History’s warning about the price of money
As one of the great monetary economists of the last century, Jacques Rueff, pointed out in the late 1960s, people react to the “growing insolvency” of a reserve currency, such as the dollar, by acquiring “gold, land, houses, corporate shares, paintings and other works of art having an intrinsic value because of their scarcity”. Sounds familiar? Indeed, this is the story of our present decade, one in which alternatives to the dollar as a store of value have soared even while the CPI has remained subdued.
This phenomenon is well-known in developing countries, where asset booms combined with low CPI inflation have preceded monetary and financial crises.
Between August 2001 and August 2007, the dollar price of gold soared 144 per cent, while the CPI rose only 17 per cent. The last time such a substantial and sustained appreciation of gold was observed was in the 1970s, on the heels of America’s loose money policy and balance of payments deterioration in the 1960s and Rueff’s warnings regarding “the precarious dominance of the dollar”.
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The dollar sustained its role as the international standard of value because of good fortune on two fronts. First, the Fed under Paul Volcker hammered out inflationary expectations with a painful but necessary period of high interest rates. Second, there was no viable alternative.
Today, in addition to that traditional refuge, gold, we have the euro available as a stable currency backed by deep and liquid markets, a worging regulatory and legal regime, and the highly credible monetary policies inspired by the Bundesbank.
And interestingly, apart from the special cases of Spain and Ireland (two peripheral economies that used the past 2 decades to play - very successfully - catch up), there has been no housing bubble to speak of in the eurozone - indeed, Germany has seen house prices essentially stagnate over the past 15 years. But there is one economy that has "enjoyed" its own debt fuelled boom - the UK.
Wolfgang Munchau (Financial Times)
Perhaps the biggest structural problem of the UK is an over-reliance on personal debt and a built-in tendency towards speculative housing bubbles. Britain has owed much of its 15-year spell of good economic growth to an unprecedented credit and housing binge that has lasted abnormally long.
(...) housing cycles are very long – long enough even for rational people to form irrational expectations. The boom was driven by cheap money and abundant credit and it was sustained by an irrational belief that prices would rise for ever in real terms. The downturn is driven by the same process in reverse: expensive money, a credit squeeze and an equally irrational belief about how far prices can drop.
The underlying mechanisms of "prosperity" in the US and the UK in recent times have been very similar. Beyond the fact that most of the wealth that has appeared in statistics goes to the very wealthy, their main driver has been a staggering boom in debt and its twin, asset appreciation, which both makes debt look smaller and justifies taking more of it.
In both countries, asset price inflation reflect a debasement of currency by increasing financial speculation while the underlying economy stagnates. That's what I've dubbed the "Anglo Disease" (see earlier articles at the bottom of this diary): a focus on wealth capture via the relentless use of financial instruments to push the logic of ever growing returns on capital, which both drains the real economy and feeds an ever larger virtual economy based on Ponzi finance jobs and (slightly less virtual) house building.
Such parasiting of existing wealth can last for a while, as the middle class uses up its reserves to keep up (see the savings rate) and the pressure is ratcheted up and up on the weaker members of society, who are told that they just have to work harder, or have to face "deserving" their low status. In the case of the US and the UK, two additional strategies have been used to parasite wealth from other countries:
- in the case of the USA, the role of the dollar as global reserve currency cannot be overstated. Being able to borrow freely in one's currency, in the knowledge that others are forced to buy the currency to trade or to hold reserves, is a huge privilege, which can easily be abused (and it has) - abuse which can be tolerated for a long time as long as it remains commensurate to the benefits for others of having a reserve currency, and that it does not bring political problems at home. Warmongering and higher interest rates are bringing an end to that.
- in the case of the UK, the trick has been twofold: (i) to import foreign billionaires (by offering them an unbeatable tax regime, ie no taxes on earnings from outside the UK), which nicely feeds the top end of the housing market and, in a very trickle down effect, pulls all real estate prices up as everybody else has to pushed outwards (it also creates a nice self-fulfilling boost to the image of London as the place to be for the jetset et al) and (ii) to export the parasiting competences of the city on the rest of the European economy which is, after all, subject to the same globalisation forces, and the same competition for capital seeking out the best returns and the lowest taxes. Accompanied by a consistent ideological discourse (the inevitability of the Thatcher-Reagan neoliberal reforms) and the constant drum of the "success" and mystique of the City and Wall Street and their well-heeled professionals, this has had a good run. But changing the way other economies work can happen only once, and, even if their numbers are growing exceedingly fast, billionaires can relocate only once as well.
As always, the boom will be followed by a bust, in the form of inflation, followed and/or repressed by significantly higher interest rates. And just as the boom has been particularly extravagant, the boom is likely to be just as painful.
However, the two articles above suggest that the two countries may take different paths to get there: a currency crash in one case, as foreign investors move out of the dollar, triggering higher interest rates (and a recession) even before inflation is visible in the CPI numbers; and a housing market crash in the other, as market psychology changes bring out more stringent lending standards, and speculative buying collapses.
What hasn't entered the general discourse yet, and this is where our work is, is that this boom-and-bust cycle was by no means inevitable: it was the result of an explicit ideological drive, whose goal was to hollow out the State and all the policies enacted out since the first half of the 20th century precisely to avoid the destructive effects of boom-and-bust. The current prosperity is doubly illusory: (i) because it benefits only a very small minority and (ii) because it was based on currency debasement via cheap credit and debt forced upon the majority to cope with stagnating wages.
It is not intrinsically "anglo" - after all, the New Deal and a thriving middle class were created by progressive Americans, but I am nevertheless using that name to reflect the unavoidable origins of the ideology, the places where it was put in action first, and the location of the two main centers of the financial world: the City and Wall Street, which drive so much of the political drivel we have to fight today.
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