Alan Go Braugh

ALAN GREENSPAN'S POT O' GREEN

By Gary North

ALAN GREENSPAN DRESSED FOR WORK

This week was St. Patrick's Day. When we think of Irish myths, we think of little people dancing to the music of tiny fiddles. We think of rainbows leading to pots of gold. Above all, we think of green.

Americans have imported and then re-worked these myths, bringing them up to date. The little people are gone. They stayed behind in Ireland. The gold stayed with them. Here, rainbows lead to pots of green.

Yes, there is a yellow brick road. It leads to the Emerald City of Oz, where the Wizard resides. As soon as you get inside the gates of the Emerald City, however, the yellow bricks disappear. Inside the Emerald City, yellow is an unacceptable reminder of a barbarous relic. Silver slippers are not in fashion, either. In the Emerald City, one always wears green. In the Emerald City, every day is March 17.

THE RUN ON AMERICA'S GOLD BANK: 1958 UNTIL TODAY
Prior to August 15, 1971, foreign central banks could legally demand payment in gold for dollars they presented to the Treasury. The official exchange rate was fixed at $35 per ounce. From 1945 to 1957, central banks rarely made the exchange. A trade surplus had been America's luxury, 1945-57. West Europe was in no condition to compete against us. We loaned them the money, or else gave it to them through the Marshall Plan. Contrary to textbook accounts, the Marshall Plan was a foreign aid program that subsidized large-scale American export companies at the expense of American taxpayers, whose money funded the Europeans' purchase of American goods.

In 1957, the U.S. government's official gold reserve peaked in its number of ounces. Gold began flowing out in 1958, the year the Eurodollar market began, and it kept flowing out until 1971. Gold's bargain price of $35/oz was too much for central bankers to resist. Central banks started stacking up gold bars in their piles in the depository at the Federal Reserve Bank of New York. (Remember "Die Hard III"?)

In the mid-1960's, gold began flowing out of the United States' official stockpile of gold because of Lyndon Johnson's decision to pay for his war on poverty and his war in Vietnam without raising taxes officially. He called on the FED to buy U.S. debt, which it did. The Chairman of the FED at the time, William McChesney Martin, Jr., had held this office since 1951. In the late 1960's, he went along to get along. (Nixon replaced him with Arthur Burns in 1970, and had tried to replace him in 1969. He blamed Martin's tight money policy in 1960 for his defeat by Kennedy, which was probably an accurate assessment.)

In early 1968, when gold's price in private markets went above $35, central banks started selling their gold to private buyers at prices higher than $35. They would then buy more gold from the Treasury at $35. It was a sweet deal for them. A two-tiered gold price was imposed by Johnson in March, 1968. It failed to stop the outflow. In August, 1971, Nixon suspended gold redemption.

Critics of the FED's monetary policy in the 1960's pointed to this international "run on the gold bank" by foreign central banks. They declared that the cause was monetary expansion. An incipient hard-money movement began to take shape in this period. There were even a few economists who sounded the warning: members of Walter Spahr's Economists National Committee on Monetary Policy. (In 1968, I was its newest and youngest member.) But these warnings went unheard in high places, or even middling places.

Critics of the hard-money camp adopted this slogan in response: "You can't eat gold." Quite true, as I admitted at the time. But I added this obvious point: you also cannot eat Federal Reserve Notes.

The FED has never wavered for very long in its commitment to sacrifice its gold holdings for the sake of expanding the monetary base. There is increasing evidence that the FED has quietly transferred most of its gold holdings to the German Central bank, which has in turn loaned the gold into the private markets. By lending physical gold rather than selling it, the central banks have allowed themselves the right to keep on their books the transferred gold, as if it had not been delivered to the world's private gold market.

Central bankers have had no more difficulty in lending gold to the so-called bullion banks at about 1% per annum than international money-center commercial bankers had trouble lending money to Argentina's government. The bullion banks sold the borrowed gold, just as Argentina's government spent the borrowed money. The bullion banks' difficulty will come in getting re-paid in the commodity that was borrowed: in this case, gold bullion.

Today, to keep from letting voters know what is happening to their nations' gold holdings, central banks lend the gold rather than sell it outright. If James Turk is correct, the game is still the same: a flow of U.S. gold into foreign central banks as "swaps," and from there through the bullion banks into the private markets. This time, however, there is no resistance from the FED. In fact, Turk believes, there is cooperation.

DIGITAL WEARING OF THE GREEN
Since the beginning of 2002, the Adjusted Monetary Base has risen at a rate of 15% per annum or higher.

The Federal Reserve System's policy of rapid money expansion has produced mild economic recovery, matching the mild recession of 2001, which was mitigated by the FED's expansion of money at the time. In January, business inventories climbed by $2.1 billion, or 0.2%. This was the first increase in a year. In the 4th quarter, business inventories fell at an annual rate of $151 billion.

Despite the recession of 2001, America's current account deficit in the 4th quarter was $98.8 billion, slightly above the $98.5 deficit of the 3rd quarter. We are seeing a steady expansion of the trade deficit in the range of $400 billion a year, recession or no recession. America's consumers are still buying foreign goods with abandon.

This is another way of saying that foreigners are investing $400 billion a year in the United States. This can be viewed optimistically: foreigners like the prospects of America's economic future. They think the dollar will keep rising in relations to other currencies. They continue to trade their goods for ownership of American financial assets. This seems to show confidence in the dollar by America's trade partners.

But this continuing trade deficit can also be viewed pessimistically. When the deficit finally ceases because foreigners cease to buy American investment assets in exchange for their exported goods, Americans will have sold off a large portion of their capital assets to foreigners. That portion of the net output of American capital that is owned by foreigners will be repatriated by them to their home countries. Why would they do this? To buy raw materials. They will finally decide to consume, as investors eventually do. They will enter the world's markets for raw materials as consumers rather than producers.

Americans have ceased to save as individuals. They are net sellers of their own capital today, just as they are net consumers of foreign goods. They are trading their inheritance for the trinkets supplied to them by foreign producers. They are in effect eating their seed corn. They are sacrificing on the altar of present consumption their personal financial futures as retirees. In this sense, they are becoming present-oriented.

I cannot see this on-going development as anything but pessimistic, long-term. There was a prophecy to ancient Israel that speaks to our situation as Americans. It was a "good news/bad news" prophecy. The LORD shall open unto thee his good treasure, the heaven to give the rain unto thy land in his season, and to bless all the work of thine hand: and thou shalt lend unto many nations, and thou shalt not borrow. And the LORD shall make thee the head, and not the tail; and thou shalt be above only, and thou shalt not be beneath; if that thou hearken unto the commandments of the LORD thy God, which I command thee this day, to observe and to do them (Deuteronomy 28:12-13).

There was a parallel negative prophecy regarding resident aliens: The stranger that is within thee shall get up above thee very high; and thou shalt come down very low. He shall lend to thee, and thou shalt not lend to him: he shall be the head, and thou shalt be the tail (Deuteronomy 28:43-44).

Today, we don't need resident aliens. Capital markets are international. An alien does not have to reside inside the jurisdiction of America to be a lender to Americans. All he has to do to secure a future economic return is to make a purchase of a capital asset, or lend money to an American debtor. Consider this: foreigners now own almost 43% of U.S. Treasury-issued debt.

In 1998, the U. S. Trade Deficit Review Commission, an official government commission, published a report on the implications of the U.S. government's increasing reliance on foreigners to fund the nation's official debt. This report drew no attention. It laid out in no uncertain terms where this development is leading.

A central question, however, which should largely determine the substantive policy response, is whether it is in the interest of the international financial system for the United States to continue to run large if not growing current account deficits. And more narrowly defined, because what the United States does will be critical to the future course of the system, is it in the U.S. interest to continue such large current account deficits?

It is extraordinary how neglected or diverse the answers are to these fundamental questions. There has been little international discussion of the subject, while in the United States some leaders and experts claim that a large external deficit is a net benefit for the United States, others believe that it has a negative impact, and still others view it as of little significance one way or the other. There are four largely independent reasons, however, which lead to the conclusion that continued large current account deficits could have substantial adverse impact on U.S. interests:
1. Interest payments on the debt. The net external U.S. debt is rising toward $2 trillion by early in the next decade, which at 7 percent interest would equate to $140 billion per year indebt servicing, or about 1.5 percent of GDP, a significant cost for Americans now and in the future.

2. Protectionist backlash. A rising U.S. trade deficit will increase protectionist pressures which, however irrational, can have an adverse impact on the overall international economic system.

3. Market volatility against the dollar. The likelihood of a disruptive shift out of dollars by foreign holders of dollar-denominated financial assets grows as the volume of such assets increases rapidly and apparently without end. The launching of the euro could generate additional speculative incentives to move in this direction.

4. Foreign government leverage against the United States. During the 1990s, central banks have been tempted to buy rather than sell dollars, but this macroeconomic-based situation could change, in conjunction with a speculative run out of dollars as in (3), whereby some other governments with large dollar holdings -- China, for example -- could threaten the sale of official dollar holdings as leverage for foreign policy or other objectives.

A CURRENCY PLAY
The reason why the dollar is stable or even rising in relation to foreign currencies is that foreigners who invest here keep thinking that it will outperform the currency back home. Foreign investors are not rushing to buy stock market dividends of 1.5% or take advantage of a federal funds rate of 1.75%. They are buying (they hope) the future appreciation of the dollar.

Consider a Chinese exporter. He is making a killing on the exporting side of his business. He can beat the Japanese, Koreans, and surely the Europeans. He can beat the American manufacturer. So, he gets a tremendous mark-up on his sales. He sells to rich Americans, not to poor Chinese. He thinks that he can stay even with his profits by investing here. This keeps him invested in the financial markets here. It is a form of risk-reduction through currency diversification.

But the money he invests here is not making much of a return. The dollar has performed well, but investments inside the U.S. are not performing well. The stock market has fallen for two years straight. Capital gains are gone. Short-term interest rates have been cut by two-thirds. This leaves U.S. bonds. Their rates have held up. And the dollar has remained stable.

If I were a Chinese exporter today, I would sell my dollar-denominated investments, buy Chinese yuan in the currency markets, and expand my operations at home. I could make a far higher rate of profit by expending my business than by holding dollars in the United States.

Why don't Chinese businessmen do this? First, they may fear that their own government is not reliable. They may think that it's safer to have money outside of China. I can understand this motivation. The rule of law of far more entrenched here than in China.

Second, there is still an aura of capitalism here. To invest in America is like investing in the mother country of entrepreneurial capitalism. Foreigners may think that the faltering of the American stock market is temporary. Most Americans think the same thing.

Consider the future of capitalism. There are some 1.2 billion Chinese. They are now -- in certain regions, anyway -- adopting private property and entrepreneurial techniques. The country is experiencing phenomenal economic growth: 8% per annum, year after year. The output of the typical urban Chinese worker is rising, due to capital flowing in from Taiwan, but mostly due to a freeing up of China's economy. Capitalism increases the rate of capitalization. These people are going to become more productive. This means that they will become consumers. They are going to go from bicycles to motor scooters.

A century ago, Europe was carving up coastal China into regional trading spheres. The Europeans saw China as this huge market for European exports. Surprise! China now sees the West as a giant prosperity sphere: a huge market for China's exports.

What is happening in China is also happening in India. Indians speak English. Their major problem is their concept of time, which is still cyclical. "Indian Standard Time" is slow and unreliable. Marxism made the Chinese Western in their view of time. India, like the Caribbean, has only partially made the transition to a clock-run society. But this will change. As India's population of a billion people become more productive, they will become competitors for the West's buyers.

We should be able to see what is coming. The pot of green at the end of the rainbow will not look so alluring as the home markets rise along with domestic productivity. Americans will find themselves having to compete with Asians for the world's natural resources. The Asians will nor be dependent on our lust to buy their goods. They will find large home markets because of capitalism's power of wealth-creation.

Americans are importing $400 billion a year, net, of foreign products. They are selling off ownership in American industry. The U.S. government is transferring ownership of American debt to foreign holders. This can go on for many years, and has. But the lure of American financial markets is comparative. Foreigner investors see our capital markets are stable and reliable -- more immune from government interference that their markets have been. They are diversifying their holdings.

But asset diversification comes at a price: lower net returns. As capitalism takes hold of foreign societies, especially Asian societies, America's semi-monopoly of reliable capital markets will find itself in competition. The competitors will be able to offer far higher rates of return on capital invested.

Why? Because when you are growing from a smaller numerical base, you can sustain higher rates of growth than you can with a larger numerical base. It's easier to grow from one to two than from a million to two million. Today, high rates of capital growth are available to domestic producers in both China and India because the productivity of capitalism is only just getting a toehold in those gigantic societies. Their capital base is still small. Foreigners find it difficult to enter these family-intertwined markets to participate. The rate of return stays high for those Asian insiders who are already part of the system. But, as capitalism spreads, and the rule of law becomes a way of life, these Asian capital markets will increase their productivity because capital flows in from domestic and foreign investors. The rate of return will fall because risk will fall. But output will remain high because of the flow of capital.

The American century cannot be maintained. The secret of America's prosperity has at last been discovered. First the Asian tigers learned after 1945. Now mainland China and India are learning. World productivity will rise. But America's dominance cannot be maintained, any more than Great Britain's 19th century dominance could be maintained.

CONCLUSION
Growing world productivity will not impoverish all Americans and Europeans. West Europeans got richer after 1945 when Americans got even more rich. Capitalism expands wealth. But it does not expand it equally.

Americans should be realistic. Asia's mainland economies are going to grow at rates that dwarf America's rates and, especially, Europe's rates. Mainland Asia has no unfunded, government-guaranteed pension systems to pay off. This alone gives Asian capitalists a huge advantage. They suffer from heavy regulation, but this is being reduced, not increased. They are walking down the side of regulatory mountain. Americans are still climbing it. (Just wait until Congress fixes the economy so that "there will be no more Enrons.")

Americans are going to pay more for raw materials. Consider oil. When all those Asian bicycles are traded in for motor scooters, the demand for oil will rise. That's what the pipeline war in Afghanistan is all about: supplying future demand for oil. Call it "Pipelineistan." See the article in the ASIAN TIMES (Jan. 25). (Link below)

A March 7 article follows up on this theme. It seems that insurance companies are not willing to insure the pipeline unless U.S. troops are there to protect it.

The U.S. military deployment in Georgia is tied to the demands of the oil and insurance companies involved in the construction of the Baku-Tbilisi-Ceyhan pipeline, analysts say.

According to experts, the insurance companies were demanding a security guarantee for the pipeline.

Commenting that Georgia was the short-term route for Caspian oil reserves, while Afghanistan was the long-term route for energy reserves, authorities have stated that every step taken in these two states has been linked to oil-politics.

The most important mission of the U.S. military deployment will be the enhancement of the security of the Baku-Tbilisi-Ceyhan route, analysts say, while the Armenian route for the pipeline has been completely shelved.

This is taken from Hoover's UK site. Hoover is one of the most respected companies in the field of economic reporting. My only objection is the title of the article. The headline guy missed a great opportunity. It should have been titled "Marching Through Georgia." A follow-up article should be titled, "The Long March." American troops with be in central Asia from now on. It's about terrorism, all right: terrorism against the long-planned oil pipeline.

Dollars won't help American consumers when two billion Asians actively enter the world's markets for raw materials -- not to sell finished goods to Americans for dollars, but to consume at home. Only one thing will allow Americans to participate as equal competitors for the world's raw materials: increasing productivity. This will require increases in thrift, liberty, and entrepreneurship. America surely has the edge in entrepreneurship, but we are steadily depleting our supply of the future-orientation that is required to build a nation of voluntary savers. Meanwhile, government regulations never decrease.

There is no pot of gold at the end of the rainbow.

There will at best be a pot of green.

You can't eat green.

Related Links:

Little Shop of Horrors: The Two Heads of Alan Greenspan

ASIAN TIMES - Jan. 25