of identified reserves, while the next largest component, the euro, weighs in at just over 26 percent. The IMF reports a slow but steady decline for the dollar over the last ten years; in 2000 the dollar comprised 71 percent of total identified reserves. This decline in reserve status has been orderly, not precipitous, and is consistent with the expansion of trade between Europe and Asia and within Asia itself.

  The continuation of the trend toward a diminished role for the dollar in international trade and the reserve balances begs the question of what happens when the dollar is no longer dominant but is just another reserve currency among several others? What is the tipping point for dollar dominance? Is it 49 percent of total reserves, or is it when the dollar is equivalent to the next largest currency, probably the euro?

  Barry Eichengreen is the preeminent scholar on this topic and a leading proponent of the view that a world of multiple reserve currencies awaits. In a series of academic papers and more recent popular books and articles, Eichengreen and his collaborators have shown that the dollar’s role as the leading reserve currency did not arise suddenly in 1944 as the result of Bretton Woods, but was actually achieved as early as the mid-1920s. He has also shown that the role of leading reserve currency shifted between the dollar and pounds sterling, with sterling losing the lead in the 1920s but regaining it after FDR’s dollar devaluation in 1933. More broadly, the evidence suggests that a world of multiple reserve currencies is not only feasible but has occurred already, during the course of Currency War I.

  This research has led Eichengreen to the plausible and fairly benign conclusion that a world of multiple reserve currencies, with no single dominant currency, may once again be in prospect, this time with the dollar and euro sharing the spotlight instead of the dollar and sterling. This view also opens the door to further changes over time, with the Chinese yuan eventually joining the dollar and euro in a coleading role.

  What is missing in Eichengreen’s optimistic interpretation is the role of a systemic anchor, such as the dollar or gold. As the dollar and sterling were trading places in the 1920s and 1930s, there was never a time when at least one was not anchored to gold. In effect, the dollar and sterling were substitutable because of their simultaneous equivalence to gold. Devaluations did occur, but after each devaluation the anchor was reset. After Bretton Woods, the anchor consisted of the dollar and gold, and since 1971 the anchor has consisted of the dollar as the leading reserve currency. Yet in the postwar world there has always been a reference point. Never before have multiple paper reserve currencies been used with no single anchor. Consequently, the world Eichengreen envisions is a world of reserve currencies adrift. Instead of a single central bank like the Fed abusing its privileges, it will be open season with several central banks invited to do the same at once. In that scenario, there would be no safe harbor reserve currency and markets would be more volatile and unstable.

  One disturbing variation on Eichengreen’s optimistic vision consists of regional currency blocs, with local dominance by the dollar, euro and yuan, and possibly the ruble in Russia’s area of influence in Eastern Europe and Central Asia. Such blocs can arise spontaneously according to well-known models of self-organization in complex systems. Regional currency blocs could quickly devolve into regional trading blocs with diminished world trade, undoubtedly the opposite of what the advocates of multiple reserve currencies such as Eichengreen envision.

  Eichengreen expects what he calls healthy competition among multiple reserve currencies. He discounts models of unhealthy competition and dysfunction—what economists call a “race to the bottom,” which can arise when leading central banks lock in regional dominance through network effects and simultaneously abuse their reserve status by money printing. The best advice for advocates of the multiple reserve currency model is “Be careful what you wish for.” This is an untested and untried model, absent gold or some single currency anchor. The missing-anchor problem may be one reason why the dollar continues to dominate despite its difficulties.

  Special Drawing Rights

  Perhaps no feature of the international monetary system is more shrouded in mystery and confusion for the nonexpert than the special drawing right, or SDR. This should not be the case, because the SDR is a straightforward device. The SDR is world money, controlled by the IMF, backed by nothing and printed at will. Once the IMF issues an SDR, it sits comfortably in
the reserve accounts of the recipient like any other reserve currency. In international finance, the SDR captures the mood of the 1985 Dire Straits hit “Money for Nothing.”

  Experts object to the use of the word “money” in describing special drawing rights. After all, individual citizens can’t obtain them, and if you walk into a liquor store and try paying for a few bottles of wine with SDRs, you will not get very far. However, SDRs do satisfy the traditional definition of money in many respects. SDRs are a store of value because nations maintain part of their reserves in SDR-denominated assets. They are a medium of exchange because nations that run trade deficits or surpluses can settle their local currency trade balances with other nations in SDR-denominated instruments. Finally, SDRs are a unit of account because the IMF keeps its books and records, its assets and liabilities in SDR units. What is different about SDRs is that citizens and corporations in private transactions cannot yet use them. But plans are already afoot inside the IMF to create just such a private market.

  Another objection to treating SDRs as money is based on the fact that SDRs are defined as a basket of other currencies, such as dollars and euros. Analysts with this view say that SDRs have no value or purpose independent of the currencies in the basket and so they are not a separate form of money. This is incorrect for two reasons. The first reason is that the amount of issuance of SDRs is not limited by any amount of underlying currencies in the basket. Those underlying currencies are used to calculate value but not to limit quantity—SDRs can be issued in potentially unlimited amounts. This gives SDRs a quantity, or “float,” which is not anchored to the currencies in the basket. The second reason is that the basket can be changed. In fact, the IMF has plans now under way to change the basket so as to reduce the role of the U.S. dollar and increase the role of the Chinese yuan. These two elements—unlimited new issuance and a changing basket—give the SDR a role as money in international finance independent of the underlying basket of currencies at any point in time.

  The IMF created the SDR in 1969 at a time of international monetary distress. Recurrent exchange rate crises, rampant inflation and dollar devaluation were putting pressure on global liquidity and the reserve positions of many IMF members. Several SDR issues were distributed between 1969 and 1981; however, the amounts were relatively small, equivalent to about $33.8 billion at April 2011 exchange rates. After that, no SDRs were issued for the next twenty-eight years. Interestingly, the original SDR from 1969 was valued using a weight of gold. The gold SDR was abandoned in 1973 and replaced with the paper SDR currency basket still in use today.

  In 2009 the world again faced an extreme liquidity shortage from losses incurred in the Panic of 2008 and the subsequent deleveraging of balance sheets of financial institutions and consumers. The world needed money fast, and the leaders of the international monetary system went to the 1970s playbook to find some. This time the effort was directed not by the IMF itself but by the G20 using the IMF as a tool of global monetary policy. The amounts were huge, equivalent to $289 billion at the April 2011 exchange rate. This global emergency money printing went almost unnoticed by a financial press that was preoccupied with the collapse of stock markets and home prices at the time. Yet it was the beginning of a new concerted effort by the G20 and the IMF to promote the use of SDRs as the global reserve currency alternative to the dollar.

  Dollars, euros and yuan would not disappear under this new SDR global currency regime; rather they would still be of use in purely domestic transactions. Americans would still buy milk or gasoline using dollars, the same way Syrians could do the same locally using their Syrian pounds. However, on globally important transactions such as trade invoicing, international loan syndicates, bank bailouts and balance of payments settlements, the SDR would be the new world money and the dollar would be a subordinate part, subject to periodic devaluation and diminution in the basket according to the dictates of the G20.

  In addition to the direct printing of SDRs, the IMF has more than doubled its SDR borrowing capacity from a precrisis level of about $250 billion (equivalent) to a new level of $580 billion as of March 2011. These expanded borrowings are accomplished by loans from IMF members to the IMF, which issues SDR notes in exchange. The borrowings were designed to give the IMF capacity to lend to members in distress. Now the IMF is positioned to perform the two key functions of a true central bank—money creation and lender of last resort—using the SDR as its form of money under the direction of the G20 as its de facto board of governors. The vision of the creators of the SDR in 1969 is now coming to fruition on a much grander scale. The day of the global central bank has well and truly arrived.

  Even with these expanded issuance and borrowing facilities, the SDR is still far from being able to replace the dollar as the dominant international reserve currency. In order for the SDR to succeed as a reserve currency, SDR holders will require a large liquid pool of in-vestible assets of various maturities that holders can invest their reserve balances in to achieve a return and preserve value. This requires an SDR bond market with public and private instruments and a network of primary dealers and derivatives to provide liquidity and leverage. Such markets can emerge piecemeal over long periods of time; however, the G20 and IMF do not have the luxury of time, because other liquidity sources are drying up. By 2011 the Fed was facing the limits of its ability to provide global liquidity single-handed. The Chinese yuan was not yet ready to assume a reserve currency role. The euro had problems of its own, stemming from the sovereign debt crisis of its peripheral members. The IMF needed to fast-track the emergence of the SDR. Some kind of road map was required. On January 7, 2011, the IMF provided the map.

  In a paper entitled “Enhancing International Monetary Stability—a Role for the SDR?,” the IMF presented a blueprint for the creation of a liquid SDR bond market, the antecedent to replacing the dollar as the global reserve currency with SDRs. The IMF’s paper identifies both potential issuers of SDR bonds, including the World Bank and regional development banks, and potential buyers, including sovereign wealth funds and global corporations. The study contains recommended maturity structures and pricing mechanisms, as well as detailed diagrams for the clearance, settlement and financing of such bonds. Suggestions are made to change the SDR basket over time so as to enhance the weight of the Chinese yuan and to diminish the weight of the dollar.

  The IMF study is optimistic about the speed and stealth with which this could be accomplished. “Experience . . . suggests the process may be relatively fast and need not involve significant public support,” it states. And the IMF took no pains to disguise its intentions, explaining, “These securities could constitute an embryo of global currency.” The paper also lays out a schedule for SDR money printing, suggesting that $200 billion per year of new SDR issuance would get the global currency off to a good start.

  Private organizations and scholars have also contributed to this debate. One group of multinational economists and central bankers, guided by Nobelist Joseph Stiglitz, has suggested that SDRs could be issued to IMF member countries and then deposited back with the IMF to fund its lending programs. This would accelerate the IMF’s ascension to the role of global central bank even more quickly than the IMF itself has proposed. Adding the role of depository to the already implemented roles of currency issuer and lender of last resort would make the IMF a global central bank in all but name. The rise of a global central bank and a world currency would leave the U.S. dollar and the Federal Reserve in a subordinate position by default.

  Here in all its technical IMF-speak glory is the global power elite’s answer to the currency wars and the potential collapse of the dollar. Triffin’s dilemma would be solved once and for all, because no longer would a single country bear the burden of providing global liquidity. Now money could be printed globally, unconstrained by the balance of trade of the leading reserve currency issuer.

  Best of all, from the IMF’s perspective, there would be no democratic oversight or accountability on its mone
y printing operations. While the IMF was drawing up its plans for a global SDR currency, it also proposed more than doubling the IMF voting rights of Communist China at the expense of democratic members such as France, the United Kingdom and the Netherlands, among others. Interestingly, these new voting arrangements made the top twenty members of the IMF more closely resemble the list of the twenty nations in the G20. The two groups of twenty are not quite identical but they are converging quickly.

  The IMF is explicit in its antidemocratic leanings, what it calls “political considerations.” The SDR blueprint calls for the appointment of “an advisory board of eminent experts” to provide direction on the amount of money printing in the new SDR system. Perhaps these “eminent experts” would be selected from among the same economists and central bankers who led the international monetary system to the brink of destruction in 2008. In any case, they would be selected without the public hearings and press scrutiny that come in democratic societies and would be able to operate in secret once appointed.

  John Maynard Keynes famously remarked, “There is no subtler, surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.” If not one man in a million understands debasement, perhaps not one in ten million understands the inner workings of the IMF. It remains to be seen whether we can gain a fuller understanding of those inner workings before the IMF implements its plan to displace the dollar with SDRs.