It’s been 3 years since the G7 made a serious call for the Yuan to appreciate. But not much has happened since then (apart from a complete meltdown in the global financial system) except for the global trade imbalances to worsen. We are now faced with the distinct possibility of more currency mayhem as markets reach another tipping point.

We are starting to hear more overt language from both officials and the general media about the potential for currency way, namely competitive devaluations, capital controls and other measures to shift currencies to where they should be or where officials would like them to be. Sovereign states have always messed with their currencies whether to screw their own people or other nations. It’s always about self-interest. But at some point the beggar they neighbour approach fails and we race to the bottom. There is no doubt that China is the key here but it’s played a very smart hand and has the US over a barrel. The geo-political arm wrestle is at full bore here and we don’t get to see much of it in the news. At some point though the surplus nations must adjust their currencies to bring the trading world back into equilibrium otherwise the whole system will fall apart. Keynes predicted this would happen and its been a 70 year work in progress. Kondratiev would be impressed.

The question is why hasn’t that happened already. You would imagine that a country with a trade deficit and an ongoing current account deficit (swollen by interest on borrowings to cover the trade deficit) would see its currency weaken and surplus countries would see the opposite. THis change in currency rates would, other things being equal, reverse the flow of trade and all would be rebalanced. On paper maybe but in the real “free market” that doesn’t happen. Why? Because deficit countries tend to have higher interest rates (in order to attract the capital it needs to pay off its debts) and those higher yields attract more and more capital looking for a home. So we have the ludicrous situation of one country lending another country the money to buy its goods…….that is not a recipe for long term success….unless you happen to be running a criminal organisation where your goal is to get your clients hooked on the product…..

It’s also known as debt slavery. And it must stop.

So does this mean we are headed for a new Plaza/Louvre Accord? I think that will be very difficult to achieve at the moment. It’s unlikely the Chinese would accept a single focus on the Yuan. It would almost be better to completely realign the whole global currency system where all surplus/deficit currency rates were realigned to new levels. The obvious problem (other than agreeing new rates) is that there would be nothing to stop markets moving rates right back. This suggests capital controls may come into play (Brazil is already trying something here with its bond market) perhaps in the manner of Malaysia.

More over steps such as currency intervention can be a problem unless the stars are aligned in your favour. Trying to weaken a surplus currency is next to impossible as the SNB found to their chagrin when buying huge amounts of Eur/Chf at a time when the market was actually desperate for Chf. The Japanese are repeating the same mistake as the Swiss by intervening, cutting rates, increasing liquidity and generally flapping about in the Yen. At this point in time they have made no progress at all. Why? Because the market wants to own surplus currencies and not the $. At some point $/Yen will collapse which will suit the US though probably not the Japanese.

For deficit countries with an appreciating and overvalued currency like New Zealand there may be better opportunities for influence. More on that net time.

For now though begun the currency wars have.

Well after years of allowing banks to categorise any paper bearing the words “i hope to pay back” as Tier 1 capital, G20 has agreed to a new global framework on bank capital under which “banks will face higher capital requirements”.

I guess we can call this Basel III or maybe a souped up Basel II. Who knows? When you have an inherently unstable system any new plan for control is likely to end up in the round filing cabinet before it has a chance to be implemented.

But one thing is clear from the latest global pow-wow: monetary stimulus will remain in place for some time as extra tightening through higher capital requirements sucks in more capital. With all the talk of recovering economies and poistive GDP reads in some countries, it is easy to forget the amount of wealth that has been sucked into the black hole of balance sheet never never land.

Who would be a bean counter these days?

It reminds me of the time I was working on the ticket sales operation for the Brisbane Expo back in 1988. It was a $60m take and I was drafted in to make the numbers balance. It was a lot of fun and eventually I got to the point where I had accounted for everything but there was still a pesky $110 I couldn’t reconcile. It simply didn’t make any sense to me but in the end I just gave up and figured it didn’t matter that much.

Now the numbers seem a bit larger when it comes to bank meltdowns. We have a long way to go before we actually can understand where the money has gone, who owes it, who lost it and what the actual impact on the supply of money is.

So in this case G20 are spot on. Deflationary forces abound. I have no worry about inflation at all. Sure we will keep seeing short term rebounds in some statistics and small sighs of relief. Let’s face it, the markets ahve had an enormous rally in the last 6 months. But do they reflect the underlying reality? Nope.

That’s because the crevasses have been papered over with huge swathes of new paper. But underneath they lie there waiting for some poor fool to fall in again. Slowly it feels like the bankers are starting to understand that they let credit growth go bananas and that their carefully constructed inflation numbers didn’t always tell the truth about asset prices.

We still have major systemic problems to deal with. Tightening credit will cause severe pain but low rates will help ease some of that. But catching the tiger by the tail is the only way forward.

Pretty bubbles in the air.

They fly so high,

Nearly reach the sky,

Then like my dreams,

They fade and die.

Fortune’s always hiding,

I’ve looked everywhere,

I’m forever blowing bubbles,

Pretty bubbles in the air.

Never did I believe the mighty Hammers would have understood the machinations of central banking so well. Maybe they knew?

Reading the recent Fed statement, one may feel that the lessons of the recent crisis have not been fully understood or learnt. That’s the problem with the ability to print new money to replace old. It gives a feeling of relief and so help the markets to recover, in fact recover strongly. But there is nothing here that suggests the policymakers know what they are doing.

Crisis dealt with? For now.

Blue Monday

Just watching Bush, Sarko and some other bureaucrat from the EU announcing the coming of the new order or is it a new new order. Forget Black Monday its all Blue from here.

Actually they are right. Bretton Woods created US dominance in financial matters to go along with their dominance in military affairs. Whilst Keynes argued for a system of balanced trade the US saw an opportunity to sell the world US$ which they could print for nothing. The seignorage accruing to the US has been the backbone of their economy for 60 years and those holders of US$ and US paper must be wondering how they got sucked in so badly.

I enjoyed Sarkozy saying everyone would be part of developing a solution…..it’s amusing to watch Bush and Sarkozy together. The clash of cultures is stark and it will be interesting to see how this global summit develops and more importantly who gets to set the agenda.

One thing is for sure: leverage is history. The financial markets will shrink and exotic products will become a relic of a distant past. It will be back to basics like borrowing to create and produce rather than borrowing to invest in a synthetic financial product. The fall out from the contraction of the financial markets will be severe. Unemployment will rise not just in the financial industry itself but in all the industries that service it. Asset values will fall. How can property prices rise when the supply of money is contracting?

Of course the one issue I am looking to see on the table is who creates the supply of money: will it be banks once again creating loans deposits at will or will it be sovereign nations supplying money into the banking system to be lent out or supplying it direct to citizens as a basic income.

This is the crucial issue.

Will the sovereign right of Parliament be reasserted for the first time in over 300 years? No one remembers William of Orange but in 1685 his overthrow of the Stuarts, aided by European bankers, laid the foundations of modern banking.He gave away Parliament’s right to create money and placed it in the hands of the bankers.

Plus ca change.

But the time of change is upon us.

The flurry of raised hands for bank guarantees from central bankers and treasury ministers around the world fails to convince me we are out of fire. Certainly guaranteeing interbank lending is helpful as the pipes are well and truly frozen in that part of the monetary world.

The global banking system has now been underwritten, guaranteed and in some cases nationalised completely. There is no surprise in that course of action as it was all they could do. Whether they take stakes in, takeover or buy preferred stock makes no difference. Now they have bought some time we will have to wait and see how it pans out. The underlying problem remains the same though.

They have not addressed the difference between money and credit.

Money is what the sovereign authority issues. This carries no interest burden which is a future claim on goods and services yet to be produced i.e. drives the growth imperative.

Credit is what banks issue based on deposits and “other types of capital” that are in the bank. This carries interest. Credit makes up 97% of the money supply. Credit is treated as money although laws are very clear that only sovereign authorities can create money.

Confused?

There is a strong argument to say that bank credit is fraudulent money. I digress.

Instead of supporting the credit creation system we need to support the money creation system. It’s that simple. Let me be clear: banks do not lend out your deposits. They use your deposits as collateral on new loans.

Take Kiva, my favorite microfinance outfit: I deposit $25, find a borrower and lend them the money. My $25 is gone and i have to wait for it to be repaid. That is true lending. Think of it as investment.

Bank lending is garbage.

The answer is to nationalise the supply of money and remove the interest burden at the point of creation. I think this is likely to happen at some point as governments run into difficulties with their guarantee schemes.

We will need a new monetary authority who will issue new money into the economy and monitor the supply of money in the economy at any given time.

Only then will we be able to build a genuinely productive and healthy society and economy.

Some details from the RBNZ:

12 October 2008

OPERATIONAL DETAILS

New Zealand Deposit Guarantee Scheme

This document outlines the key characteristics of the deposit guarantee scheme announced by the Minister of Finance this afternoon.  Draft contracts containing the full details of the guarantee will be available on the Reserve Bank’s website later this evening.

The Offer
Under the terms of the Public Finance Act, the Crown will invite eligible institutions to enter a guarantee of their deposit liabilities. Eligible financial institutions, will be New Zealand registered banks and non bank deposit-taking financial institutions, who are fully compliant with the requirements of their trust deeds.

The decision to enter a guarantee with any specific institution, whether now or in the future, will be at the sole discretion of the Crown.

Which deposits will be covered?
For New Zealand incorporated registered banks deposits from both residents or
non-residents, will be covered.

For non bank deposit takers and for the unincorporated branches of overseas entities only deposits of New Zealand citizens and New Zealand tax residents will be covered.

Deposit liabilities will be covered regardless of the currency in which they are denominated.

Deposits and other liabilities owed to financial institutions, whether in NZ or offshore, are explicitly excluded from this guarantee.

How long will the guarantee last?
The guarantee will be offered for a term of two years.

Fees
The government will charge a fee for any guarantee offered on amounts in excess of $5 billion.

For covered liabilities in excess of $5 billion a fee of 10 basis points per anum will be charged for the guarantee.  The fee will be charged on the basis of the total covered liabilities, in excess of $5 billion of the institution.

What will trigger the exercise of the guarantee?
The Crown will make payment in the event of the liquidation of a guaranteed financial institution, if its assets are shown to be insufficient to meet the liabilities covered by this guarantee.

Administration
These guarantees will be offered and administered by the Treasury.

Further Information
For institutions wanting further information on their eligibility for this guarantee please contact the Reserve Bank on: 021 682 757.

________________________________________

DEPOSIT GUARANTEE SCHEME

Q & A

12 October 2008

What is a deposit guarantee scheme?

It is a facility where the Crown guarantees people who have deposits with institutions in the scheme.  It covers all retail deposits of participating New Zealand-registered banks, and retail deposits by locals in non-bank deposit-taking entities. This would include building societies, credit unions and deposit-taking finance companies.

It only covers deposits and other debt securities.

What is “retail”?

Deposits by anyone other than financial institutions (eg banks and non-bank deposit-takers themselves)

What will it cost?

The scheme will be free for institutions with total retail deposits under $5 billion.  A fee of ten basis points per annum will be charged on total deposits above $5 billion. This means that a bank with $20 billion in retail deposits would pay $15 million in fees per annum.

There is no direct fee for individuals, but institutions will determine if and how the costs of the scheme are passed on

What is the cost to the Crown?

This obviously depends on the degree (if any) to which it is drawn on (like any insurance scheme).  Any guarantees will be recorded as
unquantified, contingent liabilities of the Crown.

Why was the facility announced this afternoon? What precipitated it?

The government has moved today to ensure ongoing depositer confidence in
New Zealand given the international financial market turbulence.   The
New Zealand banking system remains sound.  This move is to give further assurance to New Zealanders that their deposits are safe.  It follows other measures that have been undertaken by the Reserve Bank in recent weeks to ensure the liquidity of the banking system.

Why has this been done without legislation?

Parliament is not sitting, and therefore legislation can’t be introduced.  However, the Minister has powers under the Public Finance Act to act in this way.

Does this apply to non-banks / finance companies?

Yes it does, inasmuch as they meet the criteria (above).  Customers should check with their institution to confirm whether they are going to seek cover.

It does not apply retrospectively.

What about non-residents?

For branches of overseas banks and non-bank deposit-takers, non-residents will not be covered.

Is this scheme comparable with the facility announced in Australia
today?   What about other jurisdictions?

From what we’ve seen, the schemes are different - but both are aimed at encouraging confidence

Where can I go for more information?

Individual customers should talk with their banks or non-bank institutions.