Colonisation, the phoney-money way

S. GURUMURTHY (The Hindu Businessline,14 June 2013)

India is running after dollars created out of thin air that comes as FII and FDI to buy high-value real assets.

As the rupee threatens to fall to Rs 60 per US dollar, the Finance Minister is running around the world seeking foreign investment into India to get enough dollars to defend the rupee. Meanwhile, the public simply doubled the quantum of imports of gold in April 2013 mocking the Government’s desperate attempts to stanch the flow through repeated hikes in import duty over the last one year. To bring down gold imports, the Finance Minister is advising Indians to buy stocks and not gold, but they are not obliging.

Even as India's woes continue on the external front, it is time that we understood what is the value of the valuable foreign investment we are seeking to overcome our present problems on the external side. If not today, soon this question is bound to present itself. Read on. The US has in the last several decades flooded the world economy with US dollars and co-opted the rest of the world into its economy. Some two-thirds of the physical dollars printed are circulating outside the US and as much of the global forex reserves are being held in dollar assets.

A research paper by Joseph Botta (BIS Paper No 15, 2003) published by Bank of International Settlement traced the cross-border dollar holdings from 1980 till 2001 and projected what would be the future dollar holdings till 2005. The paper brings out that, from 1980 till 2001, year after year two-thirds of the dollars printed by the US was held outside the US.

Considering that, year after year, the amount of dollars held outside the US was exactly two-thirds (and inside the US exactly one-third) of the dollars created by US Fed, this could never have happened by free market demand and supply.
This amazingly precise division of dollars between the US and the rest of the world, year after year, could have happened only by design. But how did the dollar populate and dominate the world? Read on.

This process commenced with the post World War II Breton Woods structure which made the dollar the global currency with the backing of US gold reserves. But, when, in 1971, the US unilaterally went back on its commitment to back the dollar with its gold reserves, the dollar had so populated the world that the holders of dollars had to hold the dollar rather than junk it. At that time some 40 per cent of the dollars printed by US Fed was held outside the US. Considered equivalent to gold itself, till then the dollars were good investment. Thereafter, the dollar, for almost a couple of decades, ceased to be great as investment. Instead, it became the compulsory working capital for global trade. How?
The US and Arab countries worked together to drive up the oil prices and made the oil exporters insist on payment only in dollars. It had two effects. One, every oil importer needed to stock dollars to buy oil and two, the Arab countries saddled with petro-dollars out of sale of oil for dollars had to invest it in low-yielding US Federal, State and Municipal bonds.

The dollar that went out of the US thus came into the US via the Middle East. And the dollar-starved countries had to seek to export to the US or get US aid or loan to fund their needs. Arab oil made the dollar as valuable as oil and more valuable than gold. And later, with the evaporation of the global socialist order, the US as the unchallenged superpower made the dollar the unchallengeable currency.

The power of the dollar became manifest in falling gold prices in dollar terms from $460 an ounce (oz) in 1981, to $362 in 1991, and to $279 in 2000. Gold was $445 an oz in 2005.So, gold prices were lower with the dollar becoming more valuable in 2005 as compared to 1981. It was from 2006 that gold began looking up – $603 an oz in 2006, $872 in 2008, $972 in 2009, $1225 in 2010, $1572 in 2011, peaking at $1800 and now hovering below $1400 an oz.

To measure the power of the dollar, if, instead of in gold, $460 had been invested in 1981 in long-term US bonds, according to the formula, it would have yielded $3460 in 2005 as against the gold value of $445 an oz in 2005 – meaning that 2005 gold commanded in 2005 just a seventh of its value in 1981. So, besides being the sole source of working capital for the burgeoning global economy, it also became more valuable than gold.

Look at US national and global economic performance in this period. In the 32 years between 1976 and 2009, the US ran current account deficits in 29 years, with a net aggregate current account deficit of $7.9 trillion – meaning, that much of dollars was exported out of the US. During this period the US national debt rose 39 times, from $381 billion to $14.4 trillion; and US external debt 137 times, $100 billion to $13.7 trillion.

Against which the US GDP rose just 14 times from $1 trillion to $14 trillion. And the net US global investment positive at $165 billion in 1975 became negative at $3.47 trillion – that is, the US got more investments into US than it invested abroad after 1975. Any other country's currency would have crashed in value with this kind of economic performance.
Yet, instead of falling, the trade weighted dollar index which was 34 in 1975 rose almost four times to 127 in 2002, and even after the worst crisis of US, stood at 106 in 2009 and now it is around 100. And the Dow which was 632 in 1975 topped 14000 on October 12, 2007, fell to 6600 in March 2009 and again rose beyond the pre 2008-crisis levels and now hovers around – believe it! – 15000.

How, despite the poor account of the US economy, the US stock values have hit the roof is best brought out by David A. Stockman, former Republican Congressman and President Ronald Reagon's Budget Director (1981-85). Stockman wrote in the New York Times on March 30, 2013: “Since S&P 500 first breached its current level, in March 2000, the mad money printers at the Federal Reserve have expanded their balance sheet six-fold (to $3.2 trillion from $500 billion).

Yet, during that stretch, economic output has grown by an average 1.7 per cent a year (lowest since the Civil War) real business investment has crawled forward at only 0.8 per cent annually; the payroll job has crept at a negligible 0.1 per cent annually; real median family income growth has dropped by 8 per cent; and the number of full-time middle class jobs, 6 per cent.

The real net-worth of the bottom 90 per cent has dropped by one-fourth. The number of food stamp and disability recipients has more than doubled to 59 million, about one in five Americans.” Stockman added, “Sooner or later – within a few years, I predict – this latest Wall Street bubble inflated by egregious flood of phoney-money from the Federal Reserve rather than real economic gain, will explode too.”

It is obvious that the US economy has done nothing to deserve such high value either for its stocks in the US or for its dollar outside. In the absence of any rational explanation within economics, in 2006, two Harvard economists even tried an exotic explanation outside economics, in physics, for the high value of the dollar in the low-performing US economy. They said that like the unseen “dark matter” sustains the universe, the dollar sustains the global economy and entices people to invest in dollars.

But the dark matter theory was exploded in the 2008 crisis . What sustains the US economy now? In a word, what David Stockman said: phoney-money. It bears respectable technical names – Quantitative Easing (QE) and monetary base. QE means this: when the market is unwilling to borrow money from central banks even at nil rate of interest, the central banks entice the market operators and buy the private investments in bonds and securities, and thus release digitally created dollars to private sellers, thus letting new – phoney – money into the financial system.

US Fed has created $2.35 trillion digital money since 2008. The European Central Bank has, through its computers, issued euros for $1.14 trillion. UK created digital sterling for $588 billion. And Japan has released yen for $848 billion through its computer servers and plans to release another $1.35 trillion in the next 18 months.

In the last four years, $4.928 trillion phoney dollars, euros, sterling and yen have been pumped into the global economy, with another $.1.4 trillion entering at the rate of $72 billion a month from Japan. This non-existent cash is created by computers without real growth or savings. But it is driving up the stock indices all over the world. Stockman calls it phony-money and the BBC, money from thin air. The risks that phoney-money exposes the world economy to, is again a topic by itself .

This phoney promissory note is intended to buy out stocks, assets and wealth and release cash into the respective economies to sustain the asset prices. It is this false money that comes in as FDI and FII investments and buys up high value real assets in the rest of the world, including India.

It is this money out of thin air which we welcome with a red carpet under our cross-border investment policies and trade treaties to sell our real assets for. Is this not colonisation by phoney-money?

(The author is a commentator on political and economic affairs, and a corporate advisor.)