 Michael Maloney: Guide to Investing in Gold & Silver (paperback) |
August 2008
Pages 84-88
Most people think that the United States is borrowing most of the world's savings to fund the deficit. Ben Bernanke, our Fed chief, who is presiding over ever higher inflation rates, even made a speech in 2005 titled "The Global Saving[s] Glut and the U.S. Current Account Deficit". The speech makes it sound, as if the rest of the world has way too much savings, so much so, that they don't know, what to do with it, except loan it to the U.S.
People think, that the excess dollars, that go overseas due to the U.S. trade deficit, are being loaned back to us. This is not entirely true. To be sure, there is a lot of real foreign investment happening in the United States, but it's not nearly to the extent reported. So where does all that extra currency, that purchases all those U.S. Treasury Bills to fund a large part of the deficit, come from? The countries, that are the U.S.'s major trading partners, create it.
China is the best example, so we'll start here. When someone in the U.S. buys something in the U.S., that was made in China, that vendor bought that product from a Chinese businessman and paid in U.S. dollars. The Chinese businessman then deposits those dollars into his checking account at his local Chinese bank. The bank then converts the dollars to yuan. Now the local bank has a glut of dollars and a shortage of yuan, so it sells the extra dollars to the People's Bank of China (PBC) and buys more yuan.
As long as the trade between the two countries is in equilibrium, there is no problem. But when one country is running continuous trade deficits and the other continuous surpluses, as the United States and China currently are, a problem arises.
In the case of China, because there is more currency flowing into China, than out, the PBC ends of with a huge glut of U.S. dollars. Under the rules of the game of international trade and currency exchange they are supposed to sell those excess dollars on the Forex (foreign exchange market) and buy yuan. But that would mean, that there would be a glut of dollars and a shortage of yuan [on the international market], which would cause the dollar to fall and the yuan to rise. Chinese goods would then become very expensive in the U.S., slowing China's imports and that's the last thing, China wants.
so to get around the international trade and currency exchange game, China bends the rules. The PBC takes the extra dollars and neutralizes them by buying a dollar-denominated asset, most often some sort of interest-bearing investment instrument, like U.S. Treasuries. This keeps the yuan from rising and the dollar from falling.
This is known as "neutralizing" or "sterilizing" excess currency inflows. The funny thing is, that the U.S. was doing the same thing by sterilizing excess gold inflows all through the 1920s, to keep the dollar artificially low and exports up and it was one of the major factors, that contributed to the Great Depression.
So if the PBC used the excess dollars to buy U.S. Treasuries and didn't buy the yuan on the Forex, to sell to the businessman's local bank, where did the PBC get the yuan? Richard Duncan, in his excellent book The Dollar Crisis, explains it this way:
There is a widespread misconception, that the United States relies on the savings of other countries, to finance its current account deficit. This is incorrect. During recent years at least, the U.S. current account deficit has been financed primarily by money created by the central banks of other countries.
Therefore it is not a matter of the U.S. using up all the rest of the world's savings, to fund its deficit. It is a matter of that deficit being financed by the central banks of the United States's trading partners. And for their part Asian central banks in particular have consistently demonstrated their ability and willingness to create money, in order to finance the U.S. current account deficit.
As I said, the U.S. was sterilizing excess money inflows in the 1920s, just as China sterilizes excess currency inflows today, so history is repeating itself. It's the same game, but with a little twist. Well, actually it's a really big twist. When Europe paid the U.S. in gold, the Federal Reserve would cheat gold by locking it away, instead of expanding the currency supply to match, thereby preventing the commensurate inflation, it would have caused, keeping the price of U.S. goods low and ensuring a continuing trade surplus. This was hugely deflationary. As the rest of the world bought cheap American goods, gold would just disappear into the black hole of the Federal Reserve and the world money supply would contract.
When China sterilizes excess currency inflows, however, it's extremely inflationary. For every excess dollar, that China neutralizes by buying U.S. Treasuries, the PBC has to conjure up a commensurate amount of yuan out of thin air. This is brand-new currency, commonly called "high-powered money", because when it hits the commercial banks, it is used as the reserve asset for fractional reserve banking. If you recall the chapter on the Federal Reserve, fractional reserve banking means, that when someone deposits one dollar in the bank, the bank can keep that dollar in reserve, to pay out against deposits and (under a 10-percent reserve) they are allowed to create $9 in loans. I like to call it "bunny money", because it multiplies, like rabbits.
For more, than two decades the inflation of China's currency supply has puffed up their financial, stock market and manufacturing sectors, but now it is finally down to the consumer level. Price inflation is heating up bigtime with workers complaining about the cost of living and causing Beijing to ask local governments to raise minimum wages, which is a cost, that companies will have to pass on to consumers in the form of higher prices, which will cause workers to complain about the cost of living and so on. But the increase in prices, that was caused by the inflation of its currency supply, isn't just a local problem within China. Soon one of China's leading exports to the world is expected to be price inflation itself.
I recently interviewed a job applicant, who along with her husband has owned a successful import business since 1983, which imported goods mostly from China. But lately they've received numerous price increases, the most recent coming so soon on the heels of the last, that new price sheets hadn't even been printed reflecting the previous prices. Because of the new higher prices their goods aren't as competitive, so now she's looking for a job. As Ben Simpfendorfer, China strategist for the Royal Bank of Scotland, puts it: "Where China was a deflationary influence over the last ten years, it will be an inflationary influence over the next ten years."
All this is the free markets once again winning out over our governments' meddling and correcting the imbalances. China pegged its currency low, to keep exports cheap. To maintain the low peg, it had to create currency. The extra currency is causing the cost of living to increase. Increased workers' pay causes the cost of Chinese goods, whether consumed domestically or exported, to rise. Then the increased price of Chinese goods in the U.S. causes U.S. consumers to buy less of them. And this will continue, until the trade imbalance is corrected.
As a result of all the games, that can be played under a fiat currency system, the total cumulative U.S. trade deficit has grown to over $7 trillion, since the dollar was taken off the gold standard in 1971. These deficits are sustained by fiat currency from other central banks around the world. All the while these bank are hoarding ever increasing mountains of U.S. debt (Treasuries) and artificially propping up the value of the dollar. Much of our debt cannot be repaid and if our trade partners begin to dump U.S. Treasuries on the world markets, the whole credit bubble will implode, resulting in a worldwide depression. The longer governments and central banks try to cheat the free markets, the greater the pain will be, when the correction occurs. Like the precious metals, the free markets always win.