Sunday, April 24, 2011

Currency Union or Disunion?

The difficulties surrounding the euro were not difficult to foresee. In fact, they have been so since the euro was first conceived. The key question is whether there should be a single currency or multiple currencies. To find the answer, we must delve into the fate of nation-states: will they form a regional union or will each state splinter?

The fate of nation-states themselves is downright precarious. Like a humongous mammal, a modern nation-state consumes massive resources to keep it going. Only the wealth generated by the four technology waves that began with the Industrial Revolution has made the proliferation of nation-states possible. If we meticulously study the wave pattern, we would realise that there's only one more wave left before the world's wealth generating engine turns off. Even now, the rate of wealth generation has slowed down.

The time for tinkering with the political structure is now ripe. However political leaders faced with the loss of their raison d'etre will pull out all the stops to retain the status quo. This struggle against the tide of political and social transformation certainly makes for an interesting spectacle (and writing) if only we could be bystander spectators to this upheaval. Alas, this is not meant to be. To prepare ourselves, we need to look for signs of the impending collapse. They usually start off in the field of economics, not politics, though. Political and social turmoils are always preceded by economic troubles and the extent of the political collapse depends on how severe the economic troubles are.

We have seen how this has unfolded in the Middle East and is spreading to the sub-Saharan African countries. Soon the whole world will be engulfed in this calamity. The direction is clear: the fracturing of nation-states. The latest casualty is Sudan. As for Libya, the solution to its predicament is to split the state into two. Even if NATO and the rebels manage to defeat Muammar Gaddafi, there is no certainty that the rebel leadership can hold the country together. The real problem in all the troubled countries does not lie with the authoritarian leaderships but with the growing young populations that could not be kept economically occupied. Their seething anger was wholly directed at the long reigning autocratic leaders who were made convenient scapegoats for their hardship. The new leaderships of Tunisia and Egypt would in time face the same predicament that brought down their predecessors.

The lack of economic growth marks the later half of any Kondratieff Wave which in its fourth reincarnation is expected to last till 2020. In the second half of the fourth wave which started around 1990, the productive capacity of the global economy exceeds its consumptive capacity. Remember the monopoly board game. If you play long enough, there'll be only one winner and many losers at the end. It's not that people cannot consume, it's just that they cannot do so at the right price because money is stuck with the winners. A new wave which will usher in cheap energy and materials based on biotechnology and nanotechnology will unlock the wealth retained by the current winners but that won't be due before 2020, even then the initial progress may not be fast enough.

Most countries are blaming Ben Bernanke for unleashing inflation but they'd better look at their own selves in the mirror. As I've said earlier, Ben Bernanke's quantitative easing (QE) is impotent. Look at the total credit figure in the US. For the first three quarters of 2010, it was negative throughout. Only in the fourth quarter 2010 did it grow, even then a measly 0.7 percent. With the potential budget impasse looming, the credit growth (and hence the money supply) in the US will again revert to negative territory, dragging Obama's popularity down with it. Bernanke's QE is not going to create new credit but merely exchanging credit (US treasury bonds) ownership. The treasuries held by other countries and the private sector are now being held by the US Federal Reserve. No wonder inflation in the US is low. The one suffered by the emerging countries is due to their unleashing of bank lending - more bank loans, more money supply. That's the reason for their pumped-up property and commodity prices. But this is a temporary phenomenon. When those properties begin their price drops once the banks stop lending, which one day they have to, we'll see the start of the deflation cycle. Money supply would quickly run out as loans get written off. Then everyone knows what a deflationary depression really is.

Each country has its own peculiar way of lunging into depression. The US is already into it though Obama's three consecutive fiscal years (2009-2011) of more than a trillion dollar deficits each have delayed, but not averted, the day of reckoning. The EU is stuck in limbo as the well-off states of Germany, France, and the UK seem lost in how to handle the impending collapse of the PIGS quartet of Portugal, Ireland, Greece and Spain. Should they withdraw their loan assistance, the PIGS sovereign debts will redound on the banks in Germany, France and the UK which have combined exposure to the PIGS of more than $1 trillion. If they continue, the sovereign debts get bigger making the eventual collapse more catastrophic. The PIGS economies are all uncompetitive because of the euro's high value. Their only salvation is through a debt relief AND exit from the EU so that each country can resurrect their old currencies.

The BRIC emerging nations of Brazil, Russia, India and China, and a string of other small nations are all waiting for their highly exposed banks to drop like a hot brick. As for the oil producing countries, actually oil prices are supposed to drop. What's been holding them back is the massive liquidity created by the bank lending and the speculation unleashed by Bernanke's release of capital that used to be tied up in treasury bonds. This liquidity will disappear when the loans are written off. The money used in commodity speculation will also vaporise once the commodity prices plunge.

What will be the currency of choice if nation-states cease to exist. The answer lies in the European Middle Ages. Back then, they were using gold, silver and copper. Now we do not use specie not because paper money lends itself easily to unrestrained printing by the powers that be. The uncontrolled printing of paper money is an afterthought exploited by unscrupulous leaders. The real reason is that the supply of precious metals could not keep up with the tremendous supply of goods and services unleashed since the advent of the Industrial Revolution. Had we used precious metals, we would have been suffering from frequent shortages of money. But if the economic growth is stagnant, which would be the case after the fifth Kondratieff Wave, then precious metals would be the answer to our currency needs. By then paper currency would have been useless because most states would have fractured to nothingness to be replaced by small communities of towns and villages.

Indeed currency union is an anachronism that has no relevance in a fast changing world. It is fitting to remind ourselves of the insightful observation of Benjamin Disraeli, the British Prime Minister in the 19th century: "Our gold standard is not the cause, but the consequence of our commercial prosperity." Substitute the euro or free trade or even democracy for the gold standard, and you will find that his statement would be valid for all of them. Hard to believe? Watch the world unfold in the coming years.

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