Following the two interviews on the precarious state of the economy and the unavoidable fall of the dollar, Willem Middelkoop and I decide to dig deeper into these issues. Middelkoop manages quite well to convey enthusiasm for a subject which on the surface seems to revolve around tedious numbers. For a subject that was so boring in school, Middelkoop brings it to life by placing everyday economic reality into a larger perspective. It's then that the numbers come to life, and it's then that you begin to understand why everything revolves around money in this world. It's also then that you learn how to look beneath the surface.
Years of self-study by someone who out of sheer curiosity wanted to know just exactly what was going on with all that money resulted in an independent, unacademic look at the fundamental elements of our daily existence: money, finances, economics. Middelkoop has been a journalist from the very beginning - before he made his transition to the financial world, he was a photojournalist for the Dutch daily Het Parool. That observant eye makes him a nice partner for a conversation.
It's July 18th, a warm summer evening in Amsterdam, the wine is chilled. I turn on the recorder and begin the conversation with the fundamental question of what money is. Memories from high school Economics 101 float to the surface as Middelkoop talks about bartering. The uncreative cartoons in the study books, the non-communicative teacher, the scribbling on the chalkboard - it all flashes before my eyes. It made the subject of economics inaccessible for me, and I was someone who had more of a knack for language as it was; this didn't exactly culminate in a love of calculations and economic models.
But as a result of the first two discussions with Middelkoop I once again find myself on the edge of my seat as soon as the conversation comes around to the economy. By way of the simplistic question of what money is, we quickly find ourselves at the concept of bartering and so that people wouldn't have to trade via the mutual exchange of goods, they went in search of a valuable unit of exchange. Okay, so then what?
"Then there is really only one thing that fits the bill, and those are the precious metals. Throughout the last 4000 years, gold has been regarded as having a fixed value in almost all cultures. Whether you look at the Pharaohs or the Incas, that gold could be found everywhere. So it seemed to meet all the basic requirements that a unit of exchange had to quite nicely. Because gold presented practical problems when transporting it (heavy) and with small transactions (pay with gold flakes?), paper money was developed as a logical alternative. But of course you had to be able to exchange that paper for gold, and that gold had to actually be stored somewhere, otherwise you'd never accept that paper money. These days we think of it as normal to accept paper money, but back then you wouldn't just go and sell your cow for paper."
Later on the people who issued those certificates realized that they could distribute more certificates/banknotes than were actually represented in gold.
"Those goldsmiths found out that at the most, five to ten percent of the population came to collect that gold. And that is actually the basis of our current monetary system."
So in order to avoid quickly getting into trouble, you could issue ten times the value of your gold supply - and it's lucrative to boot.
"What we see today - quite a big leap from the year 1200 up until now - is that the entire financial system revolves around this one fundamental idea. Basically, we issue much more money than we can actually answer for. They do this in Japan, they do this in China, we do it here in Europe and they do it in America. Most money is created out of nothing, and in this way we create immense prosperity."
And so you're thinking, "that can't be good".
Middelkoop confirms this thought by way of an example from the period around the year 1720, when John Law, "a clever Scotsman", got the monopoly on the creation of money from the French regent in exchange for the financing of wars.
"That lasted for 12 years. This gave rise to an enormous boom, the greatest prosperity in France. Everything was possible, there was no end in sight - just like today. Law began creating money out of nothing, just like we are doing now, but then at a given moment that system fell apart and he had to flee the country. He reportedly fled across the border with a cart-load of gold."
Many times monetary systems have broken down.This already happened two hundred and twenty times, says Middelkoop. There have been 220 different monetary systems which were backed by insufficient amounts of gold and silver, which were in fact unsecured, and those systems collapsed at a certain point in time. There comes a point when the confidence in paper money starts dropping in such a waythat the system collapses. Middelkoop points to a number of recent examples: the ruble crisis, the crisis with the Argentinian peso, and the introduction of a new peso in Mexico in 1993. The collapse of monetary systems is not a phenomenon limited to any one time period, be it that the period we are living in stands out.
"All of us have chosen to switch on that printing press. All these different countries, all of these different power blocks, have decided to allow the value of their currencies to shrink more and more. The dollar has already lost 95% of its buying power in a hundred years; at the same time no one wants to find themselves in a situation where their currency is so strong that their export position is endangered. Let's say that the dollar were to continue to drop in value - in other words become cheaper - then the euro would get more and more expensive, which would put our export position in danger because our products would simply become too expensive.
So what are we seeing now? Japan, China, Europe, America - instead of trying to keep their currencies as strong as possible - something that used to be desirable - they are all going out of their way to keep them as cheap as possible. The reason is that the bankers and politicians are all afraid of a serious recession, especially after the collapse of the stock markets in 2001, 2002 and 2003. We all have to keep the economy on track, and we all want to protect our exports, so actually we're participating in a kind of World Championship of Monetary Depreciation. Countries are deathly afraid that they'll lose their competitive edge, so they try to protect their exports by keeping their currencies weak."
Middelkoop calls it a World Championship because it's occurring on a global scale, as opposed to earlier times.
"In the past you did find these unsecured monetary systems on a per country basis, or in a specific region. But what's happening now has really never been exhibited before."
The successful policy of Europe to issue the strongest currency has been undermined by the power of the dollar and the decision to abandon the gold standard. Even the Swiss franc is no longer backed by gold.
"In the past a fairly large percentage of the money, around forty percent, was backed by gold. You could not simply turn on the printing press. Many wars had the aim of capturing another country's gold. Once you came into possession of the gold, you could create more wealth, and you could distribute more money. But that's been completely turned on its head."
Daan de Wit:
"When Nixon abandoned the gold standard, that's when things went wrong".
"Yes, then it really went wrong. But it actually began prior to that, in 1944. Taking advantage of the fact that they emerged the great victor in the Second World War, the Americans thought: "
If we can now convince the world that all currencies should be backed by the dollar instead of gold, then we"ll be in a very, very strong position from the outset. Then we'll be the only one who can print that dollar, and everybody will have to accept that dollar - it will be the official world reserve currency."
During the Bretton Woods Conference, America "sold" us that financial system. At that time, America had to promise that the dollar could always be exchanged for gold."
As a government, you had the guarantee that your dollars could always be traded in for gold. Even though Middelkoop is all too well familiar with this story, he relates it with enthusiasm. He explains that the system worked fine until the 1960's, at which point the Vietnam War had to be financed.
"At that point the printing presses started to roll in America, and de Gaulle, the French president who had always been so opposed to this dollar system, began to exchange massive amounts of dollars for gold, along with other European countries. America saw Fort Knox emptying out (the vast American gold reserves are stored in Fort Knox)."
Richard Nixon, president of a country that at the end of WWII was in possession of the largest supply of gold, summoned his advisors together in August of 1971. Their verdict was clear: break the pledge assuring that dollars could be exchanged for gold. In the years following this decision, the value of the dollar was cut in half, while the price of gold rose from $35 to $700 per ounce. In the late 70's and early 80's, the free-falling dollar threatened to push inflation through the roof.
In order to restore faith in the dollar, the Federal Reserve intervened and raised interest rates to what are now almost unimaginable heights - 16, 17 percent. The strategy was successful - confidence in the American currency was restored. In the meantime things are changing again.
"The whole world is chock-full of dollars and the value of the dollar continues to slide. We've now gotten to the point that people are beginning to have doubts about a system that is creating unlimited amounts of dollars. And meanwhile even the Rabobank has published a study [PDF] which maintains that we now find ourselves at the beginning of the end of the dollar era. it's now a question of time, at most between ten and twenty years, before the entire dollar system has to be replaced by a new system."
HUMO magazine interviewed [3457-50] Joseph Stiglitz, the man who was chief economist for the World Bank in the late 90's, and who won the 2001 Nobel Prize for Economics. He speaks of the collapse of the global financial system as a real possibility:
Stiglitz: "It wouldn't be the first time: Bretton Woods, the monetary system that was set up after the war, fell apart at the beginning of the 1970's. The question now is whether or not the same thing will happen with the current system."
HUMO: "But you write that that's not really the question; the only question is when it will happen."
Stiglitz: "Things that can't last, don't last, I once heard someone say. How much longer can the massive U.S. trade deficit last - it's borrowing about 3 billion dollars every day - while at the same time China is experiencing a trade surplus of almost 500 million dollars per day? that's not sustainable. The question is whether or not enough people can realize this in time, so that a remedy can be found before everything falls apart. Then we're all going to be standing around in shock. But this has actually been demonstrated many times before."
Daan de Wit:
"It seems like the same mistake is made every time."
"It's extremely tempting for governments to create money out of nothing. A government always has a budget that has to be financed. Often times governments want to wage war, and that costs a lot of money. So what could be more convenient than having a printing press at your disposal that you can just crank up at will? If you read up on contemporary history, you see that it actually happens all the time. Even the Romans saw to it at a given moment to make their silver coins a little smaller, with a little less zinc and a bit more copper. Compare that with someone who makes good sausages, and each year puts 5 percent less beef in them. You"re not going to notice this in the first year, and not in the second year either, but by the third or fourth year you"ll be thinking: "These are some lousy sausages". There has always been a kind of genuine need for politicians and bankers to devalue their currency, so as to issue more money than you have. In this way you can distribute gifts, and you can finance your projects."
Daan de Wit:
"There's no such thing as a free lunch. Ultimately, everything has to be paid for."
Middelkoop nods in agreement and says that at a given moment in time it's going to be:
"...pay back time. There comes a time when people begin to lose their faith in a currency."
"...we're seeing this now, it's starting to happen with the dollar. And now there are various countries which have recently announced plans to shift their currency reserves away from the dollar and in the direction of euros. Russia has said this, the United Arab Emirates has said this, and South Korea too". it's a sliding scale, in which the pace of change starts out slowly. "But at a particular moment you reach a kind of "tipping point", and all of the sudden the currency crashes and everyone is falling all over each other in order, as in this case, to dump the dollar, and now there"s really a very serious fear of this happening.
A documentary from VPRO from last year on this problem was entitled The day the dollar falls.In the program, Cees Maas, chief financial officer for ING bank, said that at a meeting of the IMF in Washington where all the bankers had come together, the conclusion had been reached that if the dollar crashes they really won"t know what it is that they"re supposed to do either. He said that he is definitely still afraid of that happening. In short: There"s quite a lot that we can control, and there"s quite a lot that we can neutralize, but if the currency that the system is based on suffers a crisis in confidence, then we're done for."
Daan de Wit:
"Could we not then transition to a strong currency, like the euro for instance?"
"There again the euro is actually backed in large part by the dollar. Everything is way too intertwined with everything else. At the moment that the dollar (i.e., the World Reserve Currency) crashes, then every currency will have a lot to endure, every currency will be affected by the fall of the dollar."
Middelkoop explains that in that case the entire financial system could in fact topple. A complete implosion of our capitalist system is not at all inconceivable. Insiders such as Jim Rogers and Marc Faber expect this system to grind to a halt within the next fifteen to twenty years.
The American-based Indian professor Ravi Batra predicted as far back as the 1980's that communism would collapse under its own weight before the end of the 20th century. In his opinion the same thing will happen to the capitalist system before the year 2025. But it's possible that it could meet its fate within ten years, or if we're unlucky, within five. Paul Volcker, former chairman of the Federal Reserve, estimates that there is a 75 percent chance of a major crisis within five years.
In order to prevent this, a responsible global financial policy would have to be carried out. But according to Middelkoop good intentions are the first things out the door when budgets need to be hashed out or when wars have to be financed; at the moment that reserves would need to be replenished, those very reserves get looted.
He points to an article about a report by Professor Laurence Kotlikoff, a former advisor to President Ronald Reagan, which Kotlikoff wrote for the Federal Reserve. His central thesis is that, technically speaking, the United States is already bankrupt.
"America has 66 trillion dollars in unsecured financial obligations. Technically speaking you're already broke at that point. All you can do of course is prolong the current situation. Or you can opt for the well-known "flight forward"."
it's not only in the U.S. that people are living beyond their means. We're doing this in Europe as well. The so-called Zalmnorm, which mandates that the European federal budget deficit be held under three percent, has been abandoned for the time being, though it's still being adhered to more or less.
Also done away with is the regulation requiring that the amount of money introduced into the European Monetary Union (thus money created out of nothing) can't exceed 4.5 percent annually.
"Without giving too much attention to it, it was decided after the crash of the markets to abandon that ceiling. This was necessitated by slumping markets, and it was supposed to be temporary, but it's been going on for years now and we never hear anything else about it. And now if you look at how much money is being added to the European Monetary zone each year, it's up above 8 percent. While the economy is growing at a much slower pace. Anyone with a high school economics class under their belt knows that that's going to bring on monetary depreciation. And we're doing that to stimulate the economy, and because the Americans are doing it as well."
Economics journalist Willem Middelkoop on the feeble basis of our monetary system. Middelkoop (left ) is an investor and freelance economics reporter for RTL Z. He edits the free email-newslette rInveztor Nieuwsflash, a column for De Scopist and a column for Inveztor. The interview [MP3, 8 Mb, part one of the third interview] was held in Dutch. This above article was translated into English by Ben Kearney.
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