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US financial showdown with Russia is more dangerous than it looks, for both sides
The US Treasury faces a more formidable prey with Russia, the world's biggest producer of energy with a $2 trillion economy, superb scientists and a first-strike nuclear arsenal
Washington is tightening the noose on Russia, slowly shutting off market access for Russian banks, companies and state bodies with $714bn of dollar debt Photo: Alamy
By Ambrose Evans-Pritchard
6:24PM BST 16 Apr 2014
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/10771069/US-financial-showdown-with-Russia-is-more-dangerous-than-it-looks-for-both-sides.html
The United States has constructed a financial neutron bomb. For the past 12 years an elite cell at the US Treasury has been sharpening the tools of economic warfare, designing ways to bring almost any country to its knees without firing a shot.
The strategy relies on hegemonic control over the global banking system, buttressed by a network of allies and the reluctant acquiescence of neutral states. Let us call this the Manhattan Project of the early 21st century.
"It is a new kind of war, like a creeping financial insurgency, intended to constrict our enemies' financial lifeblood, unprecedented in its reach and effectiveness," says Juan Zarate, the Treasury and White House official who helped spearhead policy after 9/11.
“The new geo-economic game may be more efficient and subtle than past geopolitical competitions, but it is no less ruthless and destructive,” he writes in his book Treasury's War: the Unleashing of a New Era of Financial Warfare.
Bear this in mind as Washington tightens the noose on Vladimir Putin's Russia, slowly shutting off market access for Russian banks, companies and state bodies with $714bn of dollar debt (Sberbank data).
The stealth weapon is a "scarlet letter", devised under Section 311 of the US Patriot Act. Once a bank is tainted in this way - accused of money-laundering or underwriting terrorist activities, a suitably loose offence - it becomes radioactive, caught in the "boa constrictor's lethal embrace", as Mr Zarate puts it.
This can be a death sentence even if the lender has no operations in the US. European banks do not dare to defy US regulators. They sever all dealings with the victim.
So do the Chinese, as became clear in 2005 when the US hit Banco Delta Asia (BDA) in Macao for serving as a conduit for North Korean commercial piracy. China pulled the plug. BDA collapsed within two weeks. China also tipped off Washington when Mr Putin proposed a joint Sino-Russian attack on Fannie Mae and Freddie Mac bonds in 2008, aiming to precipitate a dollar crash.
Mr Zarate told me that the US can "go it alone" with sanctions if necessary. It therefore hardly matters whether or not the EU drags its feet over Ukraine, opting for the lowest common denominator to keep Bulgaria, Cyprus, Hungary and Luxembourg on board. Washington has the power to dictate the pace for them.
The new arsenal was first deployed against Ukraine - of all places - in December 2002. Its banks were accused of laundering funds from Russia's organised crime rings. Kiev capitulated in short order.
Nairu, Burma, North Cyprus, Belarus and Latvia were felled one by one, all forced to comply with US demands. North Korea was then paralysed. The biggest prize yet has been Iran, finally brought to the table. "A hidden war is under way, on a very far-reaching global scale. This is a kind of war through which the enemy assumes it can defeat the Iranian nation," said then-president Mahmoud Ahmadinejad to Iran's Majlis. He meant it defiantly. Instead it was prescient.
The US Treasury faces a more formidable prey with Russia, the world's biggest producer of energy with a $2 trillion economy, superb scientists and a first-strike nuclear arsenal. It is also tightly linked to the German and east European economies. The US risks endangering its own alliance system if it runs roughshod over friends. It is in much the same situation as Britain in the mid-19th century when it enforced naval supremacy, boarding alleged slave ships anywhere in the world, under any flag, ruffling everybody's feathers.
President Putin knows exactly what the US can do with its financial weapons. Russia was brought into the loop when the two countries were for a while "allies" in the fight against Jihadi terrorism. Mr Putin appointed loyalist Viktor Zubkov - later prime minister - to handle dealings with the US Treasury.
Mr Zarate said the Obama White House has waited too long to strike in earnest, clinging to the hope that Putin would stop short of tearing up the global rule book. "They should take the gloves off. The longer the wait, the more maximalist they may have to be," he said.
This would be a calibrated escalation, issuing the scarlet letter to Russian banks that help Syria's regime.
He thinks it may already too late to stop Eastern Ukraine spinning out of control, but not too late to inflict a high cost. "If the US Treasury says three Russian banks are "primary money-laundering concerns", do you think that UBS, or Standard Chartered will have anything to do with them?"
This will graduate to sanctions on Russian defence firms, mineral exports and energy - trying not to hurt BP assets in Russia too much, he adds tactfully - culminating in a squeeze on Gazprom should all else fail. Whether you are for or against such action, be under no illusion as to what it means. We would be living in a different world, and Wall Street's S&P 500 would not be trading anywhere near 1,850.
It is true that Russia is not the power it once was, as you can see from these Sberbank charts showing relative economic size against China and Europe.
This is not a repeat of the Cold War. There is no plausible equivalence between Russia and the West, and no ideological mystique.
It has $470bn of foreign reserves but these have already fallen by $35bn since the crisis began as the central bank fights capital flight and defends the rouble. Moscow cannot easily deploy the reserves in a slump without causing the money supply to shrink, deepening a recession that is almost certainly under way. Finance minister Anton Siluanov says growth may be zero this year. The World Bank fears -1.8pc, while Danske Banks says it could be -4pc.
Putin cannot count on global allies to carry him through. Only Venezuela, Bolivia, Cuba, Nicaragua, Belarus, North Korean, Syria, Sudan, Zimbabwe and Armenia lined up behind Mr Putin at the United Nations over Crimea, a roll-call of the irrelevant.
Yet as the old proverb goes: "Russia is never as strong as she looks; Russia is never as weak as she looks."
Princeton professor Harold James sees echoes of events before the First World War when Britain and France imagined they could use financial warfare to check German power.
He says the world's interlocking nexus means this cannot be contained. Sanctions risk setting off a chain-reaction to match the 2008 shock. "Lehman was a small institution compared with the Austrian, French and German banks that have become highly exposed to Russia’s financial system. A Russian asset freeze could be catastrophic for European – indeed, global – financial markets," he wrote on Project Syndicate.
Chancellor George Osborne must have been let into the secret of US plans by now. Perhaps that is why he issued last week's alert in Washington, warning City bankers to prepare for a sanctions fall-out. The City is precious, he said, "but that doesn't mean its interests will come above the national security interests of our country".
The greatest risk is surely an "asymmetric" riposte by the Kremlin. Russia's cyber-warfare experts are among the best, and they had their own trial run on Estonia in 2007. A cyber shutdown of an Illinois water system was tracked to Russian sources in 2011. We don't know whether US Homeland Security can counter a full-blown "denial-of-service" attack on electricity grids, water systems, air traffic control, or indeed the New York Stock Exchange, and nor does Washington.
"If we were in a cyberwar today, the US would lose. We're simply the most dependent and most vulnerable," said US spy chief Mike McConnell in 2010.
The US defence secretary Leon Panetta warned of a cyber-Pearl Harbour in 2012. "They could shut down the power grid across large parts of the country. They could derail passenger trains or, even more dangerous, derail passenger trains loaded with lethal chemicals. They could contaminate the water supply in major cities, or shut down the power grid across large parts of the country,” he said. Slapstick exaggeration to extract more funds from Congress? We may find out.
Sanctions are as old as time. So are the salutary lessons. Pericles tried to cow the city state of Megara in 432 BC by cutting off trade access to markets of the Athenian Empire. He set off the Pelopennesian Wars, bringing Sparta's hoplite infantry crashing down on Athens. Greece's economic system was left in ruins, at the mercy of Persia. That was a taste of asymmetry.
The Continuation of Policy by Other Means
Juan C. Zarate
Treasury’s War
The Unleashing of a New Era of Financial Warfare
PublicAffairs, New York, 2013, 336 pp., $27.99 (cloth).
http://www.imf.org/external/pubs/ft/fandd/2013/09/books.htm
Treasury’s War offers a guided tour of a decade of the U.S. government’s efforts to wield its financial and economic power to achieve its strategic interests and alter the balance of various conflicts. Juan Zarate is well positioned to tell this story: he joined the George W. Bush administration’s Treasury Department as a young, gregarious former prosecutor with antiterrorism credentials just months before the terrorist attacks of September 11, 2001, and eventually rose to become deputy national security advisor.
Zarate was personally involved in many of the developments recounted in the book, including the “war on terror,” the U.S. invasion of Iraq, and efforts to contain the nuclear ambitions of North Korea and Iran and to undermine the Qaddafi and Assad regimes in Libya and Syria.
Following 9/11, financial and economic sanctions and the role of financial intelligence became increasingly important and effective tools in the U.S. national security arsenal. Zarate attributes this to several factors, including the globalization of financial markets and the central role played by the dollar in international trade transactions.
He implies but doesn’t state that many of the Treasury’s legal authorities had been developed during prior administrations, but he makes quite clear that the U.S. government was willing, after 9/11, to take risks and pursue initiatives that previously would have been considered too controversial. Early on, Treasury Secretary Paul O’Neill directed his subordinates to impose sanctions even in cases where the factual basis was slim: one such case involving Somali Swedes working in the remittance business resulted in human rights protests by the Swedish government, and another in an adverse ruling by the European Court of Justice.
But perhaps the best example of the newly aggressive posture was the secret issuance of targeted subpoenas for the records of the Society for Worldwide Interbank Financial Telecommunication (SWIFT)—the global provider of secure financial messaging services. This program of subpoenas, which was entirely legal and carefully managed, nevertheless has proved difficult to defend and maintain following its public disclosure in 2006.
Many observers have noted that, short of military action, sanctions programs are one of the relatively few options available to contain North Korean and Iranian nuclear ambitions. Although Zarate makes a persuasive case that these measures have had a real impact on the targeted regimes, the question of whether and the extent to which sanctions programs are ultimately effective in changing their calculus is a debatable, second-order one that Zarate’s book does not fully address.
Rather, Zarate presents a human, first-person narrative that helps the reader understand how policy decisions were made, what motivated the actors, and how they felt. He recounts how he and a group of Treasury policy officials wearing suits and carrying briefcases felt oddly out of place flying into Kabul on a military jet shortly after the U.S. invasion of Afghanistan, to help the U.S. military and intelligence communities take advantage of the ancient hawala system of money exchange.
Following the creation of the Department of Homeland Security, which stripped the Treasury Department of the Customs Service and the Secret Service, Zarate and his Treasury enforcement colleagues were pressed to prove their relevance to the national security agenda. They set about doing so through the application of sanctions on a few select “rogue” banks that were involved in laundering money for sanctions evaders, drug traffickers, and terrorist organizations. Later, the Treasury’s strategy emerges, validated and victorious, with President-elect Obama’s decision to retain Treasury Under Secretary Stuart Levey, the public face of the Bush Treasury’s Iran sanctions program.
Treasury’s War assumes that most people are unaware of the Treasury Department’s role and its powers to implement sanctions, extract and analyze financial intelligence from banks, and negotiate global norms for financial regulation and information sharing, or how these activities have helped the United States achieve its objectives. Zarate usefully opens with a brief history of economic sanctions, from the Peloponnesian War in 432 B.C. to the Clinton administration’s targeted sanctions against the Milosevic regime, Colombian drug traffickers, Hezbollah, and Al Qaeda in the 1990s.
By book’s end, Zarate ponders some of the broader implications of the policies that he and his colleagues pursued during the post-9/11 decade. In particular, he suggests that Treasury’s War has opened a Pandora’s Box and that the U.S. economy and financial sector may themselves be vulnerable to similar steps taken by its financial and economic rivals. If Treasury’s War has been as effective as Zarate says it has been, then his warnings may well be taken seriously.
Jody Myers
Assistant General Counsel
IMF Legal Department
http://www.amazon.com/Treasurys-War-Unleashing-Financial-Warfare/dp/1610391152/ref=cm_cr_pr_product_top
"Money is Their Enabler." 21 Nov 2013
By John A Cassara - Published on Amazon.com
For over ten years, the United States has been attempting to identify, penetrate, disrupt, and dismantle a myriad of financial networks of rogue regimes, proliferators, terrorist groups, state sponsors of terrorism, and criminal syndicates. Juan Zarate, one of the chief architects of this strategy, recently released his first book; Treasury’s War – The Unleashing of a New Era of Financial Warfare.
The insider’s account both pulls back the curtain of this shadowy world and gives a sobering assessment of many of the new financial threats we will be facing in the coming years.
Many readers know Juan Zarate as a national security commentator for CBS News. His perspective and insights originate from his former positions as Deputy Assistant to the President and Deputy National Security Advisor for Combating Terrorism and the First Assistant Secretary of the Treasury for Terrorist Financing and Financial Crimes.
I know Juan as my well-respected former boss at the Department of Treasury. He is hard-working, a gentleman, and a patriot.
In the book, Zarate argues convincingly that “money is a common denominator that connects disparate groups and interests-often generating networks of convenience aligned against the United States. Money is their enabler. It is also their Achilles’’ heel.”
Zarate describes how after September 11 a small cadre of dedicated professionals within Treasury used imagination and innovative tactics to unleash a new type of financial warfare that harnessed the use of the dollar as the world’s primary currency, access to the American financial markets, globalization, new forms of financial data and intelligence, freezing orders, regulatory actions, and “smart” new applications of sanctions and designations to undermine American foes including Saddam Hussein’s Iraq, Iran, North Korea, Syria, narco-terrorists, kleptocrats and others.
As a proud former Treasury Special Agent, I appreciated finally getting an insider’s account of how Treasury’s enforcement arm (Customs, ATF, and the Secret Service) was amputated at the time of the creation of the Department of Homeland Security. Many of us are still bitter. The last ten years have demonstrated that our anti-money laundering and counter-terrorist finance efforts have suffered over this myopic and politically expedient decision. As I have argued for years, and Zarate makes clear, there is a need for a reinvigorated Treasury enforcement arm to focus on illicit financial flows.
Another section of the book that I found very important is when Zarate masterfully lays out many of the threats we face in the “coming financial wars.” It is sobering reading, particularly because we are simply not prepared.
I applaud the book. However, it is important to understand that Zarate writes from a 30,000 foot policy maker’s perspective. During much of the same time frame and particularly in the years immediately preceding September 11, my vantage point was that of a financial crimes investigator at the street level. As a result, our assessments – though not our objectives - are vastly different. In my first book, Hide & Seek: Intelligence, Law Enforcement, and the Stalled War on Terror Finance (Potomac Books, 2006) I discuss from a ground level viewpoint the actual implementation of our anti-money laundering / counter-terrorism policies both in the United States and overseas.
For example, over the years successive administrations, politicians from both parties, and apologists for Treasury have praised a series of “tough new sanctions” designed to squeeze our adversaries While this is not the space to debate the efficacy of sanctions, my views have been shaped by investigations of “sanctions busters” in places like Dubai. I would also like to point out that in 2012 the Director of National Intelligence testified that sanctions have had “zero effect” in slowing Iran’s nuclear program. Or to quote an anonymous retired diplomat, “Sanctions always accomplish their principal objective, which is to make those who impose them feel good.”
In addition, Zarate makes no mention of the U.S. 2007 National Anti-Money Laundering Strategy (see: [...]). This is an important policy document that overlapped Zarate’s tenure. Most observers feel that the implementation of our strategy has been a colossal failure. Nor has there been any accountability for the various agencies and departments involved including Treasury. For example, in the book there was no mention of the long-term dysfunction of Treasury’s Financial Crimes Enforcement Network (FinCEN) charged with implementing many of the Strategy’s action-items.
And despite Treasury’s Wars upbeat pronouncements and pats-on-the-back, the fact remains that according to the United Nations Office of Drug Control (UNODC), less than one per cent of global illicit financial flows is currently being seized and frozen. It is probably about the same in the United States. In my opinion, a one percent success rate is nothing to boast about.
Zarate does make clear that despite our myriad of new financial tools and countermeasures, our adversaries adapt. And they continue to use effective but simple techniques such as bulk cash smuggling. To put things in perspective, in the United States, our success rate in intercepting bulk cash along the southwest border is approximately .0025 percent!
Indigenous, underground banking systems such as hawala are also almost impervious to the kinds of financial countermeasures described Treasury’s War. To help bring this threat alive, I recently released my first novel, Demons of Gadara. The realistic story told from the vantage point of ground level demonstrates how our adversaries use value transfer and hawala in an act of terror.
Zarate is right to say we are in a “new era” of financial warfare. To me the era is not reassuring. It is frightening.
Essential reading for anyone wanting to understand America's financial power, October 26, 2013
By Joshua B. Stanton
It is rare to find a book that tells the reader something vastly consequential that no other book has told before. Treasury's War is such a book.
As Iran races toward the bomb, as North Korea races toward miniaturizing the one it has, and as Syria uses chemical weapons largely acquired from North Korea and paid for by Iran, journalists and academics falsely assume that policy-makers have only two options -- military force, and the same diplomatic strategies that have failed, consistently, for decades.
Treasury's War is an insider's account of how Treasury Department lawyers and regulators bled Al Qaeda dry, brought North Korea to the brink of financial collapse, and have since done the same to Iran -- all without firing a shot. This new financial strategy, if used carefully and selectively and in concert with other tools of national power, may give our diplomats the leverage they've long needed to deal with rogue regimes that are not deterred by threats of force from a war-weary America. It's also apparent that some diplomats will first need a better understanding of how to use that leverage effectively.
The key to this new strategy is the status of the U.S. dollar as the world's reserve currency, and New York's banks as the hub of the world financial system. (If nothing else, this should be required reading for those who would deny the implications of a U.S. default.) All international wire transactions denominated in dollars require access to U.S.-based "dollar-clearing" services and correspondent accounts. Treasury regulators can deny bad actors access to that system at its hub, and as Zarate explains, the consequence for the target is economic devastation. Treasury's global reach derives from the adage that capital is a coward. Banks can't afford to suffer harm to their reputations or a loss of access to the hub of the financial system.
Thus, blacklisting one bank in Macau in late 2005 for laundering North Korea's counterfeit currency had a global ripple effect, with banks everywhere distancing themselves from North Korea, at least until the State Department forced Treasury to reverse itself in early 2007.
Zarate's chapters about North Korea portray the Bush Administration's State Department, particularly its negotiator Christopher Hill, in an unflattering light. For years, North Korea counterfeited U.S. currency and used the financial system for proliferation and money laundering (which it continues to do to this day). Treasury acted to isolate North Korea, and to protect the dollar and the financial system against those threats. Banks everywhere responded, and the resulting pressure drove Kim Jong Il back to the bargaining table. Unfortunately, in his desperation for a deal and ignorance of how the financial authorities worked, Hill forced a clumsy, embarrassing, and unilateral roll-back of Treasury's campaign. This not only failed to address North Korea's illicit activity, it removed the very pressure Hill would later need to prevent Kim Jong Il from reneging on his agreements. The results were predictable.
Today, an even more intense campaign of financial pressure has brought Iran's economy to the brink of collapse, and Iranian negotiators back to the table. Will State fail to learn the lessons of North Korea?
If you're looking for great literature, look elsewhere. Zarate's simple prose is meant to explain complex ideas to those us who aren't bankers, and it does this effectively enough. Zarate's last chapters are a rushed litany of ideas whose vast importance the reader will grasp, but just barely. Unfortunately, Zarate doesn't quite pursue them to conclusion with concrete recommendations. There may be material enough here for another book. Until then, no person can fully understand U.S. foreign policy without also understanding its growing financial component. No single source explains that component better than Treasury's War.
by semper occultus » Sun May 04, 2014 4:29 am
China poised to pass US as world’s leading economic power this year
By Chris Giles, Economics Editor
http://www.ft.com/cms/s/0/d79ffff8-cfb7-11e3-9b2b-00144feabdc0.html?siteedition=uk#axzz30jVoU52h
April 30, 2014 1:01 am
The US is on the brink of losing its status as the world’s largest economy, and is likely to slip behind China this year, sooner than widely anticipated, according to the world’s leading statistical agencies.
The US has been the global leader since overtaking the UK in 1872. Most economists previously thought China would pull ahead in 2019.
The figures, compiled by the International Comparison Program hosted by the World Bank, are the most authoritative estimates of what money can buy in different countries and are used by most public and private sector organisations, such as the International Monetary Fund. This is the first time they have been updated since 2005.
After extensive research on the prices of goods and services, the ICP concluded that money goes further in poorer countries than it previously thought, prompting it to increase the relative size of emerging market economies.
The estimates of the real cost of living, known as purchasing power parity or PPPs, are recognised as the best way to compare the size of economies rather than using volatile exchange rates, which rarely reflect the true cost of goods and services: on this measure the IMF put US GDP in 2012 at $16.2tn, and China’s at $8.2tn.
In 2005, the ICP thought China’s economy was less than half the size of the US, accounting for only 43 per cent of America’s total. Because of the new methodology – and the fact that China’s economy has grown much more quickly – the research placed China’s GDP at 87 per cent of the US in 2011.
For 2011, the report says: “The US remained the world’s largest economy, but it was closely followed by China when measured using PPPs.”
With the IMF expecting China’s economy to have grown 24 per cent between 2011 and 2014 while the US is expected to expand only 7.6 per cent, China is likely to overtake the US this year.
The figures revolutionise the picture of the world’s economic landscape, boosting the importance of large middle-income countries. India becomes the third-largest economy having previously been in tenth place. The size of its economy almost doubled from 19 per cent of the US in 2005 to 37 per cent in 2011.
Russia, Brazil, Indonesia and Mexico make the top 12 in the global table. In contrast, high costs and lower growth push the UK and Japan further behind the US than in the 2005 tables while Germany improved its relative position a little and Italy remained the same.
The findings will intensify arguments about control over global international organisations such as the World Bank and IMF, which are increasingly out of line with the balance of global economic power.
When looking at the actual consumption per head, the report found the new methodology as well as faster growth in poor countries have “greatly reduced” the gap between rich and poor, “suggesting that the world has become more equal”.
The world’s rich countries still account for 50 per cent of global GDP while containing only 17 per cent of the world’s population.
by coffin_dodger » Tue Aug 26, 2014 7:00 pm
Print Less but Transfer More Foreign Affairs (CFR) Sept 2014
Why Central Banks Should Give Money Directly to the People
cont - http://www.foreignaffairs.com/articles/141847/mark-blyth-and-eric-lonergan/print-less-but-transfer-more (behind paywall but one article per month viewable free)
by smiths » Wed Aug 27, 2014 5:12 am
by Elihu » Wed Jan 21, 2015 9:41 am
In other words, an entity’s liabilities may trade at par but that does not mean the entity is solvent. It could mean that governments are using their powers to conceal the truth from people.
by coffin_dodger » Wed Feb 11, 2015 9:51 am
The global financial system stands on the brink of second credit crisis The Telegraph 11 Feb 2015
The world financial system stands on the brink of a second credit crisis as interbank lending shows increasing risk
The world economy stands on the brink of a second credit crisis as the vital transmission systems for lending between banks begin to seize up and the debt markets fall over. The latest round of quantitative easing from the European Central Bank will buy some time but it looks like too little too late.
cont - [url]http://www.telegraph.co.uk/finance/economics/11398175/The-global-financial-system-stands-on-the-brink-of-second-credit-crisis.html
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by Belligerent Savant » Sat Feb 28, 2015 1:44 pm
In Greenbacks We Trust
The U.S. dollar, as we know it today, was born in terror. On April 18, 1906, the Pacific tectonic plate, which extends under the ocean from Japan to central California, darted northward about 20 feet in just under a minute; in San Francisco, buildings that were not shattered by the earthquake burned, and within two days, 80 percent of the city was gone. At the time, American companies and governments still bought insurance from the old British firms, and the payouts to San Francisco were enormous. As was standard practice, the insurers paid in gold, shipping $65 million worth of bars — an estimated 107 tons, representing 14 percent of all British gold reserves — to the Bay Area. Afraid that all that gold leaving its vaults would permanently impoverish the kingdom, the Bank of England doubled interest rates on British bonds. In response, so many wealthy Americans sent money to England that, a few months after the gold came west from London, $30 million in U.S. gold traveled east. The British vaults were replenished, while the U.S. stock fell by 10 percent in two months.
Back then, dollar bills were printed by local banks, not the government, and each bill was a claim on the actual gold sitting in a specific bank’s vault. With all that gold hurtling to and fro, many Americans grew suspicious that their banks no longer had enough. There were runs, and dozens of financial institutions failed in what was the country’s worst financial panic to that point — which is saying quite a bit, because the country had weathered major financial crises every generation since its founding. It took the nation’s most powerful banker, J. P. Morgan, to resolve the crisis. Summoning the treasury secretary to his home on 36th Street, he explained that the government and a consortium of bankers would bail out the system by, among other things, bringing $36 million in gold to New York City. (The Times, in a November 1907 headline, referred to him as “A Bank in Human Form”; the article described him as “moving the pieces on the financial chess board at will, whether they were kings or pawns.”) Americans thought their economic lives were built on a solid foundation of gold. Now, suddenly, they learned that the only thing of enduring value was the will of one rich man.
To ensure this would never happen again, Congress created a new entity, the Federal Reserve System, whose experts would manage the value of the dollar by setting key interest rates. That system worked far better than anybody imagined it would. Few people then — and few people now — could actually describe what it is that the Fed does (in a poll in late 2014, fewer than 24 percent of Americans could pick Janet Yellen as the current head of the Fed from a list of four names, less than would be expected by pure chance). But somehow we have come to accept that the invisible panel of experts, with their confusing statements about interest rates, knows what it is doing. The dollar has performed remarkably well under their power, and indeed the Fed is a part of the reason the United States became the dominant global economy in the 20th century. Before its creation, many bet on Argentina as the major new world economy. I remember a professor of the history of religion once saying that global confidence in the dollar is the greatest example of collective faith in an abstract symbol in human history. The dollar, under the Fed, has achieved something no god, no prophet, no messiah has been able to do.
It would have been understandable if faith in the dollar had wavered after the financial crisis of 2008. After all, the crisis began in the United States, at least in part as a result of bad Fed policy. For well over a year, the Fed was constantly behind, delivering obtuse assertions of health about a financial system that was collapsing. But the dollar itself never faltered. Confidence in currencies is measured in various ways — by inflation, by the interest rate governments have to pay to borrow, by the exchange rate with other currencies and so on. For years now, the dollar has performed better than at almost any point in history on all of these measures. Seven years after a U.S. financial crisis nearly brought down the world economy, confidence in the dollar has never been stronger.
The modern dollar was born because Americans wanted control over their own economic destiny. But now the rest of the world is at our whims. I spoke with Inan Demir, chief economist of Turkey’s Finansbank. He told me that Janet Yellen has the ability to influence Turkey’s economy more than Turkey’s own central bank or its president. In 2011 and 2012, with its “quantitative easing” program, the Fed created tens of billions of new dollars each month. Enough of those dollars flowed to Turkey that the economy there grew by around 9 percent for two years. “That’s China levels,” Demir pointed out. In 2013, when Ben Bernanke, then the Fed chairman, announced that the Fed would stop making all those new dollars, the Turkish stock market fell by a third and hundreds of thousands of Turks lost their jobs. The story is similar in South Africa, Hungary, Indonesia, Brazil, Lebanon and many other emerging markets, where economic policy makers and corporate executives anxiously await Yellen’s every word.
Paradoxically, this universal confidence in the dollar is not necessarily good for our economy. Since 1977, the leader of the Fed has had two legal mandates: to keep the dollar’s value stable and to maximize employment. Yellen is doing the first part of her job so well — so much better, in fact, than anyone could have expected — that she’s hampering the second part, the one about more of us having decent jobs. Corporations, as a group, are now net savers, with an estimated $659 billion in the bank, an enormous shift from historic norms. Entrepreneurship is flat; the percentage of Americans starting new businesses is near a 20-year low. Venture capital, often seen as the most vibrant part of our economy, collapsed in 2000 and has barely budged upward since. In the language of finance, the world’s money is crammed at the safest part of the risk curve. This is bad, because further out on the curve, in the riskier precincts, is where new ideas and new businesses are created.
Discussing this problem with Adam Posen, who once helped set rates at the Bank of England, I joked that Yellen’s job would be solved by simply pouring anti-anxiety drugs into the U.S. water supply, giving people the confidence to make more risky investments in the future. Barring that, Posen pointed out, there is another option. Yellen needs to make people feel a bit more afraid of what she might do.
It wouldn’t take much. If she were persuaded to state that, for example, inflation “slightly” above the long-term target of 2 percent may be acceptable, or even a hint along those lines, she would shock global markets. Fearing their piles of dollars would lose value, many investors would accept that they had to put their money in riskier ventures if they had any hope of outearning rising inflation. Yellen could most likely manage the reaction with the careful use of adjectives. If there weren’t strong enough investor response, she could substitute “a bit” for the word “slightly” in her next statement. If there’s too strong a reaction, she need say only “very slightly” the next time. The Federal Reserve, charged with overseeing the trustworthiness of the dollar, might need to instruct the world to trust the dollar less.
Before the 2008 crisis, I believed, without thinking too much about it, that there was something solid at the core of our financial system. I imagined the world was governed by math — or, more specifically, by serious men in dark suits who understood the complex formulas playing out in their Bloomberg terminals. I, sadly, wasn’t alone. An embarrassingly strong faith in math and models led so many people around the world to create, buy and underregulate securities that were, in hindsight, built not on mathematical laws but on an ugly combination of fraud and naïveté. For me and many others who watch the markets, the collapse was not just a horrible financial and economic disaster. It was also a psychological and existential blow. It brought on a painful recognition that there is nothing truly solid at the center of our economic lives. There are only the stories we tell one another, the promises we make, the shared views we have about the future. It’s something like the challenge so many writers faced in the late 19th and early 20th centuries, when they confronted a world without a knowable God providing absolute structure. Or the work by Einstein and Heisenberg that shattered the predictable world of Newton and showed that there will always be uncertainty, that there are fundamental limits to our understanding.
Economics did have its own analog to those thinkers. In 1921, Frank Knight, an economist at the University of Chicago, wrote a powerful paper that differentiated risk from uncertainty. The word “risk,” he argued, should apply to phenomena that can be modeled mathematically. But “uncertainty,” he said, is something else altogether: It is the deep unknown. Predicting where the stock market will be in a week or a month or a decade is risk. We might disagree on the number, but we agree on the basic data and measuring tools. Uncertainty describes those things we can’t begin to measure and don’t even know exist. (Strikingly, Knight introduced his version of uncertainty six years before Werner Heisenberg applied that word to the movement of atoms.)
Every economist has been trained in this Knightian distinction. But Knight didn’t transform his field in the way Einstein and Heisenberg changed theirs. The financial crisis came about because people believed they were in a world of risk — where the chance of default on mortgages and more complex derivatives can be plotted with great precision — when instead there was deep uncertainty afoot.
After the crash, it seemed, for a moment, as if finance might finally internalize this lesson, accepting that too much certainty, too much faith, can be violently destructive. Instead, though, the global economy simply grabbed onto the surest thing it could. That turned out to be the U.S. dollar.
In the future, perhaps, finance will come to terms with the fact that the dollar is not the sure thing at the center. Nothing is. And if we let go of faith in the dollar, just a little bit, if we embrace the fact that the world is more mysterious and chaotic than we could imagine, then we might find — like artists and physicists have — that a world without certainty can be richer, in all senses of that word, than a world with false convictions.
Adam Davidson is co-founder of NPR’s “Planet Money” and a contributing writer for the magazine.
Comments:
Henry Michigan 18 hours ago
Dollars are great for buying things and short term storage of wealth; but they have lost over 95% of their value since the Fed was created in 1913. While inflation is currently low, history informs us that the fate of all paper money is to be made progressively worthless by inflation, as the government, from time to time, prints too many of them. I wish it was different this time; I'm told its different this time; I'm an apostate, I don't believe.
Dr. Bob Goldschmidt Sarasota, FL 18 hours ago
The deficit hawks need to take the tranquilizers. US debt is much smaller than our national wealth. Also, we should look at the conditions present when our last significant inflation took place in the early 1970's. Payrolls were 52% of GDP vs 42% now. We also released inflationary pressures that had built by going off the last vestiges of the gold standard. Add to this the rapid growth of personal credit due to baby boomers mortgaging their first home along with the "guns and butter" deficits of the Vietnam war and OPEC asserting itself by raising gas prices at the pump by 400% in a few months, and a serious up tic in inflation was quite predictable. Today none of these factors are present.
The malaise depressing our economy is the result of the ongoing technology revolution which has enabled CEO's to reduce labor costs through automation and outsourcing. That 10% of GDP drop in payrolls represents $1.5 trillion dollars a year diverted from paychecks to corporate earnings and is the principal driver of increasing inequality. The resulting weakness in wage-based demand has led the Federal Reserve to cut interest rates to the bone as well as look the other way while another credit bubble with increasingly higher risk is used to supplement demand.
The continuing elimination of labor is unsustainable and will require a constitutional amendment to ensure payrolls are at least 50% of GDP if our political/economic system along with our dollar are to be saved.
E. Nowak Chicagoland 18 hours ago
Well, it's nice to see a member of the econogentsia admitting that a lot of his economic reasoning was based on a hugely flawed idea.
But while the world may have shifted its economic faith to the American dollar, we in the U.S. are burdened by a huge segment of the the American society who who is still absolutely convinced that we can grow the American economy with tax cuts (for the rich) and shrinking the federal budget to the point where it can be "drowned in the bathtub."
Keynesian economic theory has been thrown out and replaced with neo-liberal clap-trap that has been tried and proven untrue, over and over. Yet the Republican party -- and not too few Democrats! -- still holds on to this wrongheaded idea like a dog with a meaty bone.
That's the root of our economic problems in this country. You can't grow an economy when large corporations, sitting on piles of cash, refuse to hire workers. Or if banks refuse to lend to small business. (Why should they when Congress still allows them to make money through high-risk gambling?) Or when government is hampered by neo-liberal anti-government, radicals in Congress.
We're in a pickle because because WE ARE the pickles. Too stupid to learn from our mistakes and too stupid change.
Michael Finn Wenatchee, WA 18 hours ago
One must remember that the Fed is so powerful because it is given so much independence from congress and the American people that it can do the necessary things without too much blowback. In 2009, the Fed bailed a lot countries out by setting up 15 different loan vehicles for countries with banks that had bills due in dollars. It did this inspite of the danger of inflation to the U.S. economy. The European banks and countries wouldn't even talk to one another about this so the Feds had to intercede on their behalf as well.
That is why the dollar is so valuable right now. The trust that the Federal Reserve has built up is well deserved.
OSS Architect San Francisco 18 hours ago
The mathematical models developed for risk, do in fact cover "uncertainty", black swans, "unforeseen circumstances", etc. Financial institution just choose to ignore "catastrophic risk", because it would drive up the requirement for cash reserves.
Wind Surfer Florida 18 hours ago
Even though Paul Krugman repeats that a country's currency value can be changed by the country's interest rate, it seems that our dollar value has gone up against major currencies in spite of our historically lower interest rate. This is mainly because of the policy mistakes, austerity instead of stimulus during secular stagnation/deflation, done by EC and Japan. Because of their belated QE, a financial stimulus, their currencies dropped sharply against dollar.
The questions is, "Can US economy keep growing in spite of higher dollar?" Paul Krugman says that higher dollar is negative to our economic growth. Though most of the young Wall Street and Main Street do not know the history, there was a time that the US economy suffered from higher dollar. In 1985 the US pressured Japan and Germany to raise their currency value against dollar. This caused the eventual economic disaster to Japan and Germany. Learning from this event, China has never yielded to US pressure to raise her yuan renminbi value against dollar. For long, the dollar looks like keep its high status as the world reserve currency.
by coffin_dodger » Thu May 19, 2016 4:24 am
The UK firm that wants to give big spenders a big shock BBC News May 19 2016
One British firm is seeking to put the buzz back into budgeting by giving bank customers an electric shock if they overspend.
Intelligent Environments has launched a platform which can link the Pavlok wristband, which delivers a 255 volt shock, to a bank account.
If the funds in the account go below an agreed limit, the band kicks in.
It can also work with smart meter Nest to turn down the heating and save energy bills if funds are low.
No bank has yet announced that it will be offering the Interact IoT (Internet of Things) platform to customers but Intelligent Environments lists several British banks as clients for its existing online banking platforms.
Chief executive David Webber told the BBC the idea was about consumer choice.
"This is about reacting to changes in your financial well-being," he said.
cont - http://www.bbc.co.uk/news/technology-36301778
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