Former Fed chairmen Alan Greenspan and Paul Volcker speak with Pete
Peterson on the "Consequences of Inaction" segment from the Peterson
Foundation's "Post-Election: The Fiscal Cliff and Beyond" event.
Recorded November 16, 2012 in Washington, DC.
US Dependence on Foreign Capital:Structural Hegemony or Decline? A Critical Analysis of US Foreign Debt, Dollar Seigniorage and theEmergence of the Euro
"Given that the United States currently has a budget deficit of $500 billion, acurrent account deficit of $600 billion, well above 5 percent of GDP, and the rest of the world owns more than $7 trillion of US assets, which represents more than 50%of the US economy, there is only one question to approach: What does this USdependence on foreign capital mean? Does it mean that the United States has beenable to construct a world economic order that allows it to live at the expense of therest of the world? Or does it show a slow but irreversible decline of the superpower?At a first glance it seems that the first answer is the more appropriate. Thanks to the neoliberal financial order, the structural power of Wall Street and the centrality of thedollar in monetary affairs, the US acts as a magnet for investors, and can socomfortably live beyond its means. However, one recent event has radically changed the status quo.
The introduction of the euro is the greatest challenge to US hegemonyin the last thirty years. The European currency will compete with the dollar for international seigniorage, which means that the dollar will depreciate further, interestrates will rise and the living standards of the US citizens, who are hugely indebted,will fall. Thus, US dependence on foreign capital will pass from what is today astructural hegemony to what in the future will be a painful decline..."
"Will the US request a bailout? Will the International Monetary Fund grant it? On what terms and conditions? What writedown of US debt will be needed to restore sustainability to its fiscal accounts? What impact will this have on world financial markets? These are not questions being asked today but they are questions worth contemplating. Thinking the unthinkable is one of the lessons of the eurozone saga. Another is the speed with which complacency can convert to crisis. So although I am not predicting Armageddon, I would like to signal a series of factors that policy makers of all nationalities would do well to keep in mind..."
The global financial crisis has shown that the current international monetarysystem (IMS) suffers from an inherent flaw: it depends on US current account deficits forthe provision of global liquidity. Under this arrangement, peripheral countries in the systemhave to accept periodically the debasement of the US dollar. Thus, there are some mutualincentives for the EU and China to reform the current IMS through cooperation. Inprinciple, both are in favour of stable exchange rates and both are keen to constrain USmacroeconomic profligacy. There have been some efforts toward those objectives betweenChina and the European countries in the past years, especially during the French presidencyof the G20 in 2011. However, there has been no significant progress achieved till now. On the European side, there is not a united and independent Europe which could act as acounter-balance to the US in the reform of the IMS. On the Chinese side, Beijing does notsee Europe as a reliable partner because the latter is deemed as a major vested interest inthe current regime. As a result, the French government has failed to focus the world´s attention on the reform of the IMS during G20 Cannes Summit, and the Chinese government has chosen a more unilateral way to internationalize its own currency.
"The global financial crisis initiated in the United States in 2008 has raised doubts about the efficiency of the current dollar-led international monetary system (IMS). Two main structural theories have beenput forward to explain the crisis, each with their respectivereform solutions.
On the one hand, there is the „savings glut‟ theory (Bernanke 2005; 2011),favoured by policymakers in Washington andgreat part of the Economics literature, whichsays that the unsustainable overleveraging in the US was induced by the recycling of dollar-denominated savings in surplus economies (especially the East Asian countries,including China) in triple-A safe US debt instruments. This constant inflow oflargevolumes of savings (a by-product of East Asian countries maintaining their currenciesartificiallylow in a neo-mercantilist strategy of export-led growth) suppressed the interestrates on US debt andthus fostered over-consumption and over-indebtedness. To avoid arepeat of this mechanism, the proposed solution is to encourage countries like China to letits currency float freely so that the appropriate market equilibrium can be found and arebalancing of the global economy can be achieved.
On the other hand, there is the „Triffin Dilemma‟ theory (Zhou 2009; Padoa -Schioppa 2010;Bini-Smaghi 2011), favoured by policymakers in Beijing and a number of high profile European officials, which argues that the crisis is a product of the structural contradictionassociated to any international regime dominated by a national currency. As Triffin(1960) explained already in the era of the Bretton Woods System when the dollar was still linkedtogold, there is an inherent flaw in the dollar standard. In order to provide the necessary liquidity for theglobal economy, the US needs to run bloating current account deficits. The increase of this deficit,however, undermines the credibility of the global reserve currency.While for some time economists thought that the Triffin Dilemma was just a page in historybooks because it was only valid for a system linked to gold, the recent crisis signifies thevengeance of Triffin. Even in a system where the issuer of the main international currency,in this case the US, adopts a flexible exchange rate regime there is a limit to its liquidity provision. As current events have shown, by increasing its fiscal deficitsand expanding substantially its monetary base the US enters the risk of undermining the credibility ofthe dollar as the global reserve currency. The solution thus is to find a mechanism that can restrain US profligacy.
Influenced by this second theory, in the wake of the crisis policymakers of the BRICS (Brazil, Russia, India, China and South Africa) countries and the Eurozone have openly called for the end of the currently dollar-dominated IMS. Chinese and French officials haveparticularly beenactive in this debate. The President of China Hu Jintao, the Governor of the People´s Bank of China(PBoC) Zhou Xiaochuan, and the President of France NicolasSarkozy, have all declared that the flexible-dollar-system is a legacy of the past and that itneeds to be revised. In principle, Europe andChina have a number of shared interests in thereform of the IMS. Both are second-tier powers which advocate the creation of a more balanced, regulated and multi-polar monetary system. Both aresuspicious of the benefits of unfettered financial markets (with the notable exception of the UK).Both have historically been in favour of a more coordinated exchange rate regime able to mitigateexchange rate misalignments detached from economic fundamentals. And both have resented the factthat the US is able to misuse its exorbitant privilege as the issuer of the global reserve currency.In other words, both China and Europe would like to create a mechanism that enforcesmacroeconomic discipline upon the US..."
In seinem Urlaubsort in Südfrankreich starb vergangene Woche
Karl Blessing, 71, von 1958 bis 1969 Präsident der Deutschen Bundesbank.
Das letzte große Interview vor seinem Tode hatte Blessing dem
SPIEGEL-Redakteur Leo Brawand für ein Sachbuch gewährt, das unter dem
Titel "Wohin steuert die deutsche Wirtschaft?" im nächsten Herbst im
Münchner Verlag Kurt Desch erscheinen wird. Dem Interview ist folgender
Auszug über die Inflation entnommen:
FRAGE: Herr Blessing, ist es
überhaupt möglich, Vollbeschäftigung, Preisstabilität und ausgeglichene
Zahlungsbilanz zur selben Zeit zu haben?
BLESSING: Das ist ein Idealismus der sehr schön ist, aber der in dieser Welt nicht zu verwirklichen ist.
Andere Länder nehmen es mit der Währungsstabilität ohnedies nicht so
genau. Sie kennen das Zitat der "Financial Times" in London, es sei
immer der deutsche Schütze Schmidt, der falschen Tritt habe?
Ich würde den falschen Tritt in Kauf nehmen und würde ihn immer wieder
korrigieren durch eine Änderung der Wechselkurse, So weit bin ich heute.
FRAGE: Das hieße im Idealfall freie Wechselkurse oder sehr große Bandbreiten?
Ich würde keine freien Wechselkurse einführen, sondern ich würde
fragen: Wann entsteht ein Zahlungsbilanz-Ungleichgewicht? Wenn ein
fundamentales Ungleichgewicht vorliegt, alle zwei oder alle drei Jahr
vorliegt, muß man den Mark-Wechselkurs ändern.
FRAGE: Was halten
Sie von den Brüsseler Vorschlägen, der Währungsunion in Westeuropa
dadurch näherzukommen, daß in einer Übergangszeit von 1971 bis 1973
erstens eine engere Koordination in der Währungspolitik allgemein
praktiziert und vor allen Dingen in der Haushaltspolitik ein
verbindliches Aufeinander-Abstimmen Vorschrift werden soll?
Das wird ungeheuer schwierig werden, ein sehr schwieriges Unterfangen,
Der gute Herr Werner, ich kenne ihn sehr gut, ich habe oft mit ihm zu
tun gehabt, ist auch ein Idealist. Wenn sein Plan möglich wäre,
wunderbar. Aber die Verhältnisse sind anders. Wie wollen Sie ein
nationales Parlament zwingen, bestimmte Dinge zu machen oder nicht zu
FRAGE: Eben, all das hat ja innenpolitisch Wirkungen
... innenpolitische Wirkungen, die zu anderen Wahlergebnissen führen
oder sonst was. Wie kann man das machen? Die Franzosen -- der gute
Giscard d'Estaing gilt als Monetarist. Also will er über die Währungen
in der EWG vorankommen. Aber wenn es darum geht, Souveränitätsrechte
aufzugeben oder zu poolen, dann macht die französische Regierung nicht
mit. Wo liegt also da die Logik. Wenn eine Lohnexplosion kommt à la
Italien im Herbst 1969 oder à la Frankreich im Mai 1968, wie wollen Sie
da eine einheitliche Währung haben, eine Währungsunion? Das ist nur
möglich, wenn die ganze Politik bereit ist, auf Souveränitätsrechte zu
verzichten und die Souveränität auf eine Zentrale in Brüssel zu
FRAGE: An eine zentrale europäische Notenbank?
Ja, wenn man eine europäische Notenbank, ein Federal Reserve System of
Europe, gründen würde, das autonom gegenüber den Regierungen ist -- und
innerhalb des Systems wären die Regierungen nur in der Lage, bis zu
einem gewissen Grad Budget-Defizite zu finanzieren -, dann kann man es
FRAGE: Es ist ja zu erwarten, daß man den Dollarfluß
nach Europa durch das amerikanische chronische Zahlungsdefizit, das mit
zu unserer Inflationierung ...
BLESSING: ... in erheblichem Umfang beigetragen hat
... daß man den Zufluß abbremsen könnte durch den Aufbau einer solchen
europäischen Währung, sozusagen als Gegenpol zum Dollar.
Es ist kein Zweifel, wir könnten, wenn wir wirklich den politischen
Willen in der EWG hätten, einen Hartwährungsblock bilden, dessen Kurse
dann schwanken könnten gegenüber dem Dollar. Damit hätten wir uns
abgehängt von dem Dollar-Standard, den wir heute ja haben. Wir haben ja
praktisch den Dollar-Standard.
FRAGE: Ja, sicher, Und ist es nicht
so, daß wir -- beispielsweise auch Sie in Ihrer Amtszeit und die
Bundesbank heute noch -- durch die Aufnahme von amerikanischen
Schatzpapieren, durch das Halten großer Dollarbestände und das
Nichteinwechseln der Dollar in Gold den Amerikanern erhebliche
Schützenhilfe leisten ...
BLESSING: ... und geleistet haben. Ich
erkläre Ihnen heute, daß ich mich selber persönlich schuldig fühle auf
dem Gebiet. Ich hätte damals rigoroser sein müssen gegenüber Amerika.
Die Dollar, die bei uns anfielen, die hätte man einfach rigoros in Gold
FRAGE: Durch das Stillhalten der Notenbanken sind die Amerikaner mit ihrem Dollar nie unter Bewährungszwang gekommen?
Nein, sie sind mit ihrer Währungspolitik nie unter Bewährungszwang
geraten. Sie haben uns immer versprühen: Na, im nächsten Jahr wird das
anders, im übernächsten Jahr kriegen wir den Etat und alles in Ordnung,
wir sind stark. Sie sind auch stark als Wirtschaftsnation. Aber sie
haben es nie gebracht, es kam immer was anderes. Da kam der
Vietnamkrieg, dann kam der Präsident Johnon mit seiner Finanzpolitik,
mit einem 25-Milliarden-Dollar-Budgetdefizit damals in einem Jahr. All
das waren die Gründe für die Inflation. Ich habe zu m inen
amerikanischen Kollegen oft gesagt: Es geht ja immer weiter bei euch,
Dann kam die Geschichte mit den Truppen.
FRAGE: Sie meinen die
Drohung der Amerikaner: Wenn ihr den Dollar nicht auf diese Weise
stützt, ziehen wir die Truppen aus der Bundesrepublik zurück?
Es war nie eine ausgesprochene Drohung, aber die Drohung war immer im
Hintergrund da. Der frühere Hochkommissar McCloy war einmal bei der
deutschen Regierung und sagte: Hören Sie mal, wir haben jetzt eine
Senatsentscheidung gehabt; da kommt demnächst eine Mehrheit, daß wir
unsere Boys zurückziehen. Wir müssen was tun. Da hat er mich an einem
Sonntagnachmittag um halb vier zu Hause angerufen und gesagt: "Ich muß
heute abend zurückfliegen, können wir uns nicht noch sehen?" Und ich
habe ihm gesagt: "Mein lieber McCloy, Ihre Situation ist klar, das ist
ein Zahlungsbilanzproblem bei Ihnen, nichts weiter. Sie haben gesehen,
daß wir vernünftig sind und nicht unsere Dollar in Gold konvertieren.
Ich bin bereit, Ihnen das sogar schriftlich zu geben für eine gewisse
Zeit. Der Brief gilt leider heute noch, den ich damals geschrieben habe.
Transmitting Office Correspondence from J. Herbert Furth to Mr. Marget
regarding "speculative capital movements, balance of payments, gold
transfers, and interest-rate differentials."
Authors: Marget, Arthur W.
"Short-term capital movements were important in the U.S» balance of payments deficit and in the decline in the U.S. gold stock during the second half of i960 (see the attached table)*
fhese movements can be explained in part by interest-rate differences between the United States and other financial centers, but in large part also by other factors, including (but not limited to) uncertainties as to the future gold value of the dollar..."
"...Avoidance of excessive capital movements
Large movements from dollars into gold or other currencies can basically be attributed to an excessive supply of dollars abroad. In the 2-1/2 years preceding the start of that movement in mid-1960, official and private liquid dollar holdings (short~term claims and holdings of U.S. Government bonds and notes) of foreign countries rose $k billion. If it had not been for this increase, foreigners presumably would have been glad, in the aggregate, to keep not only existing assets but also moderate further receipts in the form of dollars: before 1958, foreigners used to complain about an international scarcity rather than an international glut of dollars.
As long as the ^basic11 balance of payments of the United States remains in long-term equilibrium, and the supply of dollars to foreigners therefore remains limited, even relatively large capital movements would be unlikely to result in a general "flight from the dollars* In principle, therefore, the best way to avoid excessive folaMie^ capital movements will be to restore and preserve equilibrium in the ^basic*1 balance of international payments of the United States...."
Date: 01/30/1968 Citation: Martin, William McChesney, Jr., January 30, 1968, Statement on Legislation to Repeal the Gold Cover Requirement. ,
from William McChesney Martin Jr. Collection, accessed Aug 9, 2013 from
"The Board of Governors of the Federal Reserve System recommends prompt enactment of legislation to repeal the statutory provisions that now require each Federal Reserve Bank to maintain reserves in gold certificates of not less than 25 per cent of its Federal Reserve notes in circulation. Some change in this requirement this year or next will be unavoidable as the volume of our currency grows in response to the demands of a growing economy. Its repeal now would help to make absolutely clear that the United States1 gold stock is fully available to serve its primary purpose as an international monetary reserve. I want to emphasize that domestic developments will necessitate elimination of the "gold cover" requirement in the relatively near future even if there are no further net sales of gold to foreigners. Federal Reserve notes account for nearly 90 per cent of all currency in circulation in this country, and for nearly 20 per cent of the total money stock including demand deposits. The amount of such notes outstanding increases each year with growth in our economy. The increase in 1967 was $2.2 billion—about 5-1/2 per cent—and this alone added $540 million to the amount of gold required under present law to be held as reserves for Federal Reserve notes. Moreover, our domestic industrial and artistic uses of gold, over and above domestic production, amounted to $160 million last year, and such uses can be expected to be at least that large in the future.
These two factors are reducing what is called our "free gold"—the amount of gold over and above that required as cover for notes—by about $700 million a year. At that rate, our free gold, which came to $1.3 billion at the end of December, would be absorbed in less than two years, even in the absence of further sales of gold to foreigners. And it would be unrealistic not to allow for some additional foreign purchases. Thus, it is clear that a change in the cover requirement is unavoidable, and cannot be postponed for long. It is true that Congress has given the Federal Reserve Board authority to suspend the gold reserve requirement for a period of up to 30 days and to renew such suspension for 15-day periods thereafter. The Board would, of course, make use of this authority if necessary, rather than permit a shortage of currency to interfere with the conduct of the nation's business. But the gold reserve requirement was established at a time when Federal Reserve notes were convertible into gold domestically, and authority to suspend the requirement was intended to deal only with a temporary shortfall. Both the requirement and the provision for suspending it are anachronisms under present-day conditions. With growth in the economy the attendant need for an increasing volume of currency in circulation will certainly continue. There is no way to ensure a corresponding increase in the gold stock. Hence, if the reserve requirement were not removed, we would soon face a continuing and increasing reserve deficiency. Furthermore, upon suspension of the requirement by the Board, we would be required by law to tax the Reserve Banks and they would have to add this tax to their discount rates. Clearly, repeated suspensions of the reserve requirement would be an unsatisfactory expedient in the face of a permanent change in the underlying conditions. To provide the additional currency that the economy requires calls for a permanent change in the law, rather than Board action every 15 days. The primary function performed by gold today is not as a reserve against domestic currency but as a monetary reserve for use internationally. This has long since been recognized in almost all other countries by suspension or elimination of domestic gold reserve requirements. The major part of the United States international monetary reserve is in gold. In the past six months our gold stock has diminished by more than $1 billion, and it now amounts to about $12 billion. In order to arrest this decline, we must achieve a major improvement in our balance of payments. That is the objective of the program announced by the President on January 1. But while we are taking the fundamental steps needed to bring our international payments into equilibrium and stop the drain on our gold, we should avoid any understatement or misunderstanding of our international reserve position. We still hold about 30 per cent of the total gold reserves held by all countries in the free world. We should make it absolutely clear that all of our gold stock is available to serve its primary purpose, and thus discourage market speculation against the dollar or anticipatory takings of gold by central banks. Speculation against the dollar might be encouraged if the gold cover requirement were regarded as immobilizing part of our reserves; the labeling of only part of our gold reserves as "free" might seem to imply that the rest of our reserves are somehow unavailable to perform their primary function of maintaining the convertibility of the dollar. Any possible misunderstandings on this point should be put at rest. This legislation would do that.
Removal of this requirement would in no way reduce our determination to preserve the soundness of the dollar. To achieve our goals both domestically and internationally we must pursue sound and equitable fiscal and monetary policies. Whatever discipline gold imposes in this connection makes itself felt from the fact of a decline in the gold stock rather than from the existence of a reserve requirement, and this will continue to be the case. Convertibility of the dollar into gold at a fixed price— $35 an ounce — is a keystone of the international monetary system and is a fundamental reason why foreign monetary authorities are willing to hold dollar reserves. The role of the dollar as the major international reserve currency, together with the readiness of private foreign organizations and individuals to hold dollar assets, places the dollar in a unique position in international commerce and finance. Prompt enactment of legislation to remove the gold cover requirement would reaffirm to the world the convertibility of the dollar. At the same time it would meet the long-run requirements for an expansion in note circulation commensurate with steady growth in the economy."
Dollars, Gold, and International Payments Remarks of Wm. McC. Martin, Jr. , Chairman, Board of Governors of the Federal Reserve System, before the Annual Dinner Meeting of The Bond Club of New York New York City February 11, 1965
"Two weeks ago, a proposal to modify our laws regarding the holding of gold as monetary reserves was put before the Congress by the President of the United States. In the interval since, we have had considerable discussion not only of that proposal but also of the entire subject of dollars, gold, and international payments.
To me, that is as it should be, for these are matters that deserve the interest and understanding of us all. Accordingly, I should like to add some comments on them tonight, though I realize that little that I might say could seem new to a group as well versed in finance as this..."
"The two-tier gold system, established at the Washington meeting of March 16-17, is threatened in two ways: (1) by South Africa's offer to sell gold to the International Monetary Fund and (2) by the desire of some European central banks to purchase gold from South Africa for addition to monetary gold stocks. The U. S. response to this problem ought to preserve the essential character of the two-tier system as the U.S. views it, while avoiding either a breakdown of international monetary cooperation or a divisive battle in the IMF over its legal obligation to purchase gold from members. The two-tier system may be said to have both a short-term and a long-term significance. For the short-run, it was intended to discourage upward pressures on the market price of gold, by saying to the market that central banks would not be contributing to the demand for gold. All the participants in the Washington meeting were in agreement that the smaller the margin by which the market price of gold exceeded the official price, the greater were the prospects for international monetary stability. If the market price of gold remained relatively low, it was less likely (1) that central banks would convert foreign exchange into gold out of fear of a rise in the official price of gold and (2) that private parties would speculate on a change in relative exchange rates by moving their funds into what they regard as strong currencies. The longer-term significance of the Washington Agreement-- and on this there is less than full unanimity among the participants-- is that the two-tier system represents an important step toward diminishing the role of gold in the international monetary system. In particular, if monetary authorities would act upon the statement that, in view of the prospective creation of the SDR facility, the amount of gold in monetary stocks is sufficient, gold would play no significant role in the future growth of monetary reserves. In effect, gold would have been demonetized at the margin. This interpretation of the two-tier system has not been accepted by some European central banks and it is not possible at present to persuade them to accept it. In fact a public airing of this interpretation by U.S. officials' would probably lead some European central bank officials to disagree publicly. The best the United States can do in present circumstances is to avoid an open breakdown of the Washington Agreement while seeing to it that any new policy agreements are not inconsistent with our preferred interpretation of its longer-term significance.
Solution to Problem It is believed, within the U.S. Government, that the best way to meet the present challenge to the two-tier system is to agree to provide through the IMF a floor price at $35 per ounce for newlymined gold that South Africa (and other gold producers) need to sell to meet their balance of payments requirements. As another concession, South Africa would be permitted to count its gold holdings as of July 1, 1968 as monetary gold. In exchange for these concessions, South Africa would be expected to sell newly-mined gold in the market, as its payments position requires, and to avoid special efforts to withhold such sales. South Africa would not offer monetary gold to central banks or the IMF unless it had disposed of all of its supplies of newly-mined gold. Finally, South Africa would withdraw its present offer to sell gold to the Fund.
Advantages of this Solution
1. This solution provides for an accommodation with South Africa and makes it possible to end the existing uncertainties in South Africa's dealings with the market, monetary authorities, and the IMF. The alternative proposal for ending these uncertainties--agreement on central bank purchases of some amount of newly-mined gold even when the market price is above $35--would constitute an open break with the Washington Agreement and would make it much less likely that the longer-term significance of that Agreement would be realized.
2. The proposed solution assures the market of a resumption of South African sales and prevents South Africa from choosing between market sales and sales to monetary authorities or the Fund as a way of maximizing the market price.
3. Central bank purchases of newly-mined gold continue to be precluded. Additional gold can enter the monetary system only if and when the market price falls to $35 per ounce or below. An opening of the system to additional gold in these circumstances would clearly be consistent with the short-run significance of the Washington Agreement. Purchases by the Fund when the price is at $35 or below would not be in conflict with the objective of minimizing the margin between the official and market prices, since such purchases would occur only when this margin were zero (or negative). (It should be noted that while the proposal would provide a floor price for sales of gold by South Africa as its payments position requires, the proposal would not put an institutional floor under the market price and would not therefore assure speculators that there is no risk at all of the market price falling below $35.)
Additions to IMF gold holdings (and the possibility that the Fund would sell such gold to members) under this proposed solution would not be inconsistent with the desire to see a diminished emphasis on gold in the long run. Gold would enter the official reserve circuit only if and when the market is placing a valuation on gold equal to or less than the official price. In the longer run, present expectations are that the market price is likely to rise above $35, as private non-speculative demand grows relative to supply. Thus, little gold would be bought by the Fund over the years. As time goes on, the market price will have less and less significance for the monetary system, assuming the U.S. balance of payments improves and the SDR facility is activated. But during the present transition period, it is vital to avoid any sort of shock that would give the market price an upward push..."
DOLLAR STABILIZATION. — Under the existing currency system,
the so-called “level of prices” is largely at the mercy of monetary and
credit conditions. The tide of prices will rise or fall with the flood
or ebb of gold or of paper money or of bank credit. Evidently a rise in
the level of prices is a fall in the purchasing power of the dollar or
other monetary unit, and viceversa. The purchasing power
of money has always been unstable because a unit of money, as at present
determined, is not a unit of purchasing power, but only a unit of
weight. It is the one inconstant unit of measurement left in
civilization. Other units — the yard, pound, bushel, etc. — were once
as unstable and crude as the dollar, sovereign or franc still are; but,
one after another, the other units have all been stabilized or
standardized. Short weights and measures cheat the buyer; long weights,
the seller. So a unit of money which changes in value or purchasing
power is always playing havoc between contracting parties. When prices
are rising — in other words, when the purchasing power of the dollar is
falling — the creditor and the creditor-like classes suffer injustice.
The sufferers include savings-bank depositors, bond-holders, salaried
classes and wage-earners. In the great upheaval of prices — i.e.
in the United States, depreciation of the dollar — which took place
between 1896 and 1921 such injustice amounted to over a hundred billion
dollars. On the other hand, when prices fall, as they did between 1873
and 1896, it is other classes — debtors, stockholders, farmers and
independent business men generally — which suffer the injustice. The
indirect effects of falling or rising prices — i.e. of a rising
or falling dollar — are equally bad.These indirect effects include
industrial discontent (either over the “high cost of living” or
unemployment) and economic crises and depressions.
Hitherto there was ample excuse for the unstable monetary units of
various countries. No instrument for measuring their aberrations had
been devised. Likewise, until weighing scales were devised, weights
could not be standardized, and until instruments for measuring
electrical magnitudes were invented, electrical units could not be
standardized. But for many years the “index number” of prices has
provided an accurate instrument for measuring the value of the dollar in
terms of its power to purchase goods. An “index number” of prices is a
figure which shows for a specific period of time the average percentage
increase or decrease of prices. One of the most suggestive signs of the
times is that this instrument for measuring changes in the purchasing
power of money has recently been utilized in adjusting wages and
salaries to the high cost of living, i.e. to the depreciated
dollar. A number of industrial concerns and banks, and some official
agencies, have amended wages by the use of an index number of the prices
It has been contended by some economists that this principle may be
utilized in the future more generally to safeguard agreements made at
one date to pay money at another date. Such corrections of the dollar
would gradually break down the popular superstition that “a dollar is a
dollar”; for every time we correct the dollar, we convict it of needing
corrections; and ultimately the correction might be applied, not, as at
present, as a patch on the dollar from the outside, but by
incorporating it in the dollar itself. Various methods for accomplishing
this have been proposed. The one perhaps best known is Prof. Irving
Fisher's proposal to vary the weight of the gold dollar so as to keep
its purchasing power invariable. Instead of a gold dollar of constant
weight and varying purchasing power, what is needed, he contends, is a
dollar of constant purchasing power, and, therefore, of varying weight.
It is not proposed, of course, to remint gold coins, but simply to count
an ounce of gold bullion as being the equivalent not always of $20.67 (
as at present) but of as much more or less than that sum as is required
from time to time in order to keep the purchasing power of the dollar
constant. In other words, the proposal is to vary the price of gold
according to its worth relative to other commodities, instead of, as at
present, keeping it artificially constant at $20.67 an oz. pure or £3
17s. 10½d. an oz. 11/12 fine. In this way, Professor Fisher contends, we
can control the price level, lowering it, raising it, or keeping it
from fluctuating much, if at all. Thus, if Mexico should adopt the
dollar of the U.S. (instead of its present dollar of half the weight of
gold), the price level in Mexico would be disastrously cut in two.
Again, if the U.S. should adopt the Mexican dollar, the price level in
the U.S. would be disastrously doubled. That is, the more gold in the
dollar, the greater its buying-power; and the less, the less. If,
Professor Fisher contends, this principle be admitted, it follows that
we hold, in the hollow of our hand, what the dollar's buying-power shall
be — that is, what the level of prices shall be.It can be kept from
changing greatly just as easily as it could be made to change, simply by
periodical adjustments of the price of gold, each adjustment being made
in accordance with the index number of prices. By this method, in
conjunction with any of the sound systems of banking, Professor Fisher
contends, variations of more than one or two per cent could easily be
prevented except under the most extraordinary conditions. (I. F.)
--- Continue - discussion about the Compensated dollar plan:
Origins and developments of Irving Fisher's compensated dollar plan
In 1911, Fisher published The Purchasing Power of Money . In chapter 13
of the first edition and in an appendix in the second section of 1913,
he introduced a rule to maintain the stability of the level of prices,
known as the “compensated dollar”. According to this rule, the legal
definition of money is changed. In other words, the weight in gold of
the dollar is modified once a month in order to impede the frequency of
price changes on a basket of goods. According to Fisher, this plan would
offer stability for the purchasing power of money. He sought to find an
alternative system to the fixed price of gold under the Gold Standard.
He wanted to introduce a dollar fixed in terms of its purchasing power,
but variable in terms of its metallic weight. In this paper, we will
focus on Fisher's analysis of the stability of money value and his
position in the debate on the compensated dollar from 1909 to 1922. We
will study the anticipations of Fisher's compensated dollar, the
critical reception of Fisher's project and the evolutions it gave rise
to, the gold exchange standard and the algebraic evidence. We also
examine the debate's connections to the question of whether or not the
compensated dollar plan is compatible with the quantity theory of money.
We end with the analysis of the gold price elasticity of the net supply
of gold, with an explanation of the relationship between the
Yellowbacks and the varying price of the gold reserve.
"The so-called Blessing letter, dated 30 March 1967, forms part of the correspondence
between the President of the Deutsche Bundesbank at the time, Karl
Blessing, and the then Chairman of the Board of Governors of the US
Federal Reserve System, William Martin. In the letter, Blessing
addresses US concerns that the Bundesbank might convert US dollars into
gold on a huge scale.
Such US fears have to be seen against the backdrop of the Bretton Woods
Treaty, which was still in force at the time and under which the
US dollar was backed by gold. The terms of this Treaty meant that the
United States had an obligation to convert dollars into gold on demand.
Since the end of the 1950s, however, there had been fears in the US
that the right to convert dollars into gold could be used on a large
scale, especially by European countries, where dollar surpluses had
built up owing to the substantial US military presence and the expansion
of investment by US industry.
Converting US dollars en masse could have used up US gold reserves and
negated belief in the dollar actually being backed by gold. This risk
became very acute in the mid-1960s owing to the economic situation of
the United States at the time, which had already run up a large balance
of payments deficit in the wake of the Vietnam War and the associated
This pressure was made more intense by increased inflation in the
United States, which threaten to spread to countries in Europe on
account of the Bretton Woods system of fixed exchange rates.
However, an actual reduction in the US deficit could have prompted
the US government to conduct a more restrictive trading policy, reduce
investment or withdraw American troops from Europe – few politicians in
Europe would have been prepared to bear the consequences of this. In
order to keep confidence in the dollar stable, the Americans therefore
relied on a policy of mutual agreements on both sides of the Atlantic.
This policy had the aim of achieving perpetual surplus dollar holdings
in Europe, thus allowing the US to maintain its own balance of payments
The Blessing letter has to be seen in this historical context. In the
letter, Karl Blessing promises, in effect, to refrain from a
large-scale dollar conversion into gold. He stresses that such restraint
represents the German contribution to international monetary
cooperation and is intended to avoid any disrupting effects on the
international foreign exchange and gold markets.
In connection with the Blessing letter, historians often refer to an
interview which Karl Blessing gave to the German magazine “Der Spiegel”
in 1971, in which he himself calls into question his earlier concessions
– “I state to you now that I feel myself to be personally culpable in
this matter. I should have been more rigorous with regard to the US. The
dollars that we were accumulating should simply have been rigorously
converted into gold.”
He explained that, at the time, has fears of the foreign policy
implications, which would have led to the withdrawal of American troops
from Germany, had been one of the factors that led him to give in to US
See “Der Blessing-Brief”,
30 March 1967 (Source: Historical Archive of the Deutsche Bundesbank,
Frankfurt am Main, Shelfmark: HA BBK B 330/10799). The Blessing letter
is also archived at the Lyndon B. Johnson Presidential Library in
Austin, Texas, http://www.gata.org/files/BundesbankLetter-03-30-1967.pdf
Heise, Arne, Grundlagen der Europäischen Währungsunion. Theorie, Institutionen, Politik, Düsseldorf 1997, p 41.
Zimmermann, Hubert, Western Europe and the American Challenge: Conflict
and Cooperation in Technology and Monetary Policy, 1965-73, in Journal
of European Integration History 6:2 (2000), pp 85-110, p 88.
pp 89-90. The possible implication of the US balance of payments
deficit for the stability of the dollar, the leading currency in the
Bretton Woods system, therefore shaped the debate on financial policy in
the 1960s. See Schmidt, Heide-Irene,“The Embarrassment of Strength”: Die deutsche Position im “International Monetary System” 1958-1968, in Deutschland, Großbritannien, Amerika. Politik, Gesellschaft und Internationale Geschichte im 20.Jahrhundert (edited by Ursula Lehmkuhl, Clemens A. Wurm and Hubert Zimmermann), Stuttgart 2003, pp 155-194, p 164.
Zimmermann, Hubert, Western Europe and the American Challenge: Conflict
and Cooperation in Technology and Monetary Policy, 1965-73, in Journal
of European Integration History 6:2 (2000), pp 85-110, p 89.
Ibid p 88.
correspondence on the Blessing letter. Among historians, there is some
dispute about the precise significance of the letter. Hubert Zimmermann,
for example, interprets the letter as the Bundesbank waiving its
autonomy: “the Bundesbank (with the Blessing letter) deprived itself of
an important aspect of monetary autonomy” (quoted from Hubert
Zimmermann, Money and Security. Troops, Monetary Policy, and West
Germany’s relations with the United States and Britain 1950-1971,
Cambridge University Press, Cambridge 2002, p 227). Heide-Irene Schmidt,
on the other hand, disagrees with this interpretation by pointing to
German interests: “Der Blessing Brief
beschreibt vielmehr die bisherigen Maßnahmen der Bundesbank und die
zugrunde liegenden Intentionen internationaler monetärer Kooperation; er
betont die Absicht, diese Politik fortzusetzen. Ein Autonomieverzicht
kann daraus umso weniger abgeleitet werden, als die Bundesbank vor und
nach diesem Brief Ansätze ablehnte, die USA über devisenpolitische
Maßnahmen (d.h. Verkauf von Dollar gegen Gold) zu einer „vernünftigeren“
Zahlungsbilanzpolitik zu zwingen. Die damit verbundene Destabilisierung
des Wirtschafts- und Währungssystems lag nicht im deutschen Interesse.”
[=The Blessing letter in fact describes the measures taken by the
Bundesbank hitherto and the underlying aims of international monetary
cooperation; it stresses the intention to continue this policy.
Inferring a waiver of autonomy is even less feasible given that, before
and after this letter, the Bundesbank had rejected any attempts to use
foreign exchange policy measures (ie the sale of dollars for gold) in
order to force the United States into a “more reasonable” balance of
payments policy. The associated destabilisation of the economic and
monetary system was not in Germany’s interests.](quoted from Schmidt,
Heide-Irene, “The Embarassment of Strength”: Die deutsche Position im “International Monetary System” 1958-1968, in Deutschland, Großbritannien, Amerika. Politik, Gesellschaft und Internationale Geschichte im 20. Jahrhundert (edited by Ursula Lehmkuhl, Clemens A. Wurm and Hubert Zimmermann), Stuttgart 2003, pp 155-194, p 164.
See Der Spiegel (19). 1971: “Der Brief gilt leider noch heute”, published 3 May 1971, http://www.spiegel.de/spiegel/print/d-43257718.html (retrieved on 11 January 2013)
Zimmermann, Hubert, Western Europe and the American Challenge: Conflict
and Cooperation in Technology and Monetary Policy, 1965-73, in Journal
of European Integration History 6:2 (2000), pp 85-110, pp 89-91. Quoted
by Karl Blessing from his own recollection of a telephone conversation
with John McCloy, who at the time was the US negotiator in the
Trilateral Negotiations,“Und ich habe ihm
gesagt: Mein lieber McCloy, Ihre Situation ist klar, das ist ein
Zahlungsbilanzproblem bei Ihnen, nichts weiter. Sie haben gesehen, daß
wir vernünftig sind und unsere Dollar nicht in Gold konvertieren.”
[= And I said to him, my dear McCloy, your situation is clear; what you
have is a balance of payments problem, nothing more. You have seen that
we are being reasonable and not converting our dollars into gold]. And
regarding his assessment of the external situation at the time: “Ich
habe damals eingesehen, wenn die Amerikaner abziehen würden, dann
hätten wir natürlich außenpolitisch unter Umständen eine Malaise
riskiert. Ich habe die Dinge immer ernster gesehen als sogar die Bonner
Regierung, mit Ausnahme von Schröder. Der hat mich immer gebeten, den
Amerikanern zu helfen.” [= I realised at the time that, if the
Americans were to withdraw, we would naturally have perhaps been risking
a malaise in terms of foreign policy. I invariably viewed things more
seriously than even the government in Bonn did, except for Schröder, who
always asked me to assist the Americans.](quoted from Brawand, Leo, “Wohin steuert die deutsche Wirtschaft?”, Munich 1971, pp 61-62)."
Thanks to the economic performance of West Germany, the Bundesbank
accumulated significant gold reserves over the years through
cross-compensation between central banks – in particular with partner
central banks in the major industrial countries.
Due to a surge in gold purchases in 1967 and 1968, the Fed amassed
sizeable gold delivery obligations at the storage site in London. At the
time, the Bundesbank provided the Fed with Good Delivery gold amounting
to a total value of $1 billion in gold swaps at the London site.
In return, the Fed gave the Bundesbank “government stamped bars” of
gold to the value of $350 million at the storage site in New York as
well as Good Delivery gold in the amount of $650 million at the storage
site in Ottowa (Canada). Overall, the swaps generated a return of
$470,651.05 for the Bundesbank. The transaction was settled in seven
instalments in the period from 5 April to 26 June 1968, with the
Bundesbank holding the received bars at the storage sites in New York
Quality checks during the transaction
Initially, the Fed only repaid one quarter ($250 million) of the amount
due from the gold swaps with Good Delivery bars, as its reserve of Good
Delivery bars had fallen strongly. The remaining bars with a
countervalue of $750 million were of a different quality. In agreement
with the Bundesbank, these bars were initially retained on a gold
suspense account, to be booked as Good Delivery bars only after their
weight had been assessed and they had been melted to form Good Delivery
gold. After melting, a discrepancy of 18.412 ounces was established in
the weight of the bars, which corresponded to a countervalue of $644.44.
The Fed compensated the Bundesbank for both the costs incurred from the
melting process, which amounted to 4519£ 7s 8p, and the discrepancy in
the weight of the bars. Footnotes:
Source: Historical Archives of the Deutsche Bundesbank, Frankfurt am Main, Signature: HA BBk B 330/20835
standard bar of gold that complies with the Good Delivery quality
standard has a fineness of 995 ‰ and a nominal weight of 400 troy
ounces, ie 12.44 kilograms, but it can vary in weight from 350 to 430
troy ounces. 1 troy ounce is equivalent to 31.1034768g.
"Euro-area banks can now borrow money from the European Central Bank (ECB)
more cheaply than ever before. The ECB’s policy rate – also known as
the main refinancing rate – has stood at 0.5% since the beginning of May
this year. It was still above 4% in mid-2008 but has been lowered
progressively since then. At the moment, monetary policymakers have good
reason for setting the policy rate at that level. Yet their very
expansionary policy has also kept interest rates on the money and
capital markets low for a prolonged period now. This will chip away at
savings, steer banks towards riskier business and set the wrong
incentives for highly-indebted governments.
For central banks like the ECB,
policy rates are the most important tool for keeping the value of their
currency stable, in line with their mandate. The policy rate determines
how much commercial banks must pay to borrow money from the central
bank. A central bank also uses its policy rate to influence conditions
on the "money market"; via various channels, this then affects demand in
the economy as a whole and, ultimately, the price level.
Interest rate cuts make central bank money cheaper
By deciding to lower its policy rates, for example, a central bank
initiates the following process. The lower policy rates make it cheaper
for commercial banks to borrow central bank money. This enables the
commercial banks to offer cheaper loans to enterprises or consumers, who
are then more inclined to make investments and buy goods and services
because of the favourable lending conditions. If investment and
consumption increase overall, the aggregate demand in an economy rises
and the economy gathers momentum.
So it is easy to see why the ECB
has lowered its policy rate time and again in recent years: this is one
of the many measures it has taken to alleviate the effects of the
financial and sovereign debt crisis and stabilise economic developments
in the euro-area countries. Given the limited risk of inflation, the ECB has been able to do this without jeopardising its objective of maintaining price stability over the medium term.
Inflation chips away at savings
However, a sustained period of low interest rates poses the risk of a
rise in prices after a certain length of time. If consumer prices
increase across the board rather than just for some specific goods and
services, a currency loses some of its value in a process called
"inflation". Yet this does not merely affect day-to-day purchases. A
lengthy period of low interest rates can also encourage investors to
channel large amounts of money into assets such as real estate, stocks
or precious metals, causing their prices to rise. This risks generating
dangerous speculative bubbles. The central bank then has to raise its
policy rate early enough to avoid losses in purchasing power and the
emergence of price bubbles.
According to Bundesbank President Jens Weidmann, there should be "a
timely rise in key interest rates if there are signs of increasing price
pressures in the future".
Otherwise, savers in particular will suffer the ill-effects of low
interest rates. Call deposit accounts or fixed-term savings accounts
yield little profit if their interest rates are low. If interest rates
on savings accounts are below the rate of inflation, savers will make a
loss on their deposits: the real value of their savings will fall,
making it less and less attractive to put money aside for the future.
Risky investments become enticing
Banks and insurance companies face similar problems to savers. They
have to make profits in the long term even when interest rates are
generally very low. They tie up some of their customers’ money in
long-term investments, such as ten-year Bunds (bonds issued by Germany’s
central government), which are viewed as particularly safe. Once these
securities mature (ie become due for repayment), banks and insurers have
to reinvest these funds subject to new terms and conditions. In the
present market environment, however, the return on these kinds of
investment is so low that they only generate a small profit for banks
and insurance companies.
Financial institutions therefore often look for more profitable
investments. They move their funds from low-interest, comparatively safe
investments to higher-yielding, riskier ones. This, in turn, can
generate risks to the stability of the financial system.
Recent figures on developments in financial assets in Germany reflect
a search for higher potential returns: in the period under review,
households withdrew funds from fixed-term and savings deposits and from
fixed-interest securities, channelling more money into stocks and mutual
fund shares. Businesses also invested heavily in securities and reduced
their bank deposits.
Yet all of this is apparently still being overshadowed by another
effect: the ongoing crisis has shaken confidence in many quarters. If in
doubt, investors are tending to go for comparatively safe options, in
what economists dub a "flight to safety". Future developments in asset
prices and risk-taking still warrant careful observation, however.
The temptations of cheap money
Though a headache for investors, the low interest rates are a
blessing for anyone taking out new loans: they have made borrowing
extremely cheap, above all for governments. A sustained period of low
interest rates is therefore very much in a government’s interests, all
the more so if its existing debt is high: higher interest rates would
increase the financial burden on indebted governments.
Reforms and structural change are needed in order to overcome the
sovereign debt crisis. However, the low interest rates are easing the
pressure on governments to actually tread the thorny path of change.
They might be tempted to pressurise central banks into maintaining low
policy rates for as long as possible to avoid any major changes to these
According to Bundesbank President Jens Weidmann, low interest rates
"tempt decisionmakers to delay reforms and necessary structural
1. "The stability of the financial system within European monetary union", speech held by Jens Weidmann in Munich on 11 July 2013."
In October, 1979, the Federal Reserve Board instituted a sweeping policy change. This change of "policy is discussed in this paper, and the possible effectiveness of the new policy is evaluated.
The paper is addressed to an intelligent layman in the insurance industry who may not be familiar with operations of the Amerlcan banking system. As a result, the operation of the central bank, the definitions of money, the author's definitions of'price and monetary inflation, the relationships between measures of money and Gross National Product are all discussed before prospects of the new policy's success is discussed. If the paper appears to be too pedagogical in nature, the author does apologize to the reader. However, the author cannot over emphasize how grave a matter price inflation can be for the insurance industry. An understanding of how the central bank works and what we in fact use as money today can shed light on how price inflation may be controlled.
Inflation is indeed a world-wide problem. At no time in history has there existed a situation when no country is spared the declining purchasing power of its national currency. Even Swltzerland, over the past 15 years, has seen prices rise in terms of its currency. We have become victims of a fallacy that price inflation is an inherent part of civilization. This mistaken view is especially held by young people who have really had no other experience.
Countries affected by high rates of inflation see their middle classes progressively wiped out of their liquid assets. Any semblance of sound credit arrangements is destroyed; and, as a result, additional risk is incurred by business enterprises to finance growth and real productivity increases. In especially severe situations, with the economic voting power of the middle classes destroyed, the void of economic power of the middle classes is substituted with dictators of either leftist or rightist persuasions. Inflation can eventually ruin both individual freedom and democracy.
Keeping in mind the potential gravity of the situation, let us proceed. Please bear with the author through the details. If the paper's conclusions are correct, you will be able to determine from readily
available government data if price inflation is being controlled and to what extent.
INFLATION & INSURANCE
The Property & Casualty industry's indemnity contracts are basicall promises to reimburse parties with money usually after the payment of premium. The delay between receipt of premium and payment of loss can be quite long. Other services llke engineering inspection and risk management more closely resemble the activities of non-financlal corporations; services are more nearly rendered at the time of money transaction. The Life Insurance industry to a far greater extreme defers benefits. It's the deferral period between payment of premium and payment of benefit that gives the insurance industry a vital interest in the maintenance of the general population's confidence of the "store of value" function of money. Needless to say, a Reichsbank-type hyperinflation would destroy the insurance industry..."