In the good old days of 2005, the US dollar’s share of the world’s financial system had dropped to around 60%. The dollar was slowly losing its status as the global reserve currency as the Eurozone became a reality and the Euro began to be held in reserve in the central bank coffers of Japan, China, Brazil, Russia, India, the UK, and others.
Then the October crash of 2008 happened, and the world suddenly became aware of the profound lurking global systemic risk to both its financial system — and the real-world’s global trade. It turns out that the world was really much more interconnected than ever before, and the fantasy of “uncoupling” from the United States and its financial system was just that — a fantasy.
For over 400 years, Letters of Credit have financed the world of international trade. An importer’s bank, say CitiCorp in New York, extends a letter of credit through the exporter’s bank, say HSBC in Hong Kong, to guarantee that the exporter will be paid when the shipment of goods arrives at the dock in New Jersey. Or the trade could run the other way, when a mid-west farmer plans to ship wheat to an importer in west Africa.
When the US credit crisis arose, banks worldwide immediately stopped lending to each other, since they couldn’t be sure that their correspondent bank would be around in a month or two to pay back the loan. Worse, so-called cross-default provisions between the major banks make the risks of lending to an unsure partner even worse. Trust among the banks collapsed. Even trust between operating subsidiaries of the same bank overseas were strained.
Banks stopped extending letters of credit to finance global — and even some domestic — trade.
Unfortunately, most bulk cargoes and global commodities as well as finished goods are financed in dollars — as are their commodities futures contracts written in Chicago, New York and London.
When US banks stopped extending loans to overseas banks, overnight there appeared a profound shortage of dollars available for non-US banks to continue their international trade. And unlike the US — where the international export-import sector accounts for only 25% of the GDP- in dollars (and most of that is inside the NAFTA zone between the US and Canada and Mexico) — many other countries count on foreign trade to provide from 50% to 70% of their economies. Even France & Germany, while inside the Eurozone, depend upon cross-border trade for 60% or more of their GDP.
The world’s desperate demand for dollars soared. Most companies doing business internationally buy and sell based on dollars.
Today, the US dollar’s share of the world’s finance — the so-called “reserves” — has probably shot up to over 65% — and is perhaps above 70% and growing. Who knows?
No one wants yen, rubles, renminbi, pesos, pounds or Swiss francs. Even Euros are worth less outside the closed continental Eurozone. The dollar has gone through the roof. BNP-Paribas predicts that the Euro will again drop below the dollar in value and UK analysts predict a similar fate for the English pound by early 2009.
But still global credit is in short supply. And without import-export credit, global trade grinds to a halt.
Consequently, the Baltic Dry Index — used to measure the cost of chartering bulk cargo vessels for goods like corn and wheat, iron ore, cotton, rice and other “dry goods” — has collapsed by over 90% in 2008.
When wheat can’t be shipped, the distant country’s mills can’t turn it into flour. Bakeries can’t bake bread. Stores can’t sell bread. Shortages occur. People are laid off. They stop spending. And no one can pay their bills when they are laid off or their firms go bankrupt. A recession turns into a global depression — caused by cascading real-world defaults caused by the banking system lock-up.
Meanwhile, back in the US, important trading nations like Canada, Mexico, Brazil, and South Korea continue to be favored by the Federal Reserve with directly injected liquidity (money). China and Japan are OK too — they have their own hoards of US dollars — as do Saudi Arabia and the Gulf oil countries. They are firmly inside the US dollar zone. Likewise, the 12 European Eurozone countries controlled by the European Central Bank (and indirectly the UK) are also able to maintain most bloc trade independent of the dollar.
As the world begins to unwind, people stop buying things. Sales of imported wine and toys and clothes drop, along with purchases of imported and domestic-made cars. GM and Ford totter on the verge of bankruptcy, dragged down by their bloated domestic union contracts which suck up all the profits made by their booming overseas divisions. Now their overseas divisions are slowing down too. Even mighty Toyota is crashing.
Worse, no cash is available — especially from the terrified banks — to build new modern plants and assembly lines. Planning on buying a clean all-electric car soon? Forget it. Ditto clean nuclear power plants or wind farms. Like the old days of Soviet central planning, the entire system is quickly being starved of investment credit.
Then the government politicians and bureaucrats step in to “save” the banks and then the automobile companies and then the credit card companies and then the next industry sector to fail. Bailouts await Intel, Apple, and HP as the entire system becomes morally corrupted. Even Walmart will be too big to fail…
What the politicians are really doing with all these so-called bailouts, of course, is trying to save their own skins, afraid of an angry populace which will wake up in time for the 2010 general election and toss the present bunch of rascals out of Congress.
By then, US unemployment will have reached 12% and your 401K plan will be renamed the 101K plan (except for members of the auto workers union whose own retirement plans will be bailed out by taxpayers money in exchange for their votes).
Eventually, when the whole sorry mess crashes down around us, people will remember warnings that so many of the founding fathers made in cautioning against creating a central bank. The Fed will be replaced or dissolved, and a new free-market system will emerge like a Phoenix without a corrupt politicized and easily-manipulated fiat currency to rot it out from within.
Sorry Mr. Obama. You inherited this mess, and the only solution to save our collective skins is a big dose of Austrian free-market capitalism, not a soul-crushing dollop of state-administered socialism. You must let the incompetent, the corrupt and the foolish fail.
A recession is like a brush fire which quickly burns itself out as it clears the dead wood.
But heavy-dose money-printing management of the economy, starting with the Fed and Treasury’s morally-bankrupt programs is about to turn a short and severe recession into a catastrophic forest-destroying monster depression.
If you, Barack Obama, have the audacity to turn 180 degrees to embrace this reality, you will probably be remembered in the history books as the greatest-ever president who saved America — and the world.
On the other hand, if you stick to a "progressive" wealth-destroying socialist-Marxist
big-government agenda, we will be cursed to suffer for decades.
So one can hope.
The other sad option takes us down the road to the solution that finally got us out of the 1929 Great Depression: the second world war. God help us if that is the route we take.