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The Quest for Monetary Order


Unsettled equity markets enjoyed a burst to the upside. For the week, the Dow gained 2.5% and the S&P500 rose 3%. Economically sensitive issues shined, with the Transports and Morgan Stanley Cyclical indices jumping 5%. The Morgan Stanley Consumer index gained 3%, and the Utilities added 1%. The broader market was quite strong. The small cap Russell 2000 surged 5%, and the S&P400 Mid-cap index gained 4%. Technology stocks rallied, with the NASDAQ100 gaining 5% for the week. The Morgan Stanley High Tech index jumped 6.5%. The Semiconductors and The Street.com Internet index surged 7%. The NASDAQ Telecommunications index rose 5%. The Biotechs jumped 6%, increasing y-t-d gains to almost 12%. Financial stocks general underperformed. The Broker/Dealers rose 3%, and the Banks added 1%. And while bullion gave back $1.70 of recent strong gains, the HUI gold index mustered a 2.5% advance for the week.

Today's surprisingly strong jobs report crushed the complacent Treasury market. Ten-year yields jumped 26 basis points to 4.14%, the worst one-day drubbing in eight years (according to Bloomberg) and were up 31 for the week. Five-year Treasury yields surged 30 basis points today to 3.13% and were up 35 basis points on the week. The long-bond saw yields increase 17 basis points today to 4.98% and were up 22 basis points for the week. Short rates blasted higher. The implied yield on 3-month December Eurodollars jumped 24.5 basis points today to 1.87%. Two-year Treasury yields rose 23 basis points today to 1.85% and were up 27 basis points for the week. Benchmark Fannie Mae mortgage-backed yields were up 28 basis points this week. The spread on Fannie's 4 3/8 2013 note widened 3 to 32, and the spread on Freddie's 4 ½ 2013 note widened 3 to 30. The 10-year dollar swap spread increased 4 to 41.75, the widest level since November. Corporate spreads generally outperformed Treasuries, with junk bonds gaining back some relative lost ground.

Bloomberg tallied a respectable $14 billion of corporate issuance this week. Investment grade issuers included GlaxoSmithKline $2.0 billion, Westpac Capital Trust $525 million, Wells Fargo $500 million, Prudential Finance $500 million, Diageo Finance $500 million, Nationwide Mutual $400 million, Heritage Properties $200 million, Encore Acquisition $150 million, Penn Electric $150 million, Regency Centers $150 million, Nevada Power $130 million, Atlantic City Electric $120 million, and Colonial Realty $100 million.

Junk bond funds saw outflows of $172.6 million for the week (from AMG). Junk issuers included Cablevision $1.5 billion, Glencore Funding $800 million, Cinemark $575 million, NTL Cable $525 million, CSC Holdings $500 million, Warner Music $465 million, Exco Resources $450 million, Sealy Mattress $390 million, Boyd Gaming $350 million, Service Corp Intl. $250 million, Prestige Brands $210 million, Consolidated Communications $200 million, Aearo $175 million, Port Townsend $125 million and Mission Resources $130 million.

Convert issuance included Caesars Entertainment $300 million, Kerzner International $200 million, On Semiconductor $260 million, Greater Bay $260 million, Amylin Pharmaceuticals $175 million, Massey Energy $150 million, Regal Beloit $115 million, and Impax Lab $95 million.

Foreign dollar debt issuers included Korea Highway $500 million, and JSC Kazkommer $500 million. Emerging debt markets were hit today along with Treasuries, with benchmark Brazilian govt. bond yields surging 41 basis points.

ABS issuance amounted to $5 billion (from JPMorgan), with y-t-d issuance of $142 billion running up 28% from comparable 2003.

March 31 - Bloomberg (Ann Saphir): "Banks worldwide boosted the amount of assets used to back derivatives contracts by 41 percent as they try to reduce the risk from transactions that go bad, the International Swaps and Derivatives Association said. Total collateral, or assets pledged to a lender in the event of a default, increased to $1.02 trillion this year from $719 billion last year and $437 billion in 2002, ISDA said in a statement published in Chicago at its annual meeting."

April1 - Bloomberg (Ann Saphir): "The global market for credit derivatives, the fastest-growing part of the derivatives market, increased about 29 percent last year to $3.58 trillion, the International Swaps and Derivatives Association said... The value of the market for interest-rate derivatives -- agreements to exchange a fixed interest payment for one that fluctuates with money-market rates, or vice versa - rose 14 percent to $142.3 trillion... The market for equity derivatives, which let investors bet on or guard against changes in stock prices, grew 21 percent to $3.44 trillion".

Freddie Mac posted 30-year fixed mortgage rates jumped 12 basis points to 5.52%. Fifteen-year fixed-rate mortgages were up 14 basis points to 4.84%. One-year adjustable-rate mortgages could be had at 3.46%, up 10 basis points for the week. The Mortgage Bankers Association Purchase application index remained quite strong, while dipping 1% for the week. Purchase applications were up 22% from one year ago, with dollar volume up better than 40%. Refi applications dipped 3%. The average Purchase mortgage was for $215,300, and the average ARM was for $318,100.

Broad money supply (M3) rose $10.2 billion for the week of March 22, with 2-week gains of $50.7 billion. For the first 12 weeks of 2004, M3 has expanded $177.9 billion, or 8.7% annualized. For the week, Demand & Checkable Deposits jumped $23.0 billion (up $40.9 billion over two weeks). Savings Deposits declined $4.1 billion and Small Denominated Deposits dipped $0.9 billion. Retail Money Fund deposits were up $2.2 billion, while Institutional Money Fund deposits declined $5.8 billion. Large Denominated Deposits declined $3.3 billion. Repurchase Agreements rose $5.3 billion (up $20.2 billion over two weeks), while Eurodollar deposit declined $6.9 billion.

Total Bank Credit jumped $26.3 billion during the week of March 24. Bank Credit is up $256.6 billion during the first 12 week of 2004, a notable 17.8% annualized rate. Security holdings jumped $24.5 billion, with three-week gains of $47.8 billion. Loans & Leases added $1.8 billion. Commercial & Industrial loans declined $1.1 billion, while Real Estate loans gained $3.3 billon (up $32.8 billion over four weeks). Consumer loans rose $3.3 billion, while Security loans dipped $5.3 billion. Elsewhere, Total Commercial Paper increased $13.3 billion to $1.319 Trillion. Financial CP jumped $16.1 billion to $1.207 Trillion, while Non-financial CP declined $2.8 billion to $111.7 billion. Year-to-date, Total CP is up $50.5 billion, or 15.9% annualized.

Fed Foreign "Custody" Holdings of Treasury, Agency debt declined $16.9 billion to $1.159 Trillion. Year-to-date, Custody Holdings are up $92.6 billion, or 34.7% annualized.

Currency Watch:

Currency markets remain extraordinarily volatile. And despite today's strong advance, the dollar index declined about 0.5% for the week. The yen traded yesterday to a 4-year high against the dollar, a rather remarkable feat considering the massive yen selling by Japanese authorities over the past seven months.

Commodities Watch:

March 30 - U.S. Department of Agriculture: "The preliminary All Farm Products Index of Prices Received by Farmers in March at 122, based on 1990-92=100, is 6 points (5.2 percent) above the February Index. This is the highest index level since records began in 1910. The Livestock Products Index increased 8 points (7.1 percent) from February while the All Crops Index increased 4 points (3.3 percent). Producers received higher commodity prices for cattle, soybeans, milk, and eggs. Lower prices were received for lettuce, strawberries, broccoli, and asparagus... The preliminary All Farm Products Index is up 23 points (23 percent) from March 2003. The Food Commodities Index increased 7 points (6.0 percent) from last month to 123. The index stands 27 points (28 percent) above March 2003."

April 2 - Bloomberg (Amy Hellickson): "Georgia-Pacific Corp., which makes Brawny paper towels and Dixie cups, will raise prices on several products on July 1 because of higher costs for materials. Prices for paper towels, tissues and napkins will go up 6 percent to 9 percent, and Dixie cup, plate and cutlery products will go up 4 percent to 6 percent, Atlanta-based Georgia-Pacific said... Georgia-Pacific follows Procter & Gamble Co. and Kimberly-Clark Corp., which said they will charge more for paper products because of rising pulp costs. U.S. benchmark pulp prices have risen about 13 percent in the past year..."

April 2 - Atlantic Journal Constitution (Renee DeGross): "First it was gasoline. Now it's milk and dairy prices that are on the rise. The cost of ice cream might even be going up, just in time for summer. With milk production down but the economy slowly gaining strength, demand for milk and dairy products has begun to outrun supply, said Chris Galen, spokesman for the National Milk Producers Federation. 'Production is declining, and you can't turn cows on and off like a switch,' Galen said. 'Heading into 2004, the nation has the lowest number of dairy cows since any time in the last five years.' Representatives for Kroger, Publix and Wal-Mart, metro Atlanta's top three grocers, say all three have increased prices on dairy products, from butter to ice cream... The price of a pound of cheese has hit $2.02 on the Chicago Mercantile Exchange, compared with $1.08 at this time last year, the Chicago Tribune reported this week."

This week Gold traded to a 15-year high and Silver to the highest level since October 1987. Corn traded to a 7 ½ year high. The CRB index gained better than 1%, with a y-t-d gain of almost 11%. With energy prices giving up some of recent gains, the Goldman Sachs Commodity index dipped less than 1%.

Asia Inflation Watch:

April 1 - Reuters (Nao Nakanishi): "China's overloaded railway system is nearing collapse as it struggles to cope with the demands of a roaring economy. And the side effects could be global. Against a backdrop of endemic power cuts, overcrowded and decaying roads, and ports filled with unloaded ships, the problems on the railways highlight the urgency behind the government's drive to bring growth down to sustainable levels. Industry and foreign company managers involved in moving China's massive raw material imports say the shortage of railway containers and tracks has compounded the problem. With no wagons to shift cargoes, ships must wait longer and longer outside ports, worsening the global shortage of vessels caused by China's voracious appetite for all kinds of commodities ranging from crude oil, to iron ore, to grains. But to build more tracks, wagons or engines, they need to import even more raw materials. 'There's an extreme shortage of railways, which is not geared to cope with this huge demand...Ships are used as storage," said Harry Banga, vice chairman of Noble Group, one of Asia's biggest diversified commodities trading companies. 'Now the government is in the process of ordering new railways and new wagons. That again is putting more pressure to produce more steel. That is putting more pressure to import more iron ore,' he said...To make matters worse, the Chinese government has prioritized internal transport of coal or grains as it eyes the threat of social discontent in provinces hit by power shortages or surging food prices due to the booming economy."

April 1 - Bloomberg (Daisuke Takato): "The Bank of Japan's Tankan survey showed sentiment among large manufacturers was the highest since 1997 and service companies became optimistic for the first time in seven years as an export-led recovery spreads to consumers."

March 30 - Bloomberg (Heejin Koo and Seyoon Kim): "South Korea posted its biggest current-account surplus in five years in February, helped by rising exports of computer chips, cars and cell phones. The surplus was $3.1 billion, the largest since December 1998, the central bank said in a statement in Seoul."

Thailand February Imports were up 28.2% y-o-y, and Exports were up 22.3%. Imports were up 24.3% y-o-y in Malaysia, with February Exports up 16.7%. South Korea posted its strongest current account surplus since December 1998.

Global Reflation Watch:

March 31 - Bloomberg (Yumi Kuramitsu and Taizo Hirose): "Japan sold 4.7 trillion yen ($45.2 billion) in March, less than the average for the prior two months, suggesting the government is willing to tolerate gains in the currency as the pace of economic growth accelerates. The figures, released by Ministry of Finance in Tokyo, indicate sales slowed in the last three weeks of the month. The Nihon Keizai newspaper on March 9 reported the Bank of Japan had sold 3 trillion yen since late February."

April 1 - Bloomberg (Julie Ziegler): "The world economy, led by Asia and the U.S., is projected to grow 4.75 percent this year, the strongest performance in a generation, according to a semiannual forecast from the Institute for International Economics. 'It is clear we are in a boom right now -- a U.S. boom, a world boom,' C. Fred Bergsten, director of the research group, told an audience at its Washington headquarters. Global growth may reach 4 percent next year, Michael Mussa, a senior researcher at the institute, said. The two-year performance would be the strongest since the early 1980s, the group said."

March 31 - Bloomberg (Cherian Thomas): "India's economy grew 10.4 percent in the quarter ended Dec. 31, the most in at least seven years, as record farm production and the lowest borrowing costs in three decades spurred purchases of cars and homes. Stocks rose. Gross domestic product in the fiscal third quarter grew faster than the 8.4 percent pace in the previous quarter, the Central Statistical Organization said in a statement released in New Delhi. The median forecast of nine analysts in a Bloomberg survey was for growth of 8.8 percent..."

March 31 - Bloomberg (Mark Bentley): "Turkey's gross national product grew a faster-than-expected 7.2 percent in the fourth quarter of 2003 from the year-earlier period, the State Institute of Statistics reported, driven by increased exports. The country's main indicator of economic output was forecast to expand 5.3 percent..."

March 30 - Bloomberg (Lynne Marek): "Airlines worldwide will post a $3.2 billion profit on international routes this year as passenger traffic increases after losses in 2003, the International Air Transport Association estimated. The group, representing 270 airlines such as AMR Corp.'s American Airlines, British Airways Plc and Japan Airways System Corp., also reported in a statement that February passenger traffic rose 9.8 percent from a year earlier on international routes, the sixth consecutive monthly gain."

California Housing Bubble Watch:

March 28 - Los Angeles Times (Daryl Kelley): "The money was good, the job was a natural fit and you can't beat the balmy seaside weather of coastal Ventura. But before new City Manager Rick Cole accepted his job last month, the City Council needed to provide a $325,000 down payment on a modest 75-year-old house. Cole, 50, is an expert on things that make communities tick. But the extent of the Southern California housing crisis didn't hit home until he began searching for a new house for his family. 'We paid $675,000 for 1,481 square feet,' said Cole, who fell into a bidding war for a 1929 Spanish-style house in a resurgent neighborhood with classic architecture, but an abandoned elementary school and streets full of potholes. The price started at $639,000 and just kept going up. It was an absolutely unbelievable experience,' said Cole's wife, Katherine Aguilar Perez. 'Ordinarily, you'd walk away,' Cole said. 'Except the next house is going to be the same, and a month later it's going to be worse.' His three-bedroom, one-bath house in midtown Ventura - an uneven collection of small dwellings and tattered apartments, some with distinctive architectural styles - has increased $480,000 in value since 1997, when it sold for $195,000. A Santa Barbara couple, Thomas and Cara Hill, purchased the same house in 2000 for $320,000... 'It's fairly obscene,' said Hill, 35, who owns a Santa Barbara surf T-shirt business and whose wife teaches elementary school... 'It was our first home. And we moved here out of pure necessity. We're UC Santa Barbara graduates, and we wanted to live there. But housing for us in that market was nonexistent.' Today, the Hills are counting their good fortune. They are taking more than $350,000 in equity up a Ventura hillside to buy a Spanish-style house of 2,700 square feet and slight ocean view for $900,000. 'We're still trying to catch our breath,' Hill said. 'And we're feeling we're kind of rolling the dice a little bit. But when you compare coastal Ventura with the rest of Southern California, I think there's still some room to appreciate some more.'"

April 1 - Long Beach Press Telegram: "Low interest rates have helped keep demand high, causing values in Long Beach to appreciate between 20 percent and 30 percent in the last few years. 'I think all the indications are right now is that it's the best time to buy because of the interest rates,' said Rosemary Voss, manager of Coldwell Banker Residential Brokerage. The California Association of Realtors recently upped its forecast for median home price appreciation to 20 percent to 24 percent for 2004. On a typical home, that's $8,000 worth of appreciation each month, Voss said. 'In our industry people used to say 'I wish I would have bought five years ago.' Now they're saying 'I wish I would have bought in February,'" Voss said. 'What will they be saying next?'"

March 25 - "The median price of an existing home in California in February increased 20.7 percent and sales increased 3.9 percent compared to the same period a year ago, the California Association of Realtors (C.A.R.) reported today. The median price of an existing, single-family detached home in California during February 2004 was $394,300, a 20.7 percent increase over the revised $326,640 median for February 2003, C.A.R. reported. 'While demand for housing gives no indication of slowing down, the inventory of homes for sale continues to decline,' said C.A.R. President Ann Pettijohn. 'This dynamic is a key constraint in the housing market and why we're experiencing such dramatic price appreciation.' C.A.R.'s Unsold Inventory Index for existing, single-family detached homes in February 2004 was 2.3 months, compared to a revised 3.4 months for the same period a year ago." State Condo prices were up 20% y-o-y to $315,770, with prices up 40% in just 24 months.

U.S. Bubble Economy Watch:

March 31 - Dow Jones (John Conner): "Goldman Sachs Economist Bill Dudley said the U.S. budget outlook has deteriorated sharply in recent years to the point where chronic deficits appear inevitable unless priorities change. 'Although some narrowing is likely from the $500 billion shortfall we estimate for fiscal 2004, it is apt to be modest and short lived. Over the next 10 fiscal years, we expect to deficit to cumulate to $5.5 trillion, averaging about 3.5%" of gross domestic product. 'After that the outlook gets even worse for two reasons. First, the cost of making the Bush Administration's tax cuts permanent rises over time. Second, outlays for Social Security and Medicare will surge as the baby-boom generation retires.'"

March 31 - New York Times (Michael Luo): "Saying that New York City taxi drivers are underpaid, the Taxi and Limousine Commission approved a fare increase yesterday of more than 26 percent, the first in eight years. But to soften the blow, the commission also adopted improvements for passengers, including one that could make New York one of the first major cities where all cabs accept credit and debit cards... Starting in the first week of May, a typical cab ride of 2.6 miles in the city, from SoHo to Midtown for example, with five minutes of waiting time in traffic, will increase to $8.30 from $6.60. More specifically, the base fare will rise to $2.50 from $2, and the rate for every one-fifth of a mile, about four city blocks, will go to 40 cents from 30 cents. The flat fare from Kennedy Airport to Manhattan will increase to $45 from $35."

The March Manufacturing ISM index was reported at a strong and better-than-expected 62.5. The Production, Export Orders, Unfilled Orders, Employment, Supplier Deliveries and Prices components were all up from strong February readings. While down slightly, New Orders came in at a robust 65.7. For the month, Prices Paid jumped 4.5 points to 86, the highest level since December 1994. The Prices component was up 20 points in three months and 33 points since August.

Last week, February New Home Sales were reported at a much stronger-than-expected 1.163 million pace. This was the third strongest level on record and only 3% off last June's all-time record. Sales were up 24% from a relatively weak pre-war February 2003, with combined January and February Sales up 16% to comparable 2003. And with average prices up 10.2% y-o-y to $257,200, Calculated annualized Transaction Value (CTA) was up a blistering 37% y-o-y to a record $299.1 billion.

February Existing Home Sales were reported at a strong 6.12 million unit pace. And with Unit Sales were up almost 3.6% y-o-y and Average Prices up 5.4%, CTA was up 9.2% y-o-y to $1.321 Trillion. Combined New and Existing Home Sales were at an annualized pace of 7.283 million, up 6.4% over February 2003. Combined CTA was up 16.8% y-o-y to $1.621 Trillion, with combined CTA up 40% from two years ago, 58% over three years ago and 100% from 6 years ago.

Pertinent Insights from Milton Gilbert:

Over the past few weeks we have witnessed the dollar/yen decline from 112 to trade below 104, a four year low. This despite the Japanese authorities having purchased dollars in the range of $265 billion over the past seven months, an unprecedented 85% annualized expansion of foreign currency reserve positions. Yet the dollar/yen has declined significantly from 117, the level it traded when this massive intervention began back in September. For good reason, the Japanese must now appreciate that their massive interventions are much more effectual in inflating and destabilizing commodity and myriad global markets than they are in supporting our faltering currency. The Japanese dollar support mechanism is now in jeopardy, with unknown consequences.

For some time, U.S. (and global) interest rate markets have been supported by indefinite 1% short-term U.S. interest rates. Recent giddy talk had the Fed on hold through 2005 or even past the end of Greenspan's term in 2006. The market was today forced to abruptly reassess the situation. Fear will now seemingly take a more prominent role in market psychology, replacing the endlessly profitable greed and complacency. Rosy notions of the Fed permanently held in check by the jobless recovery must give way to disconcerting thoughts of how our extraordinary Credit market (unprecedented leverage and derivative activity) will react to inevitably rising rates. The interest-rate speculators' support mechanism could now be in jeopardy, with unknown consequences.

We live in an age of extraordinary monetary disorder that somehow still passes for a sound and vibrant global financial system. Over decades the system has evolved from one of a managed "fixed" monetary regime to an indomitable system of "floating" currencies and global Wildcat Finance. This unstable system has been tested over the years. It has as many times persevered, but seemingly only postponing the inevitable day of reckoning through only more dangerous Credit inflation and financial excess. It is my view that this anomalous system is about to be tested once again.

The Great Credit Bubble has imparted massive imbalances at home and abroad. To sustain the Bubble requires enormous and unrelenting Credit excess that now inundates the world with dollar balances. Speculative flows have been unleashed on non-dollar assets of all stripes. Domestic and international asset Bubbles have reached the point of being unmanageable. Economies are structurally maladjusted and vulnerable. Individual financial systems are acutely fragile. The greatest imbalances emanate from U.S. Credit excess, with attendant liquidity effects having now afflicted financial systems and economies globally. Accordingly, our authorities absolutely refuse to initiate policies to rectify domestic excesses and unprecedented current account deficits. They have lost credibility and the dollar is suspect. Yet Credit inflation remains the order of the day. Meanwhile, gross excess runs uncontrolled and on a crash course, reminiscent of dysfunctional processes that led to the breakdown of the Bretton Woods monetary regime in the early seventies. I've gone searching for relevant historical insight.

Milton Gilbert was Economic Advisor to the Bank of International Settlements from 1960 to 1975. He wrote his Ph.D. thesis at the University of Pennsylvania on the "breakdown in exchange parities in the 1930s." He died in 1979 as he neared completion of his brilliant work, "Quest for World Monetary Order - The Gold-Dollar System and its Aftermath." From the books cover: " '...they came to treat me not only as wrong, but as a kind of half-traitor...because I argued that we didn't have to sit on our hands, and lose billions of dollars every year...' So remarked Milton Gilbert as he reflected on his unsuccessful efforts to convince the U.S. to act prudently to maintain the status of the dollar and to correct the balance of payments deficit... Conceived by a man with remarkable foresight, this vision of the international monetary system and the roots of its present instability deserves your attention."

Dr. Gilbert had truly wonderful knowledge and insight to the workings of international monetary regimes. He also comprehended clearly the heightened vulnerability of the Bretton Woods system wrought by escalating U.S. trade deficits. Gilbert was often critical of U.S. profligacy and lack of discipline, and was controversial for his belief that occasions may warrant the necessity for tight credit, and trade and capital controls.

Gilbert's book is not easily located, so I have taken liberty to extract extensively. While written about a quarter-century ago, his analysis is exceptionally pertinent in today's environment of escalating global monetary instability.  I hope you appreciate his deep knowledge and insight, as well as his intellectual integrity, as much as I do. The more things change the more they stay the same.

From "Quest for World Monetary Order:"

"The official preference for fixed exchange rates was not arbitrary, but was grounded in the experience of the monetary breakdown in the 1930s. To abandon gold convertibility of the currency and to allow the exchange rate to float were taken as evidence of monetary mismanagement and a failure of discipline. While floating could clear the foreign-exchange market, various cases of floating during the 1930's, as in Britain, Australia, and Sweden, had shown that market forces would not necessarily produce a stable rate or one that could be considered satisfactory from the standpoint of trade. Floating often encouraged speculation and induced a flight of domestic savings abroad, depressing the exchange rate unnecessarily and worsening the terms of trade. For these reasons, fixed exchange rates that would be altered only by international agreement seemed an essential foundation for international monetary cooperation and liberal trading practices. Apart from lending stability to foreign trade and the balance of payments, fixed exchange rates were considered essential to imposing discipline on domestic monetary affairs with respect to both the government budget and monetary policy. Too much creation of money in the domestic economy would soon show up in a payments deficit, which would help to enforce corrective action." Page 23

"Under the fixed-rate system, the priority in national policies had to be shifted at times from measures prompting domestic expansion to those aimed at controlling inflation and the external balance." Page 207

"The political obstacles that stood in the way of firm decision-making could in many cases be overcome only when the catalyst of a crisis atmosphere brought the matter to a head. Beforehand, spurious analyses of the situation, optimistic forecasts, fanciful theories of the adjustment process, and announcements of dubious policy measures were seldom lacking..." Page 15

"Because the authorities did not or could not deal forcefully with the balance-of-payments problems as they arose, the monetary system came apart." Page 4

"While not the exclusive concern of the United States, the problems of the international monetary system could not be solved without the United States. These problems had to do with the growth and composition of official reserves of convertible securities and gold held by central banks... There was much futile wrangling about whether the key issue was the adjustment process or the adequacy of international liquidity (official reserves). In fact, both were involved, since a reasonably prompt adjustment was essential if excessive reserve growth was to be avoided." Page 5

"To some extent, the emergence of payments deficits and surpluses could set up forces that constituted an automatic mechanism of adjustment because money supplies and relative income levels between countries would be affected. International competition was also an active force. Many instances of payment balances shifting back and forth of their own accord were evidence of an automatic adjustment process at work. Automatic processes could not, however, be relied upon when an imbalance became sizable, particularly if the cause of disequilibrium were persistent." Page 15

"...the economic sense of the matter was easy enough to understand. The Fund (IMF) was intended to favor economic expansion and high employment. But if a country's cost and price levels became uncompetitive, exports would be too low and imports too high to allow a balanced position in external payments at a full-employment level of economic activity - even though productive resources might not be under excessive demand pressure at the time and the situation not be inflationary." Page 20

"The difference between non-fundamental and fundamental disequilibrium was sometimes only a matter of degree...if the authorities procrastinated and the disparity between different countries' price and cost levels became too large, this slow-acting corrective could not be expected to work. Disequilibrium then became fundamental..." Page 21

"The real obstacles to the adjustment process were political." Page 22

"From the White House Tapes, President Nixon is known to have said: 'I don't give a [expletive deleted] about the lira.' Presumably, he did give a [expletive deleted] about the dollar. Nevertheless, he and John Connally, his...secretary of the treasury, took the decision to declare the dollar inconvertible and disrupt the international monetary system. Nixon and Connally came into the game only toward its end. The three preceding administrations had followed the same course, by deciding what U.S. policy on the dollar should be and doggedly sticking to that policy in the face of an ever-mounting crisis... The crux of the matter was the absolute refusal to initiate an adjustment process in a situation of transparent fundamental disequilibrium." Page 27

"...Some central banks felt it appropriate to convert at least part of their countries' surpluses into gold in order that the United States should be subjected to balance-of-payments discipline. Discipline was imposed on other countries by the loss of any reserves, foreign exchange or gold, and even by increases of official foreign liabilities. But for the United States, loss of gold was the only effective discipline." Page 32

"prompt action..." "was the only practical way of avoiding cumulative disorder." Page 78

"Quite a few felt that the U.S. lack of discipline and the growth of dollar reserves were the basic threats to the stability of the system." Page 173

"This, then, was the weird position into which the United States had drifted. The gold par value of the dollar had priority, and the adjustment process was to be left to revaluation by other countries... The extent to which top U.S. officials saw the implication of their policy position was a mystery... Treasury Secretary Fowler's uncertain grasp of the subject was all too evident at the G-10 meeting in Bonn in November 1968. With his policy briefing book open, he pressed the German authorities to revalue the D-Mark, although they had previously announced a decision not to do so. (German economic minister) Schiller, scarcely hiding his annoyance, asked Fowler why it was so necessary for the D-Mark to be revalued. The secretary responded that revaluation was needed because the larger German surpluses on the balance of payments showed the D-Mark to be in fundamental disequilibrium. With an evident air of trumping this ace, Schiller demanded: Then how about the U.S. deficits? Do they not show that the dollar is in fundamental disequilibrium?" Page 148

"Clearly, the only practicable alternative to a major rise in the price of gold was a floating dollar brought on under crisis conditions. This would be bound to produce a flight from the dollar, with unforeseeable repercussions. It was certainly not a conservative course to let this happen, particularly, as the credibility of the U.S. authorities was being undermined by their evident reluctance to initiate an adjustment process... If ever there had been any possibility that the White House would face up constructively to the adjustment process, the opportunity was now passed over. Later events showed that in domestic affairs President Nixon was already concentrating on the next election." Page 150

"A new feature of the situation was that the rate of wage-price inflation quickened as the recession deepened... And while the budget shifted to deficit and monetary policy was greatly eased, these impulses aimed at reversing the decline in economic activity were swallowed up in rising prices." Page 152

"The crash program was announced by the president on August 15 (1971), following a weekend meeting of the administration's economic team at Camp David. On the domestic side, the program was intended to check the inflationary psychology and give an expansionary impulse to the economy... On the external side, the main action was the suspension of the convertibility of the dollar... It has been alleged that the United States allowed, or even encouraged, the crisis of the dollar by a policy of 'benign neglect' toward its fate. The phrase had come from a private study group headed by Gottfried Haberler..." Page 154/155

"As the G-10 ministers and governors were scheduled to meet in London in mid-September (1971) to exchange views on how to resolve the crisis, a preparatory meeting of the deputies was held in Paris early in the month. Because the crisis centered on the dollar, Paul Volcker, the U.S. deputy, led off by stating the American position. Washington had ruled out the idea of itself taking any adjustment initiative, so Volcker analyzed the change required in the U.S. balance-of-payments position without proposing fresh U.S. measures to being it about." Page 158

"The state of confidence was evident from the fact that the market price of gold started to rise at once, reaching $48 in February 1972 and $60 in May. Another sign was the spurt of almost 10 percent in January in the indexes of world-market commodity prices...For 1972, the trade deficit totaled $6.4 billion, as against $2.3 billon the year before and a surplus of $2.6 billion in 1970. This sharp deterioration of the trade balance occurred despite a $5.6 billion or 14 percent increase in exports... A major factor here was the rise in the dollar price of imports due to the devaluation and to the general advance in primary commodity prices... In fact, the current-account deficit for 1972 turned out to be $10 billion; this was an $8 billion change, but the sign was a minus instead of a plus... After consulting with its Group of Ten partners, the U.S. authorities announced a new devaluation of the dollar by 10 percent on February 13 (1973)." Page 165

"Not only had the fixed par-value system broken down, but the way in which the authorities had fumbled matters left the market with an indelible impression that they did not have the will to control events. More speculators became prepared to back their own judgments on exchange rates against the official propaganda line." Page 168

"The most damaging impact of the exchange-market turmoil was the strong impetus it gave to inflation and inflation psychology. This effect was not an inherent consequence of floating but occurred for two reasons: the particular circumstances of the early 1970s and the fact that the dollar was the key currency in the breakdown... As regarding the specific role of the dollar, large increase in some countries' money stocks arose out of the flight from the dollar in 1971-72. Thus, the international economy was in a situation of boom and inflation pressure." Page 194

"The monetary breakdown in 1973 gave a further strong impetus to the inflationary forces; many traders and investors felt that the world economy had become unhinged and that many currencies were unsafe assets to hold. A buying wave for hedging and speculative purposes resulted in a violent upsurge of commodity prices; The Economist's and Reuter's indexes, neither of which included gold or oil, almost doubled over the twelve months of 1973. In their post-mortem analysis, "The 1972-1975 Commodity Boom," Richard Cooper and Robert Lawrence concluded that the demand-supply situation could explain only part of this upsurge and that exchange-rate uncertainties accounted for much of the exceptional prices rise... It was in these conditions of soaring commodity prices that the OPEC cartel announced the sharp rise in the price of oil at the end of 1973." Page 194

"...the situation was aggravated by the fact that the United States gave up all efforts toward a balance-of-payments program... The Treasury apparently continued to believe that the market would find its own floor for the dollar and that a further dose of depreciation would start a process of substantial balance-of-payments adjustment. Such optimism was misplaced. It ignored not only the obstacles to trade adjustment mentioned above [U.S. trade partners burdened with higher oil and commodities prices], but also the fact that the decline of the dollar intensified the inflationary psychology inside the United States. The 1978 report of the Council of Economic Advisors noted that the effect of depreciation of the dollar on the cost-of-living index, through the rise of import prices, was fairly moderate. But it overlooked the impact on the price of import-competing U.S. products, and also took no account of the effects of the flight from money into real assets, like housing, or of the widespread fear that the drop in the dollar was a reflection of inflation." Page 206

And snippets from his "Summary and Conclusion" chapter:

"Various rationales were developed to shift responsibility for the failure and to explain it away." Page 215

"the dollar deficit could not have been eliminated simply by exchange-rate adjustments." Page 217

"The U.S. position crystallized as a result of short-term reactions to specific political situations, both domestic and international." Page 217

"...the authorities were to blame for delaying action until capital flight had been needlessly provoked. In the critical case of the dollar, the American authorities themselves had known for several years that a fundamental disequilibrium exited. Yet they failed to take corrective action as month after month and year after year passed, and the time drew nearer when a flight from the dollar would force their hands under crisis conditions." Page 220

"The vast dollar outflow from the United States in 1970-73 boosted the money supply in many countries and was a significant stimulus to inflation and inflationary psychology...The low state of confidence was reflected in the gold market and in the extreme flare-up of commodity prices in 1973. Worse still, the boom in commodity prices provided the backdrop for the OPEC decision to boost oil prices fourfold at the end of 1973." Page 220

"While the expectations of the U.S. authorities were obscure, they seemed until late 1979 to be relying on a convergence of growth rates in the main industrial countries and the lagged effect of depreciation in order to bring about sufficient adjustment. Effective policy measures are obviously measures that work in the situation being confronted. Moderate steps can be effective when they are taken promptly, whereas indecision and delay in the face of accelerating disequilibrium will, in the end, demand much more potent and painful measures. All too often official procrastination caused by the political timetable or by fears of an adverse political reaction has resulted in accelerated inflation and external deficits." Page 226

"The usual instruments called upon to support exchange stability after depreciation of the currency are restrictive monetary and fiscal policy, with the intention of moderating economic activity so as to reduce inflation, improve the balance of payments, and restore confidence." Page 226

"...cases and times arise when the free play of market forces is subject to obstacles, as it has been with respect to trade, or when a market does not supply its own brakes against excess, as has occurred in the exchange market." Page 226

"hesitating to take effective action cannot be accounted for strictly by unfailing faith in market freedom." Page227

"...the 1970s would not have thrown up the same problems if effective adjustment had been achieved in the 1960s and if the huge increases in the world money supply that originated in the flight from the dollar had not been let loose." Page 219

"The problem for monetary authorities in the 1980s and beyond will be how to maintain exchange stability in a fundamentally unstable environment. This task is not one that they can ignore in the hope that markets will resolve for them." Page 236

If Dr. Gilbert were alive today, he would surely be appalled by current policy. He would argue adamantly against chairman Greenspan's view of benign U.S. imbalances rectified over years by the wonders of flexible prices and market forces. Instead, he would profess that only by restraining Credit would the U.S. begin the arduous adjustment process necessary to attenuate its massive external deficit and myriad imbalances. He would speak in terms of the "cumulative monetary disorder" wrought by the enormous and endemic U.S. current account deficits. And, importantly, I believe his analysis would point directly to today's fundamental disequilibrium in market and monetary processes - let's call it "free-market disequilibrium."

While we refer to the current system as one of floating currencies, I don't think it's this simple. We have "floating" currencies supported by massive central bank dollar purchases/interventions. Moreover, derivative hedging also plays a major supporting role. Despite the dollar's weakness over the past 18 months, there has been no need to sell U.S. financial assets. Instead, a phone call to one's favorite derivative desk to acquire a dollar hedge easily suffices. No dumping of Treasuries (higher interest rates) and other U.S. securities (lower stock prices) necessary with today's "monetary regime." Leave the difficult work of managing the massive and ballooning "supply" of dollar risk to the murky world of derivative traders and global central bankers. And, yes, contemporary finance appears darn right miraculous - abrogating those old supply and demand imbalances and dislocations that bring booms to their knees.

But there's a malignancy: today's currency "regime" does not impart any disciplining mechanism on the undisciplined and out-of-control U.S financial sector. Credit inflation runs unchecked, speculation unchecked, financial leveraging unchecked. Current account deficits mushroom and interest rates hover at historic lows. Credit excess begets only greater Credit excess. Escalating Asset Bubbles, structural economic distortions, and financial fragility create vulnerability only more intimidating to timid central bankers.

I believe one could build a reasonable case that the current "floating" currency system with massive central bank intervention and derivative hedging programs really is not floating at all. It is more like "fixed" with very, very wide bands. That is, currencies can move around significantly without causing much in the way of financial stress or disruption - without necessitating "adjustment." Indeed, the system has all appearances of the mythical free-floating free-market system imbued with market discipline and self-adjustment. Yet it is absolutely nothing of the sort. Instead, it is a dysfunctional system completely incapable of self-regulation; excess begets only greater excess until crisis eventually interrupts the process.

Come the day that the marketplace questions the ongoing viability of either of its supporting mechanisms - massive central bank dollar interventions or the ballooning derivative hedging scheme - the stability of the system is in immediate jeopardy. Today's camouflaged "fixed" global currency system could lurch toward a true floating dollar, entailing disruption unlike anything experienced since the early seventies. What is it that the metals are trying to tell us, anyway?

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