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U.S. House Prices Analysis and Trend Forecast 2019 to 2021

Remaking the US Dollar from the Bottom Up

Currencies / US Dollar Feb 01, 2008 - 01:00 AM GMT

By: Paul_Petillo


Best Financial Markets Analysis ArticleMarco Saba, a researcher at the Italian Center for Monetary Studies and author of a critical book about banking titled "Bankenstein" (2006) took the time to write me about the dollar at the beginning of last year. Mr. Saba?s field of expertise is seignorage (monetary rent), macroeconomic evaluations and central banking.

For those of you unfamiliar with Mr. Saba, his work has led him to the belief that the current monetary system is in need of reform. In fact, the sheer radical-ness of the idea is akin to throwing the baby out with the bath water.

Consider this idea via Mr. Saba: "If President Bush writes an Executive Order to restore monetary sovereignty to the US government, instead of the private FED, this example can be the attractor and catalyst of a real 'new world order', a good one." Is the world or the dollar ready for a new order?

Perhaps we should look at where we are right now. Aside from the fact that the Federal Reserve is cutting rates ? again this week; aside from the misplaced but ultimately necessary stimulus package about to work its way through Congress; aside from the fact that the United states accounts for 30% of the world GDP; aside from the possibility that further declines in the strength of the dollar will make the imbalances of a trade deficit lessen, the dismal performance of this global currency of choice over the past several years is not much of a surprise.

But its continued declines are not only unnecessary but actually seemed to be encouraged by the very policies that suggest we support a strong dollar. Of course we "support a strong dollar". Saying otherwise, despite our administration's actions to the contrary, would be tantamount to admitting that our willingness to pay for oil ? at any price, purchase goods from overseas with those depreciated dollars, which, producing countries use to buy more oil at what appears to be affordable prices is not going to continue. That said, the US has a strong dollar policy. Right?

Saying one thing and doing another seems to create a policy of opposites. No one in the states wants to admit that the value of the dollar makes us weaker at current levels. And no one is comfortable with the increased leverage it gives our trading partners, even if increasingly, the partnership has begun to allow those countries to gain the upper hand. In the dollar?s current state, the partnership is no longer equitable, let alone feasible.

The world views what the US has to offer quite pragmatically. Overseas manufacturers, and even the ones whose ties dilute the ability to track true countries of origin can produce any number of goods but without a marketplace, a distribution network, and a willing customer base, the effort is wasted.

This however is not a conversation about the trade deficit even though the condition of the dollar and the trade deficit are, at best only remotely related, no closer than second cousins.

The dollar on the other hand is governed by trust on a global scale. That is what gives it its true worth. As it stands right now, that confidence in the dollar is on the wane. What happens if that confidence is lost?

Globally, we will feel the rush for the exits much the way Mexico (twice), Brazil, and Argentina (twice) did. Where the risk offers no reward, investors flee. On the home front, the moment could bring about the sudden realization that the strongest economy is now a banana republic. That could see a plunge in jobs and a spike in inflation. A tandem hit such as that would make the upcoming recession seem like a vacation.

The current credit crisis has left us a good deal to digest. As economic leaders leave Davos, the much-discussed subject of who knew what when and whether they can adequately control not only risk but also transparency gives you an indication of how deep this crisis is.

But in addition to the opaque dealings among those willing to deal in risky investments, we now know two things. The current administration does not have a plan for a serious and sudden loss of confidence in the dollar. The other is the blind belief that the markets are the ultimate decision maker in how the dollar performs and because of that, simply having faith what has so far appeared to be anemic at best is enough to give the holders of so many American dollars confidence. After the January we have had so far, are you as trustworthy of the market?s ability to make rational, nonbiased decisions about the dollar?s future?

This is not yet an unsalvageable condition. Admitting that the currency is in trouble might be a good first step, first by the indefatigable Treasury Secretary Henry Paulson, whose rendition of a "strong dollar is in our best interest" has become a tiresome mantra. Ben Bernanke, the incredibly intelligent yet far-too-timid Fed chairman, who has passed on several unique opportunities to address the situation, one of which would have been getting those rate cuts in place before the current mess got as out-of-hand as it did could step up to the podium and voice his dismay. You can forgive Paulson. He is just an administration voice box. But Mr. Bernanke should take more interest in the currency. He is in charge of the Central Bank!

David Roche, president of Independent Strategy, a global consultancy wrote in the Wall Street Journal this past December that his research uncovered the fact that the main driver of financial asset prices was credit. What caught Roche?s eye and not Mr. Bernanke's was the disconnect between those asset prices and money. If credit is the devil, the details must hold a clue.

Which brings us back to Mr. Saba. When he wrote me, last year, he enlisted several high-ranking officials to make his argument for a change in how banks are run. Among the names he mentioned included the Pope, whose "Dottrina Sociale della Chiesa" or Social Doctrine outlines how man, if he is truly a creature of God, should be treated. In the document, man was entitled to his place as the "center of economic, social, political, together with his family" in the universe and as the translated version of the Italian document at Wikipedia reads, he has the "right to religious life, work, family, the use of material goods, property, just wage, freedom, participation in the life of the State, education, collaboration in the production of wealth." Work as the translation suggest is the should abet the human development while government is a "company organized for the common good." Sounds good to me.

He adds Prince Charles is focused in the right direction as well "with his interest in sustainability." Mr. Saba writes, "Islam is interested in free-interest loans which are mandated by the Quran. Jews condemn usury. It is forbidden to pay interest even if (because of devaluation of the currency) the value of the payment does not exceed the principal, and it is rabbinically forbidden to repay the full amount of a loan if the currency has increased in value. [Yoreh De'ah, Chapter 13,"

The idea of charging interest is, according to Saba, only there for political gain. It is a weapon of sorts, one party exerting power over the other. If the banks could no longer use interest to cover the cost of new money, which has a true cost that is almost zero, they would be forced to hand ?monetary sovereignty over to the state/government.?

Mr. Saba discusses the idea of reintroducing the backing of the dollar with gold but smartly dismisses the idea. His email also included the idea of creating a unified currency he calls the AMERO, combining the currencies of Mexico, Canada and the US that he believes would be a good "first step for a global currency."

Then he comes closer to a solution that would answer a problem that has become as endemic in Europe as it is in the US. The belief that banks are actually public entities allows the Central Bank to borrow money from the Treasury, which in turns prints the money and charges the citizens and because the bank does this, not at the price of printing, but the nominal cost plus interest, we lose on several fronts. Currently, the Fed prints money (liquidity) and monitors inflation (more akin to gambling on what the best rate is).

Using a presidential executive order, Saba suggests that the president could force ? once again, roughly translated from Italian- "each new Federal Reserve money (banknotes and sight deposits - i.e. credit) that comes into existence must be backed by State Bills (state notes); that each of the 50 States print those bills in proportion to their quantity of people (demographic dimension); that the Federal Reserve has to take those bills as MANDATORY 100% RESERVE (i.e. those bills are frozen, sterilized in the economic-jargon); that the same must be done by each banks when they open new credit lines (i.e. all the new monetary rents coming from new money, loans, and credit goes to the 50 United States in proportion - as a seignorage redistribution)." Seignorage refers to the right to print a globally accepted currency.

In the end, Saba believes such a plan would enable the elimination of taxes due to the revenue created by rent ? not interest ? charged to borrowers. This would have the net effect of loosening the grip of inflation on the average person. Saba, in an interview with Marcello Pamio for described the connection between money and inflation as an unnecessary waste of taxpayer?s money.

In a rough translation, he described the European banking system (a foreign version of what occurs here in the US), "First of all the money made in this way creates debt." Saba is referring to the wide difference in the cost of printing and the actual printed value on the note. He continues, "The Ministry of the Treasury then sells the newly created notes to the Central Bank and rather than charging him the typeset cost (minimal cost) of the notes, the Treasury charges the Bank the nominal cost plus interest." Saba then tells the interviewer that "This [difference] obviously goes to debt burden for citizens!"

While Saba's plan has merit, the likelihood that we will adopt such a dramatic stance during a time of crisis is next to nil. But when this is all over, the costs of the stimulus package, the cost of dumping money from helicopters into the system, and any other numerous knee-jerk reactions will all come with a cost.

It should be noted that Sabas idea also exacts a cost and he notes it in his email. He warns that any change in the current system, such as adopting the AMERO would create a global temper tantrum. He warns, that we should "be aware, the public debt has to be renegotiated between the government and the banking cartel on a-cent-for-the-10-dollar-basis." But that cost it seems may be outweighed by the benefits.

By Paul Petillo
Managing Editor

Paul Petillo is the Managing Editor of the and the author of several books on personal finance including "Building Wealth in a Paycheck-to-Paycheck World" (McGraw-Hill 2004) and "Investing for the Utterly Confused (McGraw-Hill 2007). He can be reached for comment via:

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01 Feb 08, 09:25
fractional reserve banking

I believe the problem is fractional reserve banking. the FED prints money, lends it to banks who then lend ten times that amount to people at interest. If I were to try and lend money I didn't own, I would be charged with a felony.

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