Do You Hear The Economic War-Drums Beating For A Sacrifice?

Rush to the Bottom: A Tale of Two Cities
This is a two-part story. A tale of two cities, if you will. As to the first part, there was a story out yesterday that got a lot of attention about quasi-secret meetings between oil-producing nations to toss the dollar overboard for the purpose of pricing oil.
Here’s a quote from the story, from the Independent of Britain…
In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.
Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars.
The plans, confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong, may help to explain the sudden rise in gold prices, but it also augurs an extraordinary transition from dollar markets within nine years.
… The transitional currency in the move away from dollars, according to Chinese banking sources, may well be gold. An indication of the huge amounts involved can be gained from the wealth of Abu Dhabi, Saudi Arabia, Kuwait and Qatar who together hold an estimated $2.1 trillion in dollar reserves.

Likewise, there was another story out yesterday on much the same topic, this time from the UN. A quote from Breitbart…
The United Nations called on Tuesday for a new global reserve currency to end dollar supremacy which has allowed the United States the "privilege" of building a huge trade deficit."Important progress in managing imbalances can be made by reducing the reserve currency country’s 'privilege' to run external deficits in order to provide international liquidity," UN undersecretary-general for economic and social affairs, Sha Zukang, said.Speaking at the annual meetings of the International Monetary Fund and World Bank in Istanbul, he said: "It is timely to emphasise that such a system also creates a more equitable method of sharing the seigniorage derived from providing global liquidity."He said: "Greater use of a truly global reserve currency, such as the IMF’s special drawing rights (SDRs), enables the seigniorage gained to be deployed for development purposes," he said.The SDRs are the asset used in IMF transactions and are based on a basket of four currencies -- the dollar, euro, yen and pound -- which is calculated daily.China had called in March for a new dominant world reserve currency instead of the dollar, in a system within the framework of the Washington-based IMF.For some time now, our own Bud Conrad has pulled himself away from studying the nuts and bolts of the global economy to comment on the fact that the framework of the U.S. dollar was almost rusted through and in danger of failing. On reading the story in the Independent, he felt compelled to comment, and so did in the following emailed message to me yesterday…
I’ve been saying that the current credit crisis will eventually become a currency crisis for so long that I can't remember when I first laid out the case. For months, the warning signs have been apparent in dollar rebalancing pronouncements by central bank leaders, but the effects have been muted, as the dollar decline has been slow enough to avoid panic.
The story in the Independent points to a more serious development, as it revolves around the sellers of oil to the U.S., who are apparently looking to avoid having to accept dollars up front in their transactions. The problem of finding a satisfactory alternative for these sellers of oil is that the obvious alternatives, the euro and the yen, are also flawed. I don't see SDRs issued by the IMF coming to the forefront, as there is no ready market for them, and the Chinese renminbi is government controlled and has a link to the dollar. More importantly, the track record of communist countries on honoring their obligations over time is poor. The article mentions gold, but there isn't enough gold.
Rather than relying on reports of secret meetings, we need to keep an eye out for other evidence confirming that trading around the dollar system is becoming reality. I don’t think we’ll have to look very hard, as I believe confidence in the dollar will continue to erode. Remember, the dollar is an abstraction representing a debt owed by a bankrupt government. As such, it has an intrinsic value of zero. Once it becomes obvious that the emperor has no clothes, we could see a serious loss of confidence that feeds back on itself, and the dollar, at least in its current form, could dry up and blow away.
So, the first part of the story involves the currency operators working out of the city of Washington D.C. and their need to keep the dollar from being recognized as the fraud it is. Instead, the game is to oversee a steady erosion in value that over the next twenty years turns today’s $20 bill into a $5 bill, thereby allowing the government to look its foreign creditors in the eye with a straight face and say, “Here’s your $7 trillion back!”
Will they be able to get away with this fiction endlessly? Probably not. But they will almost certainly be able to get away with it for awhile longer, and if the dollar takes anything less than a terminal beating over the next little while, who’s to argue? After all, a weak dollar can be invigorating to the exports that will be so vital to generating a real, versus imagined, economic recovery.
And that brings us to part two of our story of two cities. Setting the stage, here is a quote or two from an article titled “Unease at currency appreciation,” which ran in the Financial Times yesterday…
Central bankers and finance officials across the Asia-Pacific region have signalled their concern about the appreciation of their countries' currencies against the dollar, write FT reporters .
"If the symptoms behind the trend [of won appreciation] do not improve, we will come up with necessary measures with the government," Ahn Byung-chan, director-general of the Bank of Korea, told state media yesterday. The South Korean won has gained 25 per cent against the dollar since hitting an 11-year low of 1,574 to the greenback in March, closing yesterday at 1,174.
As the yen rose above Y90 to the dollar last week, Hirohisa Fujii, Japan's finance minister, suggested Tokyo might act against "irregular" currency movements, in comments seen as a change of tack after he had said recent currency movements were "not abnormal" and that he was opposed to intervention "in principle".
The New Zealand dollar has risen by almost a quarter against the US dollar this year. Bill English, finance minister, yesterday said Wellington had limited tools to do more than "lean" against the rise. He indicated the government hoped to bring the kiwi back to 50-55 US cents from 72 cents yesterday.
Taiwan's central bank usually avoids commenting on currency but said last month it was prepared to intervene if flows of speculative "hot money" made the rate too volatile. Traders say they see signs of attempts by the central bank to stop the currency overheating, pointing to swelling foreign reserves and sudden fluctuations in the intraday rate.
In other words, in exactly the same way that the U.S. Treasury and Fed are pursuing domestic priorities by debasing our currency, other nations are trying to look after their own interests by doing much the same.
And the Asians are not alone -- in recent days EU President Jean-Claude Trichet has been mumbling similar sentiments, albeit in less direct terms. And for good reason... this from the Dow Jones newswire…
The soaring euro currency, and not interest rate levels, now dominates speculation on the European Central Bank's next policy move.
The ECB's policy board is expected to leave both its interest rates and its unconventional monetary policy measures unchanged after its regular meeting Thursday.
But financial markets are focusing on a euro exchange rate that has risen nearly 8% against a basket of major trading partners' currencies since February, much of that happening in the last month. The euro is now close to a new high for the year, a level only topped during last year's financial crisis.
Economists worry that the euro's surge threatens the fragile economic recovery in the 16-country euro zone.
The only country, it seems, that isn’t joining the race to the bottom is Australia, which yesterday raised its rates, thereby assuring the Aussie dollar will stay strong and likely get stronger still. That allows them to reduce the cost of their imports, but it makes their export products less competitive against global rivals in world markets. Dumb move? In the case of a country whose exports are dominated by manufactured goods, yes. In a country like Australia, whose exports are dominated by commodities – and which sits on the edge of Asia, a region desperate for same – it may have been a very smart move. Simply, they have the strong hand and are playing it for all it’s worth.
But they are the rare exception. As for Asia and Europe, where manufactured goods dominate, the trend toward competitive devaluations is likely to pick up steam. This is, I believe, attributable to the recently ended flurry of debt-fueled consumption that made the U.S. the very best customer for much of the world. When you allocate a significant share of your industrial output to serving an especially important customer, it is tough to come to grips with the new reality that that customer has fallen on hard times.
It brings to mind a documentary I once saw, where a reporter hung with the late Michael Jackson as he made the rounds of his favorite Las Vegas kitsch stores. Even though Jackson was essentially broke at the time, the merchants couldn’t quite accept that fact. And so, they reflexively fawned over the man who on previous expeditions thought nothing of dropping $500,000 on a life-sized, bejeweled leopard statue to decorate, perhaps, his drawing room.
Likewise, many countries made flush by supplying sundry goods to the U.S. – from the iconic flat-screened TVs, to status-lending BMWs – are stuck in the wonder years of recent past and are hoping for a rerun, but only if their own strengthening currencies don’t price them out of the market.
While I don’t think the U.S. consumer is gone from the market forever, there has been a paradigm shift in global trade. But I think the leaders nestled in their leather chairs in capital cities around the world haven’t yet acknowledged the fact and, instead of redoubling their efforts to open up new markets, are looking to reduce the value of their own currencies so as to better compete for U.S. business.
As the citations above point out, this could very well lead to a race to the bottom for the fiat currencies – a race in which the ultimate winners will actually be gold, silver, and other tangibles. And, just maybe, the Australian and Canadian dollars, both considered “resource” currencies.
While gold’s sharp rise of the last few days gives me some concern that it’s moving too fast, I think the run is far from over. In fact, I think the best of the show is still ahead. And that goes double for gold stocks, which will benefit from the leverage they offer to the underlying commodity. To be simplistic, to a company sitting on one million ounces of gold that are already economical to extract, a $100 price increase translates to an additional $100 million to the bottom line.
As investors, it’s important to pay attention to the race to the bottom, by watching for continued signs from the U.S. administration that it is not interested in protecting the dollar, and by watching how other countries respond. Or you can save yourself the trouble by watching the price of gold.