Economics In The Age Of Paper Money

Economics In The Age Of Paper Money

Posted on: Wednesday, August 15, 2012|Written by: Richard Duncan

I call my website “Economics In The Age Of Paper Money” because our economy no longer works the way it used to when gold was money. The difference is not a small one. It is fundamental. Most economists, however, have not grasped the profound significance of the change in the way our economy works now. The purpose of my website is to point out those changes. We have a new kind of economic system. It responds differently to government policies than did 19th Century Capitalism. It is not bound by the same constraints. Our economy is turbo charged, but the operating manual that still guides the economics professions was written in the days of the horse and buggy. If we don’t learn how to operate our new economic system, it is very likely to crash.

Back in the olden days – before World War I – gold was money, governments balanced their budgets and trade between nations balanced. Sound money, balanced budgets and balanced trade were the core principles of economic orthodoxy and the foundation stones around which all classical economic theory was built.

Capitalism worked the way it did because gold (or more precisely a gold-based monetary system) would not allow it to work any other way. The gold standard forced governments to balance their budgets and it forced trade between countries to balance.

In the 19th Century, if a government spent more than it took in as taxes, it had to borrow money to finance that budget deficit. When gold was money, there was always a limited amount of money in the economy and governments could not create any more of it. Therefore, if a government borrowed a lot of money, there would be less money available for the private sector to borrow. That would cause interest rates to rise; and higher interest rates would cause the economy to suffer. Therefore, governments did their best to balance their books – at least during peacetime.

When gold was money, trade between nations had to balance because if one country bought more from another country than it sold to that country, it would have to pay for that trade deficit with gold. A persistent trade deficit would drain away all the deficit country’s money and impoverish it. Soon that country would not be able to buy any more imports because it lacked sufficient gold to pay for them. Therefore, in the past, nations were very concerned to ensure that they imported no more than they exported.

Operating within those binding constraints that the gold standard imposed, the Capitalist economy grew through a process of investment and capital accumulation. Businessmen would invest. Some of them would make a profit. They would save that profit – or, in other words, accumulate Capital (hence Capitalism). And they would repeat the process. Investment and capital accumulation drove the economic growth dynamic under Capitalism.

Everything changed when governments stopped backing money with gold. The transition from a gold based monetary system to a fiat (or paper) monetary system occurred in stages beginning in World War I, when all the European nations went off the gold standard, and ending in 1971, when President Nixon announced the US would no longer allow other countries to exchange the dollars they held into gold, thus destroying the Bretton Woods international monetary system.

Thereafter, money was no longer “sound”, governments no longer had to balance their budgets and trade between nations no longer had to balance. Governments could create money from thin air; and budget deficits and trade deficits could be financed with paper-money denominated debt. Credit growth began to explode. Every sector of the economy took on much more debt: the government, the households, the corporations and the financial sector. Total debt (and, therefore, total credit) in the US first topped $1 trillion in 1964. By 2007, it had expanded 50 times to $50 trillion. Consequently, the economic growth dynamic ceased to be driven by investment and saving. Instead, it came to be driven by credit creation and consumption.

That explosion of credit created very rapid economic growth in the US and around the world. However, in 2008, the private sector began to default on its debt on such a large scale that our new, credit-based economic system came very close to complete collapse. Had the government sector not intervened by increasing its debt by roughly $5 trillion since then (of which $2 trillion was financed by paper money creation), we would now be in a great depression as bad or worse than the one that occurred during the 1930s.

Many people think that if we just cut government spending on welfare or have fewer government regulations or fire some bureaucrats that after a short while we will once again be back in some kind of Capitalist nirvana. That is a fantasy. The truth is that there is no way for our 21st Century credit-based economic system to return to the gold-based monetary system of the 19th Century. It would completely break down if we tried to return to a system based on sound money, balanced government budgets and balanced trade. If our economic system, which I call Creditism, collapses after a four and a half decade long, $50 trillion expansion of credit, our civilization will not survive it.

Therefore, we must learn how to make our new economic system work. That is what Economics In The Age Of Paper Money is all about.

Here’s the link to my website: http://www.richardduncaneconomics.com/

Posted on: Wednesday, August 15, 2012 | Leave A Comment | Written by: Richard Duncan

Who have conned the Chinese in Malaysia?

It is very heavy heart to put up this post. No doubt this is a rock solid true fact, what 80% of the Chinese in Malaysia can do? They merely have no choice but to hang on in this Country. The balance of 20% who is either rich, educated, businessman, influential.........rather the elite group may have choice to decide to stay on or move out! It is interesting that Dr M defended that it was never his or UMNO intention to discriminate the non-Malay. Hypothetically, assuming he has a good heart (up to you to judge), did he realised that the government machinery was not implementing his wish and intention truly and fully! He need to wake up to distinguish wishes/intention and reality. For the real fact is the more advanced Singapore is the true refection of how Chinese is treated in Malaysia.

From financial perspective, have someone ever wondered why Malaysian has high saving rate?????? 30% GDP! who is saving......Malay (u know they kait petang makan petang) Indian (hardly survive brother).....you guess lah. The category that is saving is the one worry........ hoping one day the saving will be used. As time passed by, it has become a habit after 40 years (1969 - 2012). Not realising the amount kept under the pillow has ballooned. 

Honestly, i really hope, this emergency funds set up 40 years ago will not be put in use due to its original intention.

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August 17, 2012

AUG 17 — Below is an excerpt from a former MCA insider who has left the country for good. The excerpt is from his letter responding to a request from his friend asking him to consider a return to Malaysia.

The excerpt provides a personal but important perspective of the role of non-Malay parties in the Barisan Nasional. It has been reproduced with the consent of the writer whose identity we’re withholding.

An article from The Star provides the background to this disclosure.

YONG PENG: DAP’s long-term political agenda is to join Barisan Nasional in a bid to protect its supreme position in Penang, said MCA president Datuk Seri Dr Chua Soi Lek.
“DAP politicians are like any other politicians, for them it is the thirst for power.

“Penang has limited resources and how long can (Penang Chief Minister) Lim Guan Eng tender his land?” Dr Chua said, adding that the DAP hoped to see the MCA disappear and be replaced in Barisan.

He urged the Chinese community not to be conned by the Opposition party. — (extract from the newspaper on August 4)

Excerpt from the letter by the ex-MCA insider
From my experience with the MCA and the people whom I had worked with in the party, I can only say that most of them (from Lee San Choon, Koon Swan, Liong Sik, Kim Sai, Ka Ting, Tee Keat and all the other people at federal and state level) KNOW that the Chinese in Malaysia are not ever going to be in a position to influence the direction of how the country is to be governed, i.e. to say anything that affects MAJOR policies.

There’s just this denial syndrome that non-Umno parties are just there for window-dressing; so the next best thing to do is scoop up the scraps Umno throws their way... except Taib and PBB who take the lion’s share as well!

From the many, many sessions of central committee meetings and brainstorming, seminars, courses, etc, the one main thing to emerge is to only defend or safeguard Chinese position in education and economic sectors ... we’re down to TAR College, Utar and Chinese business interests which, sad to say, …is playing to Umno whims and patronage… macam crony business.

The rest in the SME (small and medium industries) can pray to God and hope to survive and are at the mercy of the idiots who run the bureaucracy.

There is NO hope ever under Umno that Chinese position will improve because the OVERRIDING philosophy since May 13 is that non-Malays/Muslims are to be assimilated (much like the Borg in Star Trek).

That is why the MCA is always fighting ghosts; Umno is always lying, even when the truth is exposed about their true intention.

MCA people know this and pretend to fight for Chinese when they know they are only protecting their personal interests/financial gain, through Umno patronage.
The BN was never a coalition; it is and always has been an illusion created by Umno to present an imaginary front to the world that the people represented by the various races and parties support them.

[Our elites] cheat and bribe their way in elections and steal what they can, when they can, with impunity. They not only do that, they find ways to criminalise the victims!! That takes them 10 levels above the Somali pirates!

To cut a long story short, and to answer your question about going back, even if Penang booms further under the DAP, the short answer is NO; I’ve burnt my bridges … It’s just too hard to ever hope that they will ever understand the meaning of a civil society, let alone try to forge one in the years ahead, even if PKR takes over Putrajaya... my prediction is that the worst is yet to come. I hope
I’ll be proven wrong in my lifetime.

Hudud has always been used as a weapon to frighten the Chinese and some extremists in PAS may have been used by Umno/Perkasa to split PKR, so the MCA is just playing the propaganda game to try to win back some Chinese votes. Umno, on the other hand, is using [the Malay fear of] Chinese political power to frighten the Malays. — Centre for Policy Initiatives

* This is the personal opinion of the writer or publication and does not necessarily represent the views of The Malaysian Insider.

Libor And The Corruption Of Creditism

Posted on: Monday, July 16, 2012|Written by: Richard Duncan

Barclays Bank was forced to pay a “fine” of US$453 million earlier this month in a case related to the manipulation of the London Interbank Offered Rate (Libor), one of the most important benchmark interest rates in the world. It now looks as if a number of other large banks will eventually be implicated along side Barclays. To me, this scandal, in and of itself, is not as important as what it exposes about the nature of the banking industry, as well as that industry’s grip on political power within our society.

Let’s begin with the basics. Whoever creates the wealth controls the political power. Before the industrial revolution in the late 1700s, almost all the wealth in the world was derived from agriculture. Thus, the landed aristocracy controlled all the political power. That economic system was Feudalism. Once the industrial revolution began, most of the world’s wealth was derived from manufacturing. Consequently, during most of the 19th Century, the “captains of industry”, or “Robber Barons” if you prefer, held control of the political power. Then, during most of the 20th Century, giant industrial corporations did. That stage of economic development can be described as Industrial Capitalism.

In recent decades a new kind of economic system has taken shape. After the United States stopped backing money with gold in 1968, credit exploded. Total credit in the US expanded fiftyfold from $1 trillion to $50 trillion in only 43 years. During those decades, most of the world’s wealth was not derived from agriculture or manufacturing, it was derived from credit creation. Consequently, those who create the credit now control the political power. Those people are the bankers. I call this new economic system Creditism.

Banks create wealth by creating credit. (And, of course, credit and debt are two sides of the same coin.) As the explosion of credit creation gained momentum in the 1970s and 1980s, the banks became much more profitable and therefore much more politically powerful as a result of their “contributions” to political parties (to both the Republican Party and the Democrat Party in the US and to both the Conservative Party and the Labor Party in the UK) as well as to individual politicians.

By the end of the 1990s, the banking industry was unstoppable. In 1999, the Gramm-Leach-Bliley Act repealed Glass-Steagall and, in 2000, the Commodity Futures Modernization Act deregulated derivatives. Glass-Steagall was enacted in the early 1930s after the credit bubble of the 1920s imploded and caused the Great Depression. Its purpose was to separate commercial (i.e. deposit taking) banks from investment banks to prevent speculation by investment bankers from destroying the deposits of everyone else. It worked very well until it was repealed in 1999 as the result of lobbying by the banking industry.

Not content to stop there, the banks next pushed through the even more audacious Commodity Futures Modernization Act, which effectively removed the regulations that, up until then, had governed the use and trading of derivatives. Afterwards, most derivatives went largely unregulated. And, roughly 90% of all derivatives now trade in the Over-The-Counter (OTC) market, where there is practically no transparency, instead of through regulated exchanges which allow much greater visibility as to who is doing what and why.

During this phase of Creditism, 1990 to 2007, things began to become surreal. The banks began creating wealth not only by creating credit but also by creating derivatives. Between 1990 and 2007, the total value of all outstanding derivatives contracts rose from roughly $10 trillion (an already astronomically large number) to $700 trillion. To put the latter figure in context, $700 trillion is the equivalent to $100,000 per person on Earth and the equivalent to the value of everything produced on earth during the last twenty years (global GDP since 1992). The dDerivatives contracts change hands at the rate of $4 trillion per day – and that is only for the 10% that trade through exchanges. No one can say how much is the average daily turnover of the other 90% that trade OTC, but a good guess would be A Whole Lot.

Derivatives became the raw material used by a sub-branch of the banking industry, the “Structured Finance” business. STRUCTURED FINANCE? It even sounds suspicious. What does that mean? Why would anyone structure his or her finances? It’s rather unclear. What is undeniablye clear, however, is that almost every major accounting scandal since 1990 has involved the culprits using derivatives to structure their finances in some illegal way; and there is a long list of such cases. I dare not name names. Google it for yourself: “Accounting Scandals” + “Derivatives”, then hit Search.

And that brings us back to Barclays. The bank was accused of submitting false information to the British Bankers Association about the interest rate at which it could borrow money from other banks. That information is compiled with thate interest rates from 17 other banks to determine a daily average. That average sets the Libor rate, which is the benchmark rate against which most conventional loans and untold (literally untold) quantities of derivatives are priced. The press has reported that Barclays falsified its submissions for two purposes. The first was to make it appear that it could borrow more cheaply than it actually could during the crisis of 2008, so that it would not seem in danger of collapse. The second reason according to press reports was to manipulate the Libor rate in a way that would allow traders employed by Barclays to earn more profits from their trading positions.

I do not know the truth of these allegations. However, the payment of a $453 million fine suggests that something was amiss somewhere.

None of this should come as a surprise to anyone. Most human beings are driven by the need and the desire to make money. And, unfortunately, history suffers no shortage of examples of the bad things – sometimes truly terrible things – many people will do to make money if society does not make and enforce laws that prohibit them from doing so. When such laws do not exist or are not enforced, no one should be surprised when bad things do happen.

In other words, there is no point blaming a dog for knocking over and going through all the trash cans in the neighborhood. It’s in the dog’s nature to behave that way. Either the dog must be chained up or the lids on the trash cans must be tightly sealed. Otherwise there will be a big mess.

As citizens of a democratic society, it is our responsibility to chain up the dogs (in every industry) and to seal the lids. Because iIn recent years a lot of dogs have slipped their leashes due to excessive deregulation. This is going to require more than the re-imposition of sensible financial sector regulations. It’s going to require campaign finance reform as well. Until banks and other corporations are prevented from making unlimited campaign contributions, it is unrealistic to expect our elected officials to bite the hand that feeds them.

Creditism is far less stable thant either Feudalism or Industrial Capitalism. In fact, it is now in danger of collapse because credit cannot continue expanding since the private sector cannot bear any more debt. In this twilight of Creditism, it is not surprising that the banks are being driven to increasingly desperate measures in order to continue generating “wealth”. That is because when they cease to generate most of the wealth, they will lose their grip on political power. And, as is well understood, when ruling classes fall, they often suffer reprisals.

Posted on: Monday, July 16, 2012 | Comments (11) | Written by: Richard Duncan

When Will The Fed Print More Money?

Premise on the article below, those who are bullish on stock market should re-strategies.

 

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Posted on: Thursday, August 02, 2012|Written by: Richard Duncan

When the Fed prints money it makes the price of gold go higher, and it makes the stock market go higher.  Many Fed watchers had expected the US central bank to announce a new round of paper money creation, the third round of Quantitative Easing, or QE 3, at its FOMC meeting on August 1st.  But it didn’t.  In the following paragraphs, I will share my views on why it didn’t.  I will also discuss the four developments that would force the Fed to push the print button.  This is important because the chances are relatively high that the price of gold, the stock market and the economy in general will weaken until the Fed prints again (unless the European Central Bank, the ECB, jumps in with another big round of Euro printing, which certainly cannot be ruled out). 

The economy is weak and getting weaker.  US GDP grew by only 1.5% in the second quarter.  Unemployment is high and getting higher, 8.2%.  So why didn’t the Fed launch QE 3 this week to rev up the economy?  I think there are two main reasons.  The first is that printing money does more than push up the price of gold and stocks; it also pushes up the price of food.  During the second round of QE, global food prices rose 60%, causing a humanitarian disaster for the two billion people on earth who live on less than $2 per day.  After QE 2 ended in mid-2011, food prices gradually declined – until a severe drought struck the United States and drove corn prices back near record highs in recent months.  That drought-provoked spike in the price of corn may have been the main reason the Fed did not act this week.  They did not dare push global food prices higher still.  The last thing they want is for the hunger-inspired Arab Spring revolutions to go global. 

The second reason that held the Fed back this time could have been that interest rates are already too low.  When the Fed prints money and buys bonds, it pushes up their price and that pushes down their yields, i.e. the amount of interest bond buyers receive.  The yield on ten year US government bonds fell below 1.4% last month.  They have never – I repeat NEVER – been lower.  With the yield on government bonds so low, it will be very difficult for pension funds and insurance companies to earn enough money from their investments in bonds to pay their obligations to pensioners and policy holders.  The Fed must fear that yields have already fallen to dangerously low levels.  Therefore Chairman Bernanke and his colleagues are reluctant to print more money and cause bond yields to fall further still.

So, what would force the Fed to fire up the printing press?  I believe there are four potential triggers that would force the Fed to print again.

The first would be a significant decline in the stock market.  If stock prices began to plummet, (paper) wealth would be destroyed, consumer confidence would drop and consumer spending would fall.  As a result, the economy would begin to contract and deflation would take hold.  That is not a worry right now, however.  The stock market is pretty strong.  If the S&P Index dips below 1250 (from 1370 now), Fed action would become more likely.  If the S&P begins to approach 1100, look for helicopter money to begin raining down from the sky. 

The second trigger would be a spike in government bond yields.  The US government must finance a very large budget deficit every year.  The budget deficit has averaged about $1.3 trillion a year for the last four years.  If the private sector won’t buy the government’s debt at low interest rates, the Fed would print money and buy the debt itself.  Right now, as discussed above, that is not an issue either.  Yields are very low.  However, should the yield on ten year bonds rise above 3.5%, then it would become an issue and the Fed would consider printing.

A third factor that would push the Fed toward printing again is the threat of deflation – and this is once again becoming a real concern.  With the US economy and the global economy weakening rapidly, the level of consumer price inflation (CPI) has started coming down fast.  Now, however, the drought in the United States is likely to cause prices to rise again quite quickly, making near term Fed action less likely.  It is certain the Fed is monitoring prices very closely because it is terrified of deflation.  If rapid disinflation resumes, the Fed will print. 

The final factor is the unemployment rate.  If it moves up to 8.5%, the Fed will probably print more money.  With the global economy weakening so quickly, that is a real possibility.  If the Congress does not avert the “Fiscal Cliff” at the end of this year (when government spending is due to be capped and taxes are due to surge), it is an absolute certainty that unemployment will soar and the Fed will print. 

So, in conclusion, keep an eye on the inflation rate and the unemployment rate. They are likely to determine when the Fed launches QE 3.  And, until then be cautious.  The price of stocks, gold and other commodities (not affected by the drought) are likely to fall – unless the ECB turns on its printing press and pushes them back up.

On a personal note, I spent the week of July 16th promoting my book, The New Depression, in London.   The week began at 7:30 am Monday on CNBC Squawk Box Europe.  Please find here the link to that interview: http://www.cnbc.com/id/48193471/How_Close_Are_We_to_New_Great_Depression

Posted on: Thursday, August 02, 2012 | Comments (1) | Written by: Richard Duncan

Mounting Malaysian Debt Could Lead to Downgrade

I think this article is important to take note and to monitor thereon that the condition does not deteriorate further.

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 By Lee Wei Lian

August 01, 2012

 

KUALA LUMPUR, August 1 — Malaysia’s public finances are weak relative to those of its ‘A’ range peers and the country is now on par with more heavily indebted ‘A’ range sovereigns such as Italy, said Fitch Ratings today.

This comes after some economists said that the federal government’s debt, which nearly doubled since 2007 to RM421 billion, poses a fiscal risk to the country if not managed carefully as it impairs Malaysia’s resilience to economic shocks, which appear to be occurring with increasing frequency.

Fitch said that despite strong GDP growth, the deterioration in public debt ratios is affecting Malaysia’s credit profile and a lack of progress on fiscal reforms could lead to a ratings downgrade.

Fitch said that the rise in the federal government debt-to-GDP ratio and the limited broadening of the fiscal revenue base have pushed Malaysia’s debt-to-revenue ratio to 246 per cent in 2011, which is well above the ‘A’ and ‘BBB’ range medians of 137 per cent and 119 per cent respectively and is now on par with more heavily indebted ‘A’ range sovereigns such as Italy at 261 per cent and Israel at 180 per
cent.

Italy is considered one of the countries at risk of a debt default and saw its borrowing costs soar to above seven per cent in November last year.

Other factors putting pressure on the country’s credit profile are low and energy-dependent revenues as well as structural weaknesses such as low average incomes.

“Fiscal slippage or a lack of progress on fiscal reforms to reverse the deterioration in public debt ratios, following the impending election, could prompt negative rating action,” said Fitch.

It added, however, that if the country demonstrated sustained political willingness to implement fiscal reforms that lead to a strengthening of the fiscal revenue base, improved budgetary flexibility and lower reliance on energy-linked revenues streams, it would be supportive of Malaysia’s ratings at their current level — which were affirmed at ‘A-’ and ‘A’ for Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) respectively.

The agency said that Malaysia’s public finances also exhibit structural weaknesses with general government revenues, which came up to 24 per cent of GDP in 2011, remaining well below the ‘A’ range median for general government revenues which was 33 per cent.

It also expressed concern that the share of petroleum-related revenues is high at 36 per cent of federal government revenues and that fiscal flexibility was crimped by fuel subsidies, which amounted to nine per cent of total expenditure last year.

Fitch said, however, that reforms were unlikely until after the general elections.

It also pointed out that a sharp increase in non-resident holdings of marketable domestically-issued medium- and long-term government debt grew to 41 per cent of foreign exchange reserves at end-June 2012 from 21 per cent at end-June 2008, which suggests that the capacity of the country’s external finances to absorb shocks may be weaker than in the past.

On the plus side, Fitch said that Malaysia’s stronger and less volatile growth, and slower and less volatile inflation compared with its ‘A’ category peers, supports its credit profile.

It also said that the government’s structural reform plan for the economy helped attract private-sector investment interest in 2011.

“However, given the political environment, Fitch believes implementation risk to the reform agenda remains material,” it said.

Other Malaysian strengths include strong foreign interest in Malaysian government securities and a large and liquid domestic debt capital market, which should be able to limit the impact on domestic financing costs in the event of a sharp reduction in foreign participation.

Fitch said that the broader public sector holds 33 per cent of marketable domestic government debt, further enhancing the stability of financing and funding flexibility.

Some economists earlier said that while Malaysia’s government debt — currently at about 54 per cent of gross domestic product (GDP), and the second highest in Asia — has not significantly impacted the country and its credit standing; yet, the volatile nature of global markets may manifest such a risk at any time, which could lead to higher borrowing costs for the country.

While the Najib administration has vowed not to let federal government obligations exceed 55 per cent of the country’s GDP, there is increasing worry that when government-backed loans or “contingent liabilities” are taken into account, the government’s total debt exposure rose to about 65 per cent of GDP last year.

The World Bank also said last November that Malaysia is too dependent on fossil fuel revenues, with its non-oil primary deficit having doubled in the last five years to almost 20 per cent of GDP.

Market Pulse

For the last two months, KLCI was bought up by local funds. As USDMYR was remained flat, i believe, KLCI will be played up by foreign funds in the coming week, while local funds will take respite.