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FIRST ACCESS to Nadeem Walayat’s Analysis and Trend Forecasts

Europe Seeks to Implement New Bretton Woods Fiat Currency System

Currencies / Fiat Currency Oct 22, 2008 - 10:10 AM GMT

By: Mick_Phoenix

Currencies

Best Financial Markets Analysis ArticleWelcome to the Weekly Report. It looks like Europe wants to re-invent the wheel and soundings are being made to introduce a "new Bretton Woods".

Bretton Woods was effectively an exchange rate mechanism, were gold backed the new kid on the world block, namely the post war US dollar and all other currencies floated around the dollar in a fixed range. If a currency moved too far either way of the range then the respective Central Bank stepped in and delivered the appropriate medicine.


However the US dollar was pegged to the price of gold which was fixed at an official rate of $35. All went well until one or two countries, well, mainly France decided that they wanted the gold that backed the dollar reserves they had accumulated by repatriating the dollars back to Uncle Sam.

Eventually President Nixon decided in 1971 to abandon the BW agreement, triggering other attempts to set other fixed currency systems which all failed. In the end FX became a free floating system that has resisted any attempts to regulate exchange rates other than "pegs". Have we all forgotten how the European Exchange Rate Mechanism collapsed? Even currencies pegged to the dollar, yen, euro or sterling can come under attack if the peg does not reflect the underlying economic fundamentals of the country involved. Here are the views of the Hindsight Brigade, first up Trichet :

  • "European Central Bank President Jean- Claude Trichet said officials reshaping the world's financial system should try to return to the "discipline" that governed markets in the decades after World War II.

    "Perhaps what we need is to go back to the first Bretton Woods, to go back to discipline," Trichet said after giving a speech at the Economic Club of New York yesterday. "It's absolutely clear that financial markets need discipline: macroeconomic discipline, monetary discipline, market discipline." (Bloomberg)

And this from Brown, Sarkozy and Merkel:

  • The Prime Minister on Wednesday called for a "new Bretton Woods", an overhaul of the world economic order that has stood since 1944.

    Mr Brown says the major summit is justified by the need to establish new rules to prevent a repeat of the recent world financial crisis.

    He made the call at a meeting of European leaders in Brussels, where he has been feted by some leaders in the wake of Britain's widely-emulated banking bail-out this week.

    However, Mr Sarkozy holds the presidency of the EU and with it the right to speak for the bloc on the world stage.

    The French President made his own call for a "new Bretton Woods" earlier this month, arguing that it was time to replace the "Anglo-Saxon" model of unrestrained markets has failed.

    Angela Merkel, the German Chancellor, backed Mr Brown's call, saying it was time to "rethink the world's financial system and prevent any repetition" of the current crisis. (Telegraph.co.uk)

So are we to believe that a return to Bretton Woods is on the cards, that the dollar, or more likely the Euro becomes backed by gold? Whilst I wouldn't rule it out, considering the ruling class are bereft of ideas other than adopting the historical methods (which all failed) of other post crash era's, I suspect we are facing some attempt to fix currencies using a supra-national, non-governmental institution.

Whilst the one being mentioned currently is the IMF, I would not be surprised to see the Bank of International Settlements given the leading role. Why do I prefer the idea that BIS is trying to put itself at the hub of the economic and financial matrix? From the BIS website:

  • "The Bank for International Settlements (BIS) is an international organisation which fosters international monetary and financial cooperation and serves as a bank for central banks.

    The BIS fulfils this mandate by acting as:

    • a forum to promote discussion and policy analysis among central banks and within the international financial community

    • a centre for economic and monetary research

    • a prime counterparty for central banks in their financial transactions

    • agent or trustee in connection with international financial operations

    The head office is in Basel, Switzerland and there are two representative offices: in the Hong Kong Special Administrative Region of the People's Republic of China and in Mexico City.

    The BIS

    • Aims at promoting monetary and financial stability

    • Acts as a forum for discussion and cooperation among central banks and the financial community

    • Acts as a bank to central banks and international organisations

What we have is a de-facto Bank for Central Banks, a hub around which everything else revolves. It has 3 offices strategically placed in the world (have a look at the world clock) and most certainly has already incorporated many of the mechanisms required by the plutocrats and politicians around the world. For instance, membership of BIS means you are immune from prosecution . Its membership would make anyone who believed in conspiracy theories shudder but I'm not going to dwell upon that.

If like me you believe FX markets lead and all else follows, then those who would diminish the main inherent risk in capitalist markets (which is the differential in currency, tax and interest rates from one currency to the next) would want to make the FX system their focal point.

Think about it for a moment. Why does trade, in any form exist?

It is about making a profit by exploiting an advantage. The only thing you have to be wary of is risk, the risk that the situation will change to a disadvantage. The Euro is a typical example and exemplifies why Gordon Brown was against it for the UK.

The Euro should be worth the same in all its member countries, the ECB sets the Eurozone interest rate so no advantage can be gained from owning French Euros from German Euros. However there are 2 problems.

The first is the individual member states tax regimes. If you do the same work, say as a Hedge Fund, in the Euro-zone then the main advantage you have is to pick the country with the lowest tax regime. The UK didn't join the Euro because Brown knew taxes were going to rise in the UK which would have encouraged Hedge Funds to move to a lower tax regime that pays out in Euro's. He allowed light regulation to encourage Hedge Funds et al to remain domiciled in the UK.

Secondly is the differential that can be achieved by choosing which nationally issued Euro bonds you buy. This from the Telegraph in March 2008 (and politicians still say they didn't see this coming? They are either liars or incompetent):

  • "A flight to safety has pushed the yield spread between 10-year Italian bonds and equivalent German Bunds to 55 basis points, the highest since the launch of the euro. A similar pattern has emerged across the southern belt of the eurozone, with spreads hitting post-EMU highs of 53 versus Greece, 44 for Portugal, 38 for Belgium and 36 for Spain."

Many commentators remarked on this at the time (the above is from Ambrose Evans-Pritchard) and indeed the risk was commentated on before March 2008. An unintentional internal market has occurred allowing trading in a single currency to exist. The differential in default risk that a Country is perceived to have is being traded.

The ramifications are deep especially if we are faced with an attempt to introduce Bretton Woods type currency controls. However, I doubt the new Bretton Woods will use gold as its anchor for valuing a reserve currency. More likely is an implicit pan-national guarantee of a non-sovereign, trade weighted measure. An expanded and strengthened version of the IMF Special Drawing Rights (SDR) springs to mind.

Unlike previous crisis when the risk (of default) tended to be concentrated in a particular area, such as Latin America, the current financial mess is worldwide and has a heavily interwoven, cross border risk that is much greater and the possibility of a break in the chain of obligations more likely. However the predicament is the same, when all is unwound the player holding the old maid is the Banks.

Banks are already in deep trouble, most are technically insolvent. So Central Banks and Treasury Departments have created enormous piles of "cash and cash equivalents" to allow Banks to rebuild their reserves by adding to their Tier 1 holdings, as Mr Brown let slip last week.

Who created the Tier ratio of debt? It was the Central banks through their nominated members who become part of the Directors Board at BIS. No wonder calls to eliminate or suspend the Tier ratios have fallen on deaf ears and have quietly died away.

Whilst the IMF has a mandate to use members money to help bailout bankrupt governments only the BIS has the ability to channel funding between Central Banks. The current US Fed lending of dollars to other Central Banks to ensure dollar liquidity is a typical example of the type of work the BIS does.

Many people ask what will happen next if the amount of debt default continues to climb. Do we face a situation in which the Central Banks become tapped out and are unable to provide further reserves? As we know Central Banks and Treasuries can continue to create reserves but even they reach a limit as we saw in the US with Congressional approval needed to deploy tax- payers money. This "revolt" by politicians, whilst it did not stop the Bail-out, will stand as a warning that the willingness of the public to continue to allow taxes to be used in this way has become exhausted. Even with the shock and awe, fear tactics deployed by the Fed and the Treasury the overwhelming majority of the public were against the idea.

So the next step is to remove further bail outs from the democratic process. By using the non-sovereign BIS to funnel funds to member Central Banks, raised by IMF member governments and re-distributed through IMF intervention to its member governments, the nationally based tax payer's wrath is circumvented.

What will be worth watching for is the implementation of other zones similar to the Euro, a particular favourite topic of the BIS in this working paper :

  • "The recent introduction of the euro and projects for monetary union in other parts of the world make the replacement of national currencies (either by a foreign currency or by a new, multilateral currency issued by a regional central bank) a topical issue. Related regimes are the tight linkage of the national currency through a currency board and the official or unofficial use of foreign currency - often referred to as "dollarisation".

    While these various monetary regimes differ in a number of respects, they have the common feature that they virtually eliminate the possibility of an independent monetary policy. Issues arising include the preconditions required for making these arrangements work, the institutions that need to accompany them, and the extent to which they harm the smooth functioning of the economy (for instance, by eliminating monetary policy flexibility and lender of last resort facilities).

    Many of these issues were considered by a small group of senior central bankers at the BIS during a two-day meeting in September 2002. The first day focused on economic issues and the second on legal and practical issues. This volume contains edited versions of most of the papers prepared for the meeting."

However what of the problems I discussed earlier about the Eurozone? Did you doubt they had not thought of this?

  • "In the European Union's case, monetary union was the culmination of these other economic initiatives. There was much debate about whether this model is the only one, with a rough consensus emerging that it need not be (for instance, the CFA franc zone has been in existence for more than 50 years, much of that period without other significant elements of integration), but that to be successful and permanent, those other elements (customs union, macroeconomic coordination, harmonisation of taxes, removal of barriers to factor mobility, etc) needed at least to be constructed in parallel." (Italics my emphasis)

Many are discussing the changes that will occur in the capitalist system as a result of the credit crash and the resultant spill-over into the World economy. Whilst such views as I have expressed here might be taken as "far-fetched" I would ask you to think back about 5 years ago and the treatment of those who warned about a property, stock and credit bubble implosion.

Still think I am being far-fetched?

To defend yourself in these times you need to be in cash with low or no debt. Just be careful where you put your money.

Subsequent bail outs will show you that you have no parachute, no protection. The long term plan appears to be to grab your assets through taxation and use the fruits of your labour to ensure the banking system survives and becomes centralised away from all government interference. Once the pain threshold for the populace has been reached then the next great plan to take the pain away will unfold before you.

Don't put yourself in a place where you beg for the pain-killers.

By Mick Phoenix
www.caletters.com

An Occasional Letter in association with Livecharts.co.uk

To contact Michael or discuss the letters topic E Mail mickp@livecharts.co.uk .

Copyright © 2008 by Mick Phoenix - All rights reserved.

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Information and analysis above are derived from sources and utilizing methods believed reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Do your own due diligence.

Mick Phoenix  Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

Ivo Cerckel
23 Oct 08, 02:25
The causes of the crisis, please!

"Eventually President Nixon decided in 1971 to abandon the BW agreement [...]"

This means that "we" are no longer living "under" BW

and that the IMF, which had to uphold BW, has no more reason for existence since more that 35 years.

We are indeed living under a fiat currency system, but not under the system which was agreed at BW. (I leave the question as to whether the BW system was a fiat currency system in the middle.)

What do our Masters want?

I read this Thursday morning that our Masters are already disagreeing on the solutions to the present crisis.

Perhaps, they should first examine the real long-term causes of the crisis.

But that's too much to ask from our Masters.

The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups. (Henry Hazlitt) http://jim.com/econ/chap01p1.html


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