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.

We live in interesting times. Interesting in that we are slowly realising that we have spent way beyond our budget: in monetary terms of course but also ecological. We are consuming ecological resources at an increasingly rapid rate (see Al Bartlett’s fabulous work on Arithmetic, Population and Energy) and using ecosystem services well in advance of their ability to provide.

But it’s useful to sit back and consider the element of contract here. When we borrow we commit to a contract that is so ancient so as to be part of our very soul. From Faustus to Scrooge, the spiritual nature of this bargain is ever present. I must mention here the fabulous work by Margaret Attwood titled “Payback: Debt and the Shadow Side of Wealth“. It reminds me somewhat of Arundhati Roy’s venture into non-fiction in “The Cost of Living“. I like brilliant writers who veer off into interesting worldly issues and Attwood’s book has certainly inspired this post and much thought on the nature of debt itself.

It’s not the type of book I would expect from an author of fiction but it’s really a masterpiece on the understanding of debt and our long relationship with it. When we look at debt and debt slavery we realise it has been around since the beginning of time. The ability to hock one’s wife and child into servitude is not a recent phenomenon. The Faustian bargain is long known even if these days it’s for a consumer good (take your pick) on a 5 year no interest deal: no interest? do people actually believe that? Yes they do.

The focus is always on the weekly amount…..’oh that’s $15 a week. yes i can fit that into my budget”….shame it’s $15 a week forever!! and that television or sofa has cost you double, treble of even more than the advertised price…..oh and it’s worth sod all to sell.

Anyone remember Polonius? The father of Ophelia and general rambling windbag in the Kingdom of Denmark (That’s Hamlet for you who didn’t have the joys of Shakespeare at school).

“Neither a borrower nor a lender be”.

Famous words reprised many years later by Keynes at Bretton Woods when he proposed that countries should keep their trade accounts balanced as much as possible…..that applied to those in credit as well a debit.

And look where we are now……we’re at Payback time. But where is Mephistopheles? Who is going to do the collecting? To pay or not to pay? That is the question said Hamlet…perhaps.

The imbalances in the system are so great that there is no amount of money available to repay the debts. Perhaps they should all be written off as a bad idea and we should start again from scratch….but hark I hear Shylock coming…is there a pound of flesh available? Land…not transportable…but commodities from the land…maybe.

At some point the contract must be addressed; At some point a bargain must be made; At some point there will be the mother of all restructuring. Who will pay…now that really is the question.

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.