On Money VI

On February 10, 2010, in Background and Research, by Joe Costello

on money VI

But the volume of trading in financial instruments, i.e. the activity of financial business, is not only highly variable but has no close connection with the volume of output whether of capital goods or of consumption-goods. – JM Keynes

Over the last forty-years, money was untethered from any objective value and became another product to trade. Money became, in many respects, simply another trade in the entirety of a financialized economy. One component of the definition of financialization is “to make trade-able”. However, a monetary system, and even more so an economy, which become entirely trade-able, are prone to instability and catastrophic volatility. Unless you’re purely a speculator, instability is the exact opposite of what you want from a sound money system.

Previously, I explained Keynes very helpful notion that, in part, money is valued through its constant interaction with the rest of the economy. Money gains value from an economy’s wealth, debt and prices. He placed the various valuing mechanisms into the categories of Money of Account and the General Purchasing Power of money. Again, for this exercise, it’s not necessary to go into detail on Keynes’ definitions, for as he remarks in the Treatise:

The fundamental equations of Chapter 10 are in themselves no more than identities, and therefore not intrinsically superior to other identities which have been propounded connecting monetary factors.

Phew, what trouble such honesty could cause our economic priesthood today! However, the point to be made is, at all

times, money constantly interacts with the whole financial system and economy to gain its value. When an economy becomes completely financialized, that is trade-able, and money is removed from all fixed standards, you allow traders to gain too strong a hand in valuing money, thus increasing volatility.

The so-called “financial innovations” of the last three decades have added further to this instability. Financial innovation was a way to make money more trade-able by adding layers of “swaps” and “obligations” on top of the real assets. This process let the entire banking system carry less reserves – money in the vault – allowing more money, liquidity, into the system. Innovation meant formerly illiquid stores of money, such as long-term mortgages or government bonds, became trade-able, all adding to the overall volatility and instability of the system.

Thus a system in which everything is trade-able, demands a greater volume of money to keep things liquid, literally becoming addicted to greater liquidity, which, as Keynes notes in the opening quote, does not necessarily impact the real economy. What helped along the great elite financial panic in the fall of 2008 was a fall in liquidity, instigating a fall in inflated prices. Suddenly with no excess cash to keep inflated asset prices afloat, the entire system began a major contraction, racing to reach what would be more realistic levels in a system that was not so trade-able, that is liquid.

However, the Fed, other central banks, and governments stepped in to boost “liquidity”, flooding market with dollars, euros, et al, not allowing a deflation in prices and thus transferring the inflated values of assets and the layers of “financial innovations” on top of them, into the currencies themselves. An aside, a better outcome would have been gained by allowing the deflation of financial assets and instead the government flooding the real economy with money to first and foremost keep unemployment from steeply rising. But Ben rolled the dice and how this eventually plays out will be interesting to see, but volatility is increasing in currency markets and as Keynes noted:

…this tendency towards sympathetic movement on the part of the individual elements within a banking system is always present to a certain extent and has to be reckoned with…in the case of the world as a whole, the tendency to instability by reason of sympathetic movement is a characteristic of the utmost practical importance.

In a global monetary system that is hyper-trade-able and currency value is derived in a great extent from trading, volatility combined with what Keynes termed “sympathetic movement” can create great instability.

What we need to begin to do is re-tether money, make it less trade-able. This can be done various ways, for example by keeping mortgages on the originating banks’ books, making it much more difficult to trade such things a municipal bonds, or tying certain money or amounts to fundamental commodities like grain or oil. The question of how to solidify excessively liquid money is quickly gaining the utmost importance.

Next: Tethering Money

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The Rape of Europa

On February 7, 2010, in Background and Research, by Joe Costello
And, now perceiving all her fears decay’d,
Comes tossing forward to the royal maid;
Gives her his breast to stroke, and downward turns
His grizly brow, and gently stoops his horns.
In flow’ry wreaths the royal virgin drest
His bending horns, and kindly clapt his breast.
‘Till now grown wanton and devoid of fear,
Not knowing that she prest the Thunderer,
She plac’d her self upon his back, and rode
O’er fields and meadows, seated on the God
Publius Ovidius Naso

For a god, Zeus sure is a cad. He spends a great deal of time transforming himself into various beautiful beasts in order to seduce fair maidens. It certainly has a great advantage over flowers and candy, such are the privileges of divinity. As chronicled by Ovid, Zeus becomes a sleek white bull to charm Europa. Ffifteen-hundred years Titian immortalized “The Rape of Europa” in paint. The Greek historian Herodotus in the fifth-century

BCE first gave the lands north and west of Greece the name Europa. The Romans took the name, along with Greece, in the second century BCE. In it’s two millenia history, the definition of Europe has undergone many changes, none more so than in the past sixty years with the creation of the European Union. Today, the ongoing global financial mess may give the rape of Europa a whole new meaning.

An easy way to tell when financial matters are reaching criticality is when they reach feature status outside the financial press. Today, both the Post and NYT have articles on Europe’s situation. The Post writes:

Investor panic is threatening to drive up the cost of borrowing for myriad nations around the world and to destabilize global currency markets, with the falling euro and strengthening dollar already hitting U.S. exporters by making such items as American beef and U.S. steel more expensive overseas. The euro, the principal European currency, fell Friday to its lowest level in eight months, tumbling almost 1 percent against the dollar.

However, the NYT has the scoop with the acknowledgment that Goldman is the chief underwriter of Greek debt and their job will be to insure bond buyers and holders that the Greeks will make the proper austerity measures and quit living beyond their means. Funny how the bailed-out masters of the universe can so quickly start taking the cleaver to mere mortals. Well, Lloyd did announce for doing “god’s work”, he was only taking a nine-million dollar bonus on your tax-money. Europa is about to discover anew the consequences of taking a ride on the beautiful white bull.

The Euro is a maiden currency, only fifteen years old and only ten years in circulation, it is about to be strongly tested. The best thing they could do is tell the Wall Street bull we’re getting off here, but that certainly is easier said than done. The Euro has certainly been a worthy experiment in bringing civilization to Europe, after centuries of hacking each other to pieces, one would say a noble one. But it brings to the forefront the “money question”, and it is a question not only Europe, but the US, China, and the rest of the world cannot avoid. It’s time we all got off the Wall Street bull.

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Monetary Relativity — On Money – V

On January 27, 2010, in Corporations, by Joe Costello

Monetary Relativity — On Money-V

This, then, is the dilemma of an international monetary system—to preserve the advantages of the stability of the local currencies of the various members of the system in terms of the international standard. – JM Keynes

In a closed national or local system, the question of money is simpler than in a global system where currencies are exchanged. Over the course of history, commodities, particularly gold and silver served as monetary standards, providing objective value by which currencies could be exchanged. However, over the last four decades, a new system has evolved. In this system, money has no objective standard, but is given value by “the market”. It is a system of relative value vulnerable to profound volatility.

How does a currency derive its value when it is tied to no objective standard? The short answer is through “the market”, but that is insufficient. For thirty years, “the market” ace has trumped all questions on the economy, despite the extremely squishy understanding of just what “the market” is. To say the market defines value of contemporary currencies is at best a dodge.

Today’s currencies, tied to no objective standard, are instead valued by everything. The entire economy of any nation gives their respective currency value, while their central bank assists by controlling volume. In some nations, such as Australia, or smaller and less developed nations, currency values are greatly dependent on their natural resources, like commodities such as oil. Others, such as Japan and South Korea, gain value with their industry. Many currencies are also tied directly to the dollar, as the dollar, though no longer an objective standard, remains the main global reserve currency. A nation can keep its currency stable on global markets by keeping in their possession dollar reserves — holding onto a certain quantity of dollars.

The value of the dollar is derived from US agriculture, natural resources, industry, education, and all other aspects of our economy. The dollar’s value is also derived from the military, by far the largest on the planet, which holds together much of the global economic system as currently structured. Thus the dollar, serving as the dominant global currency reserve, also gains value from this global system as a whole.

In the present system, the day to day, or more accurately the second to second value of the currency is gained by traders, who buy and sell currencies twenty-four hours a day. Just as every other aspect of our economy has been financialized, that is made trade-able, so too has the dollar and most other currencies.

Over the last decade, the dollar undertook an almost uninterrupted steep devaluing against most other major currencies, a decline of almost 40%. This devaluing has raised increasing questions on the role of the dollar as the major global reserve currency, for if a nation is holding dollar reserves, which are incessantly losing value, it becomes a problem for your currency, particularly if you’re an exporter.

One result of the devaluing dollar global currency standard has been a massive increase in the price of commodities – agriculture goods rose 20%, metals by 300%, and fuel by 500%. Of course, there are other factors involved in the rise of commodity prices, including rising demand and tighter supply, and dysfunctional too speculative driven market structures, however, after the dollar rose in response to the Great Financial Panic and then began to fall again, the correlation between rising commodity prices and the falling dollar once again proceeded in lockstep.

In the last four decades, for the first time in history, we have created a completely relative monetary system, where currencies are untethered from any standard, and priced by being bought and sold through jokingly loose regulated trading. This creates two problems. First, as currencies become value relative, they lose their ability to provide vigorous price signals, thus undermining one of laissez faire’s cherished orthodoxies, the pricing system, and creating distortions in valuing the real economy. One only needs to look at the volatility of the commodity sector in the last ten years to understand the impact of monetary relativity. Just as all other aspects of economic financialization, monetary relativity has been advantageous for one group – traders, Wall Street. It has been harmful to the real economy.

Secondly and most urgently, the break down of, or call it the “financial innovation” of fixed currency standards, and their replacement with distorted relative values derived from a dysfunctional trading system, has created a situation of increasing currency instability, susceptible to violent swings. Just as we saw in the recent financial panic, currency markets have been deregulated and untethered, while on top of them lie trillions of dollars in derivatives tied to currency values, interest rates, government bond prices etc,

in which a period of sharp currency volatility or panic could cause great damage. This volatility would not need to be instigated by a sharp decline or rise in the dollar, though that would serve the purpose, it might also be catalyzed simply by a short period of sharp fluctuating currency values, that were large enough to begin a series of events where parties could not meet their obligations, such as the recent failure of AIG, but in amounts and damages to the system that would dwarf the AIG fiasco.

Now, as stated in the beginning, central banks by controlling volume of a currency and taking active roles in buying and selling, also contribute to a currency’s value. In the last two years, we have seen unprecedented and extraordinary moves by the Fed and many other central banks to flood the system with money in an attempt to fight the deflationary results of a popped financial bubble, in part caused by the devaluing dollar. The action of the Fed has created new inflationary asset bubbles across the globe; in commodity markets, housing values in China, and stock markets. It has made the pricing mechanism already distorted from years of monetary relativity, all the more so. It is the equivalent of dumping gasoline on a thick forest with decades of dead undergrowth, all that’s missing is a spark.

Next: Rethinking Money

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