Page 3 of 5 OBAMA, CHANGE AND CHINA, Part 3 The New Deal dollar and the Obama dollar By Henry C K Liu This report is the third in a series. Part 1:
The song stays the same Part 2:
A dangerous balance
Jeffersonian ideal of economic democracy behind populist agrarianism.
McKinley's victory was a definitive triumph of the Hamiltonian model, as Henry
Adam observed: "The majority at last declared itself, once and for all, in
favor of a capitalistic system with all its necessary machinery." One of the
necessary machinery is the integration of business and government. In recent
decades, titans of investment banking and industry had been running the US
Treasury under both Democratic and Republican administrations. Larry Summers
was the first academic economist to run the Treasury and Geithner is the first
technocrat to do so. Both are strong supporters of neo-liberalism. No labor
leader has ever run the US Treasury.
Labor, on whose back wealth is created, has never commanded control over
monetary policy in the history of the US, despite that fact central banking was
adopted by Congress to maintain the value of money with the accompanying
objective of promoting full employment.
Since 1913, when the Federal Reserve was established, US labor has been at the
dictatorial mercy of capital. Wealth, instead of being created and enjoyed by
independent labor, has been separated from its creator to become capital, the
requisite master for creating jobs in an economic system of contract labor. In
the current financial crisis in free market capitalism, protesters against
taxation on capital gain argue against "punishing" capital, without which jobs
allegedly cannot be created. Such protests are in essence calls for punishing
labor to keep unruly capital from self inflicted losses.
By February 1933, a little over two years after the market crash of October
1929, depositors were still withdrawing money from banks in such panic
quantities that state governments had to intervene to arrest widespread bank
failure. Michigan declared a bank holiday on February 14, 1933 and by the time
FDR took office on March 4 all states had taken similar actions to create a
national bank holiday.
The new president immediately took control of the entire national banking
system. Congress passed the enabling Gold Reserve Act of 1934 on January 30,
and FDR issued his devaluation proclamation on January 31, in less than 24
hours. FDR forbade US citizens to buy or own gold and devalued the dollar 60%
by making gold valued at $35 an ounce, up from $20.67 an ounce established by
the gold standard, and kept interest rates at historical low levels. Still, US
export trade did not rise with dollar devaluation against gold, nor employment
in the domestic private sector picked up. Most of the drop in unemployment was
absorbed by the expanded public sector. The US economy did not revive until the
US entered World War II with the US adopting national planning for war
production. (See National
planning and the American myth, Asia Times Online, June 13, 2002.)
Britain's gold standard
Winston Churchill, as chancellor of the Exchequer in the Conservative
government, returned Britain, a fading superpower after World War I, to the
gold standard in 1925, again devaluing silver against gold, although a higher
gold price and significant inflation had followed the wartime suspension of the
gold standard. Under the gold standard, the US fixed the price of gold at
$20.67 per ounce from 1834 until 1933; Britain fixed the price at 3 pounds 17
shillings and 10.5 pence per ounce until World War I, and restored it in 1925.
The exchange rate between dollars and pounds - the "par exchange rate" -
necessarily came to $4.867 per pound sterling during these periods. Currency
speculation did not and could not exist.
Churchill followed tradition by resuming conversion payments at the pre-war
gold price. For five years prior to 1925, the gold price in pound sterling was
managed downward to the pre-war level, causing deflation throughout those
countries of the British Empire and Commonwealth using the pound sterling. But
the rise in demand for gold for conversion payments that followed the similar
European resumptions of the gold standard from 1925 to 1928 meant a further
rise in demand for gold relative to goods and therefore the need for a lower
price of goods because of the fixed rate of conversion from money to goods.
Because of price deflation caused by the gold standard and the predictable
depression effects, the British government finally abandoned the gold standard
on September 20, 1931. Sweden abandoned the gold standard in October 1931, and
other European nations soon followed. Even the US government, which at the time
possessed most of the world's gold, moved to cushion the effects of the Great
Depression by raising the official price of gold (to $35 per ounce from $20.67)
and thereby substantially raising the equilibrium price level in 1933-4.
The FDR Gold Parity Dollar
The deflation in the years of the Great Depression disconnected the Roosevelt
gold-based dollar held by foreigners with the de facto domestic fiat dollar of
January 1934. The Consumer Price Index for January 1934 was 132 with July 1914
set as 100, making the January 1934 dollar worth 75.75 cents of gold standard
dollar of 1914.
For this reason, the domestic dollar of January 1934 was endowed with 132 cents
(100/75.75 = 1.32) in 1914 gold standard dollar at $20.67 per ounce. In terms
of the Roosevelt dollar with its gold parity of $35 an ounce, it was endowed
with 223.5 cents. But up to 1934, before Roosevelt devalued the dollar, it was
convertible through central banks at $20.67 per ounce of gold to yield 100
cents. Foreigners could buy US goods and assets with 100 cents that would cost
US citizens 223.5 cents. This explained why investment in the US from gold
standard economies grew during 1914 and 1934 until the Great Depression finally
set in after the market crash of 1929.
The Roosevelt dollar became a two-tier currency whose purchasing power at home
did not match its set gold parity abroad at $35 per ounce. At home, it was a de
facto fiat monetary unit, not convertible to gold; and abroad, it was
convertible to gold at a devalued $35 per ounce.
When this "international gold bullion standard" was set up on January 31, 1934,
a gold standard without redemption of currency in gold coin, the Roosevelt
dollar was worth 132 cents at $20.67 per ounce of gold abroad and 223.5 cents
at home in terms of its own gold parity of $35 per ounce. At home, the dollar
was loosing purchasing power steadily, while abroad it stayed constant against
gold. On Christmas Day 1942, because of wartime price control, the fiat dollar,
descending from 223.5 cents level of January 1934, finally met its foreign twin
when it reached 132 cents level. But the reunion was to last three months only,
after which US prices began to rise even under price control.
The two-tier Roosevelt dollar, while fixed in value against gold abroad,
continue to lose purchasing power at home. On July 22, 1944, when the Bretton
Woods agreements were signed, the dollar was worth only 95 cents at home as
registered by the Consumer Price Index (CPI), while abroad the same dollar was
still worth 100 cents against $35 gold. On August 4, 1945, president Harry
Truman signed into law the Bretton Woods regime, approved by US Congress as a
simple bill that required only a majority, not a treaty that would require a
two-thirds majority in the Senate. The next day, Truman authorized dropping the
atomic bomb on Hiroshima. CPI for August 1945 put the dollar as worth only 93
cents at home while abroad it was still worth 100 cents.
By August 1947, when the International Monetary Fund (IMF) born of the Bretton
Woods regime became fully operational and member countries pegged their
currencies within 1% of their official par values to the 100-cent dollar,
convertible to gold at $35 per ounce, the dollar was worth only 75 cents at
home after war-time price control was lifted. Under the Bretton Woods
agreements, the currencies of the IMF member countries were to be defined pro
forma in weight of gold, and those "gold parities" were to be translated into
par values against the US dollar, whose gold parity at $35 per fine troy ounce
was 888.67 milligrams (or 15 and 5/21 grains 0.9 fine). The currencies of the
IMF member countries became convertible to dollars at "fixed but adjustable par
values", while only dollars were made officially convertible to gold, but not
to individual US citizens, only to foreign central banks.
The Bretton Woods regime became a rigged system of exchange in which 75-cent
fiat dollars could be cashed for 100-cent gold-convertible dollars. As the
dollar was the sole reserve currency for international trade under the Bretton
Woods monetary regime, the US enjoyed a 25% premium in all world trade. The
same US goods commanded a higher price against gold overseas than at home.
As the US after World War II was the only exporting nation to war-torn
countries around the world, what cost 75 cents in fiat dollars in the US would
sell for 100 cents in gold at $35 per ounce. While this greatly enhanced
profitability of US exporting corporations, it also discouraged US companies
from bringing their overseas dollars home where the dollar would be worth less
because US citizens could not convert dollars into gold. This created what
later came to be known as euro-dollars, dollars that stayed permanently
overseas to preserve a higher exchange value.
During the 1960s, as US commitments abroad drew gold reserves from the Federal
Reserve, confidence in the dollar weakened, leading some dollar-holding
countries and speculators to seek exchange of their dollars for gold. A severe
drain on US gold reserves developed and, in order to correct the situation, the
so-called two-tier system was created in 1968. In the official monetary tier,
consisting of central bank gold traders, the value of gold was kept at $35 an
ounce, and gold payments to non-central bankers were prohibited. In the
free-market tier, consisting of all nongovernmental gold traders, gold was
completely demonetized, with its price set by supply and demand. In 1971,
president Richard Nixon abandoned the Bretton Woods regime and disconnected the
dollar from gold altogether as he restored the right of US citizens to own
gold.
Foreigners thought erroneously they were getting rich by holding US dollars but
in effect their economies were slipping into the control of the US because
whoever controls the currency of an economy also controls the economy, as
Gresham's Law states: "Bad money drives out the good." When wealth is
denominated in fiat dollars, the US essentially owns that wealth; foreign
holders of that wealth are merely acting as temporary agents of the US. (See
History of monetary imperialism, Asia Times Online, September 26,
2008.)
Obama and China's yuan
On the second day of the new Obama administration, Geithner, Obama's choice for
Treasury secretary, in his Senate confirmation hearing supported by written
testimony, accused China of "manipulating" its currency and pledged
"aggressive" diplomatic action to drive Beijing into action if confirmed as
Treasury secretary. The comment, a politically loaded term calculated to raise
tensions with China, appeared to be a direct appeasement to Democratic Senator
Schumer, whose pet issue has been for "tough approach to force China to stop
currency manipulation or risk being sapped with large (20%) tariffs on its
exports."
It is a "lets get China to force her to stop beating her grandmother" issue, as
most trade economists, including Summers, consider the exchange rate issue as
an ignoratio elenchi (irrelevant conclusion), the informal fallacy of
presenting an argument that may in itself be valid, but does not address the
issue in question.
Geithner's testimony marked the Obama administration's first public
pronouncement in what will be one of its most critical international economic
relationships. It is an indication of the gap between US foreign policy and
domestic domestics. It is also an indication of Obama's less-than-forceful
leadership. Geithner claimed he was merely repeating Obama's views, with which
he was no doubt very familiar. The connection between Obama and Geithner goes
back a long way, to an earlier generation. During the early 1980s, Geithner's
father, Peter, oversaw the Ford Foundation's microfinance programs in Indonesia
being developed by Ann Dunham-Soetoro, Obama's mother.
In a written response to questions from concerned senators, Geithner, whose
nomination was supported by a clear majority of the Senate's finance committee
despite minor personal income tax problems, said: "President Obama - backed by
the conclusions of a broad range of economists - believes that China is
manipulating its currency." Obama would "use aggressively all the diplomatic
avenues open to him to seek change in China's currency practices", Geithner
added. Thus the position was not just to buy confirmation votes.
The price of long-term US Treasury bonds fell after Geithner's remarks, with
some traders concerned that Beijing might ease up its purchase of US debts and
assets. China is the largest foreign holder of US Treasuries. More than $3
trillion of the $5.5 trillion US Treasury market is held by foreign investors,
with China being the biggest, holding $727.4 billion in December 2008, with
Japan in second place with $626 billion. China reportedly holds $1.5 trillion
in dollar-denominated assets out of nearly $2 trillion in foreign exchange
reserves. Beside Treasuries, China at the end of 1008 held $600 billion in
agencies debt (Fanny Mae), 150 billion in corporate bonds, $80 billion in bank
deposits and $40 billion in equities.
The spectacular growth in China's foreign currency reserves appears to be
moderating as the inflow of speculative "hot money" started to reverse flow out
of the Chinese economy in the fourth quarter of 2008. China's foreign reserves
rose by $40.4 billion in the fourth quarter of 2008 to $1.946 trillion, well
below the total trade surplus and foreign direct investment over same period a
year earlier, indicating a substantial outflow of short-term capital.
While China continues to register trade surpluses from a sharper fall in
imports even as export falls, and with her foreign reserves still expected to
rise above $2 trillion in 2009, the period of
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