John wrote:Dear Higgie,
The statement, "In the absence of any serious competitors to the
dollar, he advocated international control of U.S. monetary policy,"
does not surprise me in the least, although it's interesting to see
it stated this way.
All major currencies (except the yen) are in a deflationary spiral,
but the dollar is unique in that it's the international reserve
currency, and because the hundreds of trillions of dollars of credit
derivatives were almost all written in dollars. This means that the
dollar CANNOT become hyperinflationary, and even if it could, it
would be politically impossible to allow it.
This is why the US Government CAN default on its bonds. It's clear
that those bonds will never be paid anyway, and it's quite possible
that China will forgive American debt, in the same way that America
forgave Germany's debt in 1932.
For the US dollar to become an international currency is actually the
most rational solution to this situation. It's probably a disaster
for the US, but it's quite possible that the rest of the world will
decide that it's best for the world. "Give the UN control of the
dollar, and we'll forgive all your debts."
There's no way to be sure that this scenario will unfold, of course,
but this is a scenario that makes a lot of sense.
The Russians have been thinking about the international currency situation for some time. You may remember the article I sent you a few years ago from one of the Russian newspapers that covered an interview with Andrei Illarionov (back when he was still in Moscow) about Putin's plans to try to elevate the rouble to international status. Around that time, there was also news that the Russians were trying to establish oil trading in roubles in Moscow and were building an oil pipeline to China. I figured that eventually they were going to try to put leverage of some kind on the US. We have apparently arrived at that point.
But I had originally thought that China would initiate the idea of getting Bernanke under control, and maybe they have. Besides US government debt, China owns a lot of US agency debt and I think they worked a deal last year to have the US put government guarantees behind that.
So none of this surprises me either. What I believe is happening is that reality is biting down and the US is going to have to become fiscally responsible now rather than later. Whether determined from inside the country or from outside, it was bound to happen.
It is possible that the rest of the world wants to go ahead and put us through bankruptcy now but I don't think the time has come for that. What probably needs to happen is to let the tsunami roll through and see what the fallout is. If we can meet our bond payments for a time, so much the better, and there are trillions and trillions of potentially bad debt to work out of the system before we get to the question of US bond default. I think what is happening here at the moment is that Russia and others want to preserve the value of their remaining reserves, which are still mostly in dollars, and want to prevent us from raising default risk by willy-nilly increasing the amount of bonds outstanding according to Bernanke's helicopter drop experiment, which is on the verge of either taking off or being, well, dropped. I substantially agree with you on the deflation issue (not to the tune of 100% but more like 90%) but in my view what is important right now is what the market thinks and what the world thinks about that. A lot of people really believe that Bernanke can create inflation and they are positioned accordingly. What happens if/when they find out that he really can't because he is just an economist who didn't understand the realities of international power relationships?