Wednesday, December 30, 2009

GATA Sues Federal Reserve to Disclose Gold Market Intervention Records

Press Release
Gold Anti-Trust Action Committee
Wednesday, December 30, 2009

MANCHESTER, Conn.--The Gold Anti-Trust Action Committee Inc. today brought suit against the U.S. Federal Reserve Board, seeking a court order for disclosure of the central bank's records of its surreptitious market intervention to suppress the monetary metal's price.

The suit was filed in U.S. District Court for the District of Columbia and targets Fed records involving gold swaps, exchanges of gold with foreign financial institutions. In a letter dated September 17 this year to GATA's law firm, William J. Olson P.C. of Vienna, Virginia, ( Fed Board of Governors member Kevin M. Warsh acknowledged that the Fed has gold swap agreements with foreign banks but insisted that such documents remain secret:

The lawsuit follows two years of GATA's efforts to obtain from the Federal Reserve and the U.S. Treasury Department a candid accounting of the U.S. government's involvement in the gold market. These efforts parallel those of U.S. Rep. Ron Paul, R-Texas, who long has been proposing legislation to audit the Fed. The Fed has been criticized for secrecy in its massive intervention in the markets over the last year, and Paul's legislation recently was approved by the U.S. House of Representatives.

In correspondence with GATA's lawyers, the Fed has claimed that its gold swap records involve "trade secrets" exempt from disclosure under the U.S. Freedom of Information Act.

GATA Secretary/Treasurer Chris Powell said:

"While GATA has produced many U.S. government records showing both open and surreptitious intervention in the gold market in recent decades (see, Fed Governor Warsh's letter is confirmation that the government is surreptitiously operating in the gold market in the present as well. That intervention constitutes a huge deception of financial markets as well as expropriation of precious metals miners and investors particularly. This deception and expropriation are what GATA was established in 1999 to expose and oppose.

"Of course GATA's lawsuit against the Fed will take months if not years to resolve. We think we have a good chance of winning it in court. But we can win it outside court, and much sooner, if the suit can gain enough publicity from the financial news media and market analysts and prompt enough inquiry from them and from the public, the mining industry, and members of Congress.

"So GATA urges its friends to publicize the suit and to urge journalists, market analysts, mining companies, and members of Congress to join us in seeking disclosure of the Fed's gold market intervention records. If enough clamor is directed at the Fed about these records, the gold price suppression scheme will lose its surreptitiousness and fail.

"Unfortunately the World Gold Council, which each year collects tens of millions of dollars in membership fees from mining companies in the name of representing them and gold investors, refuses to question governments about their surreptitious interventions in the gold market. These interventions powerfully influence not only gold's price but the prices of government bonds and currencies, as well as interest rates generally and the value of all capital and labor in the world. There is no more important issue in the world economy than gold price suppression.

"So what should have been the World Gold Council's work has fallen to GATA, a non-profit educational and civil rights organization that operates from month to month on donations from people who share its objective -- free and transparent markets in the precious metals and fair dealing among nations generally. As we prosecute our lawsuit against the Fed, we'll be grateful for your support. We promise to do something with it."

For information about supporting GATA, please visit:

GATA's lawsuit against the Fed is listed in federal court records as civil case No. 09-2436 ESH, the letters being the initials of the district court judge assigned to it, Ellen S. Huvelle.

The lawsuit can be found here:

Dollar Share Of Allocated Reserves Slips

By Meena Thiruvengadam
Dow Jones Newswires
via The Wall Street Journal
Wednesday, December 30, 2009

Data released by the International Monetary Fund on Wednesday showed global official foreign exchange reserves rose to $7.52 trillion at the end of the third quarter from $7.18 trillion at the end of the second quarter.

Allocated reserves stood at $4.43 trillion, up from $4.27 trillion in the previous quarter. The amount of allocated reserves held in U.S. dollars stood at $2.73 trillion, an increase from $2.68 trillion in the second quarter but below the $2.81 trillion recorded in the third quarter of 2008.

The data showed U.S. dollar reserves account for 61.65% of allocated reserve holdings, a decline from 62.82% in the previous quarter.

Euro holdings edged up to 27.75% from 27.42%, while sterling holdings rose to 4.34% from 4.30% and yen holdings climbed to 3.23% from 3.12%.

Tuesday, December 29, 2009

Are Mobile Payments a "Terrorist Dream" or Not?

Dave Birch of the Digital Money Forum blog has a recent post, "Are Mobile Payments a 'Terrorist Dream' or Not?", regarding KYC (know your customer) rules and anonymous payment products. I found it interesting because it has been a topic of ongoing concern since electronic cash dramatically burst onto the scene in the mid-1990s. Is the market adoption rate for "pure" digital money being stifled because of government-tracking initiatives and the fact that consumers do not want to lose privacy by going online? I believe that it is.

Dave is correct to point out that these restrictions are nonsensical for small payment transactions. But why stop there? If consumers currently enjoy an existing level of anonymity and privacy by transacting in 500-euro notes or $100 bills, then there is no reason whatsoever that we should lose that right with digital money. The terrorist argument does not hold water, because terrorists use the mail and the telephone and we would not blame the mail infrastructure and the telephone infrastructure for enabling terrorism. The monetary unit of account and its distributed privacy attributes are an infrastructure issue. Dave writes:
"I wasn't not arguing that we should have no KYC checks, but what I was arguing for was a sensible floor below which KYC checks are not needed. I happened to be in a local branch of national financial services organisation a few weeks ago when, for dreary reasons, I had to get into a queue. The person in front of me in the queue was trying to send fifty pounds to a relative in Liverpool. The clerk told him that couldn't, because he didn't have a passport and a utility bill. The chap complained that he had been sending this birthday money every year for decades. The clerk was unmoved. So who benefits from this? I didn't stop the 911 terrorists (who used credit cards in their own names) or the crotchbomber (who paid for one-way air ticket in cash) or the tube bombers (who were carrying identity documents). My argument was, and is, that we should decide where the balance should be in order to get the best result for society as a whole."

"My suggestion is that we fix on 500 euros as the breakpoint. People should be allowed prepaid cards, prepaid accounts, money transfer accounts or whatever with no identification provided that the maximum balance is limited to 500 euros (it is currently 150 euros) and a maximum annual turnover over 10,000 euros (it is currently 2,500 euros). This will lower costs and ease accessibility -- I might even go and get an O2 Money card -- thus achieving a variety of goals including social inclusion and reduced transaction costs for the poor."

For further reading:
"Mobile Phone Laundering: Fact or Fiction?", Saskia Rietbroek, March 2008

North Korea to Ban All Foreign Currencies

By Andrew Moran
Digital Journal
Monday, December 28, 2009

The North Korean government will ban its citizens from possessing, using or trading foreign currencies. The restriction would also affect visitors from other nations.
According to a report from a Seoul-based North Korean news website on Monday, the government of North Korea will restrict citizens to use foreign currencies, while the ban will also apply to visiting foreigners, reports Global Times. The latest decision by Kim Jong-il’s government is to curb inflation, which maybe increased due to foreign currencies.

Earlier this month, Pyongyang banned locals and foreigners from using United States Dollars and Euros. In the past, tourists could pay hotels and restaurants with foreign money. But now stores, merchants, hotels, restaurants and other places of business cannot accept any other currency.

This move may upset the general public and some reports state Koreans will not surrender their currency voluntarily. However, the North Korean People’s Security Agency declared that citizens will receive severe punishment if they do not hand over international currencies.

Joong Ang Daily reports that the North Korean regime will confiscate all foreign currency owned by citizens. Furthermore, trading companies who have earned US Dollars through exports must deposit the money within the next 24 hours. Tourists visiting the country must exchange their currency for North Korean Won.

An anonymous source said, “For now, it would be difficult to use foreign currency but that will change over time. We just don’t have faith in the North Korean won.” While another businessman stated, “No foreign currencies such as the U.S. dollar, euro, yen or yuan can be used in North Korea from Jan. 1. Authorities have ordered that all foreign currencies should be exchanged into the North Korean won.”

Nevertheless, Donga notes that experts believe North Korea will never be able to get rid of foreign currencies because it’s described as “foreign currency paradise” due to major economic and financial transactions being conducted since the early 1990s.

Digital Journal reported in December that citizens are buying as much as they can with their local currency because a major revaluation is being conducted by the central bank. Residents fear that their savings may be wiped out.

Monday, December 28, 2009

Asia Central Bankers Say It with Gold

By David Roman
The Wall Street Journal
Monday, December 28, 2009

Strong dollar equals falling gold price, right?

Except, perhaps, when Asia's central bankers are involved.

Three-quarters of the region's $5 trillion in foreign-exchange holdings are parked in U.S. dollars. A desire to diversify away from the greenback, though, has become evident. The dollar's share in reserve accumulation dropped to less than 30% in the third quarter, Barclays Capital estimates.

Admittedly, knowing exactly what is in central bank reserves takes guesswork, but analysts think most diversification in 2009 favored the euro.

Recently gold has turned up as a second alternative. The Reserve Bank of India stirred markets when it revealed it purchased 200 tons of gold from the International Monetary Fund in October, increasing gold's share of central bank reserves to 6.4% from 3.6%.

Even if other central banks don't start making large purchases like India's, they will likely remain a substantial buyer as reserves continue to pile up. In the 12 months through November, the banks added around $800 billion to their foreign-exchange holdings, a side effect of their efforts to slow the appreciation of local currencies.

China, which has seen its reserves rise by more than 50% in the past two years to about $2.3 trillion, has bought 450 tons of gold during the period, Merrill Lynch estimates. That is a substantial chunk in a market where annual turnover is about 3,800 metric tons. Accumulation of reserves by Asia's central banks will likely continue as long as strong regional growth and high interest rates continue to attract foreign investors.

A shift in portfolios, like India's, would only add to this, and there is scope for this to happen. Gold accounts for around 2% of reserves in emerging markets, Merrill Lynch calculates. That compares with a 10% average globally, and more than half of all holdings in the case of the U.S. Federal Reserve, and France's and Germany's central banks.

Asia's central bankers will move slowly, particularly with gold prices still above $1,000 an ounce. But a shift toward the global average would mean more buying -- regardless of what the dollar does.

Sunday, December 27, 2009

Do We Need a New Reserve Currency?

By Emirates Business, Dubai
Sunday, December 27, 2009

A new global currency should replace the US dollar as the international reserve currency, as the long-term deterioration of America's economy and the greenback is fuelling a "currency-regime crisis," says Martin Wolf, associate editor and chief economics commentator of the Financial Times.

Wolf, who has honorary doctorates from three universities, bases his argument in part on the Triffin dilemma, an economic paradox named after economist Robert Triffin. The paradox shows that the US dollar's role as a global reserve currency leads to a conflict between US national monetary policy and global monetary policy. It also points to fundamental imbalances in the balance of payments, particularly in the US current account.

Speaking at an event organised by the Singapore Institute of International Affairs, Wolf said Triffin believed that the host nation of a global reserve currency will inevitably run up a huge current account deficit that would consequently undermine the credibility of its currency and adversely impact the global economy. "You can't have an open globalised economy that relies for its ultimate liquidity on the currency of one country. That was his [Triffin's] argument. And, therefore, he said the Bretton Woods system would break, which it did. And exactly the same thing happened with Bretton Woods II, which is the system of pegging.

"So I agree with this. And I'm absolutely convinced now, in a way that I was not three or four years ago, that we cannot continue with a genuinely global economy which relies on national money, and that's not sold by just adding another couple (of currencies). It actually means having a global money."

Indeed, Wolf said he's in complete agreement with China Central Bank Governor Zhou Xiaochuan, who has argued for a new global currency "most credibly and convincingly."

"On the dollar, there is nothing to support this currency except the Chinese government and a few other governments that are prepared to buy it," said Wolf. "Anybody can look at the arithmetic of the fiscal deficit, the monetary policy, the external balance, which has improved but largely because of the recession -- the dollar is not adequately supported."

The US currently has a national debt in excess of $12 trillion or almost $40,000 per citizen, with a debt to GDP ratio of more than 85 per cent. In the July-September quarter, the US current account deficit rose sharply by 10.3 per cent from the previous quarter to $108 billion. In the past year, the US dollar index, which measures the performance of the greenback against a basket of currencies, has also fallen significantly.

Apart from the economic risks posed by the decline of the US dollar, China's devaluation of its currency is causing "a real problem" for Europe. The "very perverse currency adjustment" is highly destabilising for the euro zone economy and could create a crisis, said Wolf.

"There is nothing to prevent this, unless the Europeans decide they are going to intervene in the foreign currency market to buy dollars, and that would be over (European Central Bank president) Jean-Claude Trichet's dead body."

As there is "no chance" of European governments intervening in the foreign exchange markets to improve the competitiveness of the euro, it will result in major currencies such as the euro and Japan's yen becoming "very vulnerable."

"This is simply the American way of shifting the recession from them to their trading partners," said Wolf.

"What we need are global currency adjustments and it has to include the renminbi and global macro adjustments in those countries which make this less painful."

"In terms of the impact of this on the role of the US dollar as the currency of denomination for international transactions, basically I think it's become very unreasonable."

"Because the dollar, to my mind, given its underlying conditions, is no longer a credible long-term store of value," said Wolf. The decline of the US dollar underscores a phase of global power transition, with the balance of power moving from the US to Europe, China, and India, Wolf argues, adding that the greenback's loss of credibility as the dominant global reserve currency is part of this messy transition.

"The Americans no longer have the means to save themselves, this is what I think people don't understand. There is no credible American policy," said Wolf.

"We need to discuss this globally in a harmonious way. It's not happening, so at the moment the euro zone is a prime victim and it will continue to be, and that will create very big problems for European-based manufacturers, and quite particularly those that are relatively vulnerable to global price effects.

"And it's a tremendous mess, a horrifying mess, and that's where we are. I'm sorry. And we've got to get through this transition as quickly as possible to a more stable global monetary system with a lesser reliance on the dollar. We're going to get there over the next 10 years; I'm sure of it. We're going to get there. The only question we have to decide is how we're going to get there."

Meanwhile, a trade skirmish between the US and China could ensue, if Beijing continues to devalue its currency to bolster export-driven economic growth at the expense of economic recovery in the US, said Wolf.

He says China is working hard to defend the artificially low value of the renminbi in the hope that exports will pick up when external demand recovers. According to China's customs authorities, exports from January to November plunged by 18.8 per cent to $1.07 trillion from a year ago. However, according to the Royal Bank of Canada, export growth should pick up in the coming months and reach double-digits in early 2010.

China's efforts, Wolf said, will spark a "very vigorous, even vicious" reaction from the US as it's destabilising US efforts to engender an economic recovery.

Saturday, December 26, 2009

Central Problem: The Central Bank

By Robert Klein and George Reisman
Saturday, December 26, 2009

The Federal Reserve's easy-money madness must end.

President Barack Obama heads the list of Americans who believe that the continuing financial crisis should be blamed on excessive risk-taking by bankers who had an unbridled desire to make money in mortgages. These would-be reformers want stronger government regulation of the bankers to make sure that nothing like this ever happens again.

In a recent 60 Minutes interview, Obama blamed "fat cat bankers" for causing the crisis, putting America through its "worst economic decades." He went on to chide Wall Street banks for "fighting tooth and nail" the new regulations he believes would be vital in preventing future crises.

A deeper examination, however, reveals that this is neither a housing crisis nor a Wall Street banking crisis. This is a monetary crisis, rooted in the lending of money created out of thin air. This is what leads to economic booms and busts.

The current crisis goes back to the Asian Contagion of 1997 and the meltdown of the Long Term Capital Management hedge fund in 1998. In response to each of these situations, the Federal Reserve cut interest rates and rapidly expanded the money supply. This excess liquidity helped push stocks, especially tech issues, to unsustainably high levels. The excess money created by the Fed and the banking system spilled into the rest of the economy, pushing up consumer prices.

To combat the rise in prices that it had caused, the Fed tightened monetary policy, which precipitated a massive plunge in stocks. Then, to bail out investors and stimulate the slowing economy once again, the central bank expanded the money supply rapidly to force rates lower. It ultimately jammed down the overnight fed-funds rate to 1%.

Unhappy with the correspondingly low returns on money-market funds, recently burned by the stock market, and spurred on by Washington policies intended to encourage homeownership, investors turned to real estate, largely housing, seeking higher returns. In time, in the hands of frenzied investors, the new money created by the Fed and banking system boosted home prices sharply.

In our present crisis, excess money created by the Fed also pushed up consumer prices. Once again, concerned about this, the Fed raised interest rates, thus raising mortgage rates. Subprime borrowers were the first casualties of these higher rates. Unable to afford their interest payments, they kept refinancing their loans by taking out new ones. When the easy money and credit stopped flowing, the loans became harder to refinance, and these borrowers began to default; the higher interest rates and reduced availability of easy mortgage credit also hurt more highly rated borrowers looking for homes. And, of course, the speculators, or flippers, who had feasted on the easy-money loans, saw their schemes disintegrate without easy credit flowing from Washington.

When the Fed tries to induce business activity in this manner, it never lasts. This is because the central bank always has to cut off the flow of easy money, in fear of causing further damage in the form of rising consumer prices. When the Fed removes this artificial stimulus, business activity dependent on it grinds to a halt, asset prices plunge, and recession sets in. In some ways, the process is analogous to a doctor administering adrenalin to a patient. Remove the stimulus and the patient collapses.

Healthy economic growth is supported by savings, rather than newly created money. People and businesses save and invest the money they don't need to consume right away. They make loans and investments that create computer equipment, copper mines, retail stores, and new homes. These loans and investments need not be cut off suddenly by a Fed worried about rising prices, as is the case when the Fed induces business activity by simply creating money.

In the most recent boom, total debt rose to a record 375% of gross domestic product. (By comparison, debt was 150% of total GDP in the inflationary boom of the 1970s.) Thus, the Fed has had to resort to desperate measures to bail out the economy. Along with its gargantuan loan programs, it has injected over $1.2 trillion in new bank reserves into the system -- building upon a base of about $800 billion -- in an effort to hold overnight interest rates near zero. This has propelled stock and commodity prices upward, while credit spreads have tightened. In time, borrowing and lending should accelerate, and economic activity should increase. This should continue until the inflationary consequences of the easy-money policy become evident. Consumer prices should rise, as should long-term interest rates. Then, confronted with the inflationary effects, the Fed once again will have to reverse its easy-money scheme and raise short-term interest rates, or allow the inflationary effects to accelerate.

How many more crises must we endure until we realize the common denominator is the creation of money and credit by the Fed? Wall Street bankers and speculators, who try to game the system and make profits during each boom, are mere bit players in these crises. By fostering the booms and triggering the busts, the real villain is the institution of central banking itself. Thus, instead of providing stability to the economy, central banking has created great instability. Until this is understood, we will make little progress in preventing future crises or easing the current one.

Lurching from crisis to crisis in boom-bust fashion is unacceptable and unnecessary. The Federal Reserve must stop juicing the economy with massive amounts of newly created money and move to a monetary system free of government-caused booms and busts. The only effective way to do this would be to remove control of our money supply from politicians and their appointees. We need to move to a money that is 100% backed by a commodity, such as gold. Only then can we rid the economy of the devastating effects of the creation of money and credit out of thin air.

Robert Klein is a financial advisor in Newport Beach, California and George Reisman is author of "Capitalism: A Treatise on Economics".

For further reading:
"America's Forgotten War Against the Central Banks", Mike Hewitt, October 19, 2007

Wednesday, December 23, 2009

Can China Beat US in Gold Reserves in 10 Years?

By David Lew
Commodity Online
Wednesday, December 23, 2009

China has set the most ambitious task on gold reserves and gold mining: take the country’s gold holdings from the current 1054 tonnes to a massive 10,000 tonnes in the next 10 years.

Is this grand task a realistic plan or a golden dream? Chinese officials say the dragon country wants to overtake the United States in gold reserves. America is the world leader in gold reserves. America owns 8133 tonnes of gold reserves that accounts for 76.5% of its foreign exchange reserves. Naturally, the Chinese plan is to ensure that bulk of its foreign exchange reserves--currently held in the forms of US dollar and bonds--is turned into gold reserves.

Unlike the United States, China has been acting slow all these years in building up its gold reserves. In 1981, China had 395 tonnes of gold holdings; it increased to 500.8 tonnes in 2001, and 600 tonnes in 2002. In April 2009, China officially announced that it has increased its gold holdings to 1054 tonnes. Since then, Chinese officials and People’s Bank of China have been meticulously chalking out plans to build up gold reserves in the next one decade.

China’s move to step up gold reserves got a moral boost when last month India—a large consumer of gold in the world—bought 200 tonnes of gold from the International Monetary Fund (IMF) for a big amount that Chinese would have never thought of purchasing. According to Zhang of the China Gold Association (CGA), India’s decision to buy IMF gold has been the real boost for China’s recent spirited moves to step up gold reserves.

“In view of the declining US dollar value, it is paramount that China steps up gold reserves. How to do this is the only question that China is debating these days. The possible steps include opening up new gold mines, aggressively going for gold mining, buying gold from the open market etc. All said and done, it is imperative that China needs to buy more gold,” Zhang points out.

China has emerged as the largest consumer and producer of gold in the world. It is, thus, natural that the Chinese mop up gold reserves to keep up its status as the No 1 gold consuming and producing nation in the globe, bullion analysts argue. In 2007, China overtook South Africa to become the world’s largest producer. The World Gold Council and global consultancy GFMS have already predicted that China will overtake India as the world's largest consumer as well.

China raised its national gold holdings in April by buying domestically mined gold. Bullion commentators like Mark Robinson are surprised as to why China has not yet shown any interest in buying gold from international markets. As a result of this, shares of Chinese gold mining companies have been rocketing all these months in the last one year. Shanghai and Hong Kong-listed shares of companies like Zijin, Shandong Gold and others are up 3x-4x this year alone. But the main factor at play is fear of a U.S. dollar devaluation.

Erik Bethel of points out the following major thrusts to explain how the Chinese appetite for gold reserves is simply rising and rising:

People in China are seriously starting to take notice of the fragility of the U.S. dollar and are loading up on commodities.

Chinese retail investors are also starting to take notice. As an example, there are "gold retail stores" popping up throughout major cities where individuals can buy mini gold bullion. There's even a China Gold Store located in Beijing Airport's new Terminal 3.

Another example is that while it was illegal to buy gold two years ago, Chinese citizens can now go to the bank and purchase "paper gold" certificates. Paper gold is basically the Chinese equivalent of an ETF and is supposedly backed by bullion held at the banks.

Chinese gold mining stocks are red hot and up 2-4x since last year.

China has US$2 trillion and is going to start deploying it in overseas mining assets.
Following are also some of the major points you wish to read on China’s gold mining spree:

China’s domestic gold production has risen by 15% annually compared to the 3% decline in global production in 2006. This tremendous increase has been due to rapid capital expansion and low costs of labor. Chinese gold producers have gained enormously from the record high gold prices as investors worldwide are seeking stability due to the decline in the value of the dollar.

Domestic producers still suffer from a lack of scale. In 2000, there were about 2,000 gold producers - most of them relatively small and unsophisticated by international standards. Few are able to operate on a global platform, though the number of producers had shrunk to about 800 in 2007 after mergers and acquisitions and restructuring and consolidation. Most of these firms' technological standards and management are weak and inefficient.

China’s oldest and largest gold producer is the China National Gold Group Corporation (CNGGC), which accounts for 20% of total gold production in China and controls more than 30% of domestic reserves. CNGGC also controls Zhongji Gold, the first publicly listed gold mining company in China.

China's gold reserves are relatively small (about 7% of the world total). Production has usually been concentrated in the eastern provinces of Shandong, Henan, Fujian and Liaoning. Recently, western provinces such as Guizhou and Yunnan have seen a sharp increase, but from a relatively small base.

Zhaoyuan, a Shandong provincial city of a population of 580,000, has more than 60 gold mines operating in the hills around the city. They annuall produce about 15% of China's total gold - the most in the country.

In the last five years (2002-2007), China's Geological Survey Bureau found that five new gold deposits with reserves of 600 tons were found.

Top foreign investment has come from Canada and Australia. Though foreign investment still constitutes a very important part gold mining expansion, since 1995 it has no longer been actively encouraged by the Chinese government.

Vancouver-based Jinshan Gold Mines Inc. started production in July at its Chang Shan Hao gold mine in China's northern province of Inner Mongolia, reaching 19,000 ounces of gold by December 18. The mine is designed to produce about 120,000 ounces of gold per year, making it one of the country's largest producers.

Gold Fields and Australia's Sino Gold Mining Ltd., have set up a joint venture focused on discovering large gold deposits in China with the potential to produce about 500,000 ounces a year. Sino Gold has been buying stakes in Chinese gold deposits and explorers. In May it started production at its Jinfeng mine in southern China, with planned gold production of 180,000 ounces per year.

For further reading:
"China Set To Drive Up Global Demand For Gold", Adrian Ash, December 18, 2009

Tuesday, December 22, 2009

Social Media Websites Move Toward Virtual Currency Standardization

By Max Burns
Pixels and Policy
Monday, December 21, 2009

While the big graphical virtual worlds developers grapple with each other about standardizing the virtual experience for consumers, several big social media websites are steaming towards currency standardization with surprising cooperation.

Pixels and Policy reports on how several social media sites are preparing for the launch of a currency exchange in early 2010. It's going to change the way social media does business.

Creating a Foreign Exchange for Zynga Dollars

A recent article in CNET details how social media websites IMVU and MyYearbook are well into the process of constructing a virtual currency market to better facilitate transactions between websites. The joint project - currently titled "Currency Connect" - aims to foster a big change in the way social games bring in money:
Currency Connect is billed as a "cross property virtual currency exchange" system similar to how you would change U.S. dollars into euros if you were traveling in Europe.

Users simply swap their currencies depending on what site they are on. Overall this is not a bad idea as I still find it surprising that users pony up real money for virtual money that can never be taken out of a specific site.
Currency Connect may seem overambitious, but if it succeeds, the project could serve as a much-needed catalyst for encouraging the easy swapping of currency across virtually every social media game. Think of the project as a Lindex that includes other virtual worlds in addition to Second Life - a truly global virtual currency exchange.

Low on FarmVille Dollars? Why not convert some of your Mafia Wars currency at a predetermined exchange rate? Since earning Mafia Wars currency is much simpler than amassing the slowly-accumulating FarmVille dollars, you'd best be prepared to fork over a pretty penny for the higher-valued Farmville bucks.

As the article points out, a successful launch could spur PayPal - the biggest name in purchasing goods online - into providing a universal virtual currency. PayPal would certainly be the heavy hitter in any future currency exchange, perhaps even powering the mechanics behind the trades, and the weight of PayPal would surely bring in names like Facebook, MySpace, and pay-for-perks worlds like Runescape and Evony.

A Virtual Market Economy

These browser-friendly social worlds are blossoming into revenue-generating monsters, and a true virtual currency exchange would further remove constraints that limit the market potential of games like Evony and FarmVille.

What constraints, you might ask? Simple: Gamers invest a great deal of time in their Mafia Wars or FarmVille rank, and aren't keen on starting over from scratch at another time-consuming online game.

By opening up the virtual currency markets to easy trading, gamers can now use their progress in a game like Mafia Wars to purchase a helping hand in Evony, and vice versa. In effect, creating a virtual currency exchange like IMVU and MyYearbook have planned would mean your wealth and success in one virtual world would become transportable to other participating worlds.

What about speculation? Could players invest real money into virtual currency in the hopes that their holdings will appreciate compared to another game? Does the virtual currency exchange mean that virtual currencies can also be cashed out into real-world money at a market-driven exchange rate? If so, wouldn't virtual currencies also qualify as investments in the same way foreign exchange trading does?

Developing a virtual currency trading mechanism opens up a lot of questions about the platform of social media gaming. Will consumers jump at the chance to move their virtual coins around with the same eye to profit that they focus on a child's college fund or their own sagging stocks? Most of all, will competing in a world where long-time gamers can throw their wealth around be as fun as the current environment?

For further reading:
"Virtual currency exchange to launch in 2010", CNET News, December 15, 2009
"IMVU and myYearbook set up virtual currency exchange", Dean Takahashi, DigitalBeat, December 15, 2009

Wednesday, December 16, 2009

Do We Really Need a Central Bank?

On December 2, 2009, Professor Steven Horwitz gave the following speech at The Future of Freedom Foundation’s “Economic Liberty Lecture Series.” The speech "Do We Really Need a Central Bank?" can viewed above in its entirety. It was part of a student lecture series sponsored by the GMU Economics Society, the Future Freedom Foundation, and the Atlas Sound Money Project.

Steven Horwitz is the Charles A. Dana Professor of Economics at St. Lawrence University in Canton, NY. He is the author of two books, Microfoundations and Macroeconomics: An Austrian Perspective (Routledge, 2000) and Monetary Evolution, Free Banking, and Economic Order (Westview, 1992), and he has written extensively on Austrian economics, Hayekian political economy, monetary theory and history, and the economics and social theory of gender and the family. His work has been published in professional journals such as History of Political Economy, Southern Economic Journal, and The Cambridge Journal of Economics . He has also done public policy research for the Mercatus Center, Heartland Institute, Citizens for a Sound Economy, and the Cato Institute. His current project is a book tentatively titled Classical Liberalism and the Evolution of the Modern Family. Horwitz currently serves as the book review editor of The Review of Austrian Economics and as an academic advisor for the Heartland Institute and a contributing editor to Critical Review and Journal des Economistes et des Etudes Humaines. A member of the Mont Pelerin Society, he completed his MA and PhD in economics at George Mason University and received his A.B. in economics and philosophy from The University of Michigan.

From the Atlas Sound Money Project:
"Professor Horwitz joked that the question he set out to answer over the course of the lecture could simply be answered, “No.” But, for the sake of doubters, and to advance the cause of free-banking, Horwitz went on to explain the history of the central bank, the role it has played in our financial history, and the reasons why there are viable alternatives to the Federal Reserve system as we know it. Contrary to claims of the critics of free-banking, the United States has never really given the free-market a chance when it comes to banking. Since the earliest years, banks in the United States have been subject to regulation, first from the states, and later from the national government. The history of these regulations, and the evolution from primarily state-charted banks to the system we know today, is a gold mine for political economists. The centralization of banking in the United States is highly correlated with war, as politicians inevitably discover that the most politically expedient method of funding their budget is to print currency for themselves. A monopoly on money guarantees that in the short term, Congress can run whatever budget it desires without worrying unduly about costs. And so the Federal Reserve system came into existence as politicians required easy money during the Civil War, World War I, and the Great Depression. It is an unsavory history, tied to the centralization of power rather than the good of the financial system. Still, it is only in recent years that criticism of central banking has become mainstream, and its supporters still seem to outnumber its detractors."

"And yet, Horwitz argued, the Fed is unable to do just the things its supports claim it can do. Those who argue for the necessity of the central bank say that banking would be far too chaotic without a governing body, some government agency to watch the financial system and provide counter-cyclical force to erratic economy. However, throughout its history, the efforts of the Federal Reserve have been detrimental to the economy. Because of knowledge problems, time lags, and issues of incentives, the central bank is often unable to act, or worse, act in ways that increase the bubbles and worsen the recessions. And out of these crises, the Fed seems always to come out the other end with more power over the financial system. We have seen even in this latest crises unprecedented powers granted to, or taken by, the Fed. By singling out specific corporations to receive credit and aid, the Fed has taken on the role of caretaker for those institutions who they believe pose systematic risk to the industry at large. The criteria for deciding which institutions are ‘too big to fail’ is vague and arbitrary, and as a result the central bank has never had more political and financial clout."

"But despite the obvious failings of the central bank in the past, and the clear dangers it poses to the free market in the future, the current system still finds support in the media and the government. The current administration continues to call for more regulations of the financial industry and more powers granted to the central bank. Professor Horwitz explained to his audience that it will be no easy task to change the way banking works here in the United States. Not only is the free-banking movement still considered by many to be a fringe movement more suitable for “nutjobs” than informed citizens, but the interests and incentives of those most involved still point toward more centralization than less. The only way to get our arguments out to the general public is to continue to provide reasonable and factual arguments for why the Fed has been a force for ill rather than good in the past and, most importantly, to define and defend workable alternatives. The free-banking movement, Horwitz argued, is not really all that radical. The advent of paperless money and the extensive use of financial instruments like debit cards approximates how the system would operate with free-banking. Allowing individual banks to issue commodity backed currency would allow the market to dictate money supply, and would strictly limit the power of the federal government. The knowledge problems and perverse incentives of the central bank would be almost entirely eliminated in a free-banking system and would in turn provide greater, not less, stability. With this alternative, and all of the objections to the system as we find it today, Horwitz concluded, no, we do not really need a central bank."

Gulf Petro-powers to Launch Currency in Latest Threat to Dollar Hegemony

By Ambrose Evans-Pritchard
The Telegraph, London
Tuesday, December 15, 2009

The Arab states of the Gulf region have agreed to launch a single currency modelled on the euro, hoping to blaze a trail towards a pan-Arab monetary union swelling to the ancient borders of the Ummayad Caliphate.

“The Gulf monetary union pact has come into effect,” said Kuwait’s finance minister, Mustafa al-Shamali, speaking at a Gulf Co-operation Council (GCC) summit in Kuwait.

The move will give the hyper-rich club of oil exporters a petro-currency of their own, greatly increasing their influence in the global exchange and capital markets and potentially displacing the US dollar as the pricing currency for oil contracts. Between them they amount to regional superpower with a GDP of $1.2 trillion (£739bn), some 40pc of the world’s proven oil reserves, and financial clout equal to that of China.

Saudi Arabia, Kuwait, Bahrain, and Qatar are to launch the first phase next year, creating a Gulf Monetary Council that will evolve quickly into a full-fledged central bank.

The Emirates are staying out for now – irked that the bank will be located in Riyadh at the insistence of Saudi King Abdullah rather than in Abu Dhabi. They are expected join later, along with Oman.

The Gulf states remain divided over the wisdom of anchoring their economies to the US dollar. The Gulf currency – dubbed “Gulfo” – is likely to track a global exchange basket and may ultimately float as a regional reserve currency in its own right. “The US dollar has failed. We need to delink,” said Nahed Taher, chief executive of Bahrain’s Gulf One Investment Bank.

The project is inspired by Europe’s monetary union, seen as a huge success in the Arab world. But there are concerns that the region is trying to run before it can walk.

Europe took 40 years to reach the point where it felt ready to launch a currency. It began with the creation of the Iron & Steel Community in the 1950s, moving by steps towards a single market enforced by powerful Commission and European Court. The EMU timetable was fixed at the Masstricht in 1991 but it took another 11 for euro notes and coins to reach the streets.

Khalid Bin Ahmad Al Kalifa, Bahrain’s foreign minister, told the FIKR Arab Thought summit in Kuwait that the project would not work unless the Gulf countries first break down basic barriers to trade and capital flows.

At the moment, trucks sit paralysed at border posts for days awaiting entry clearance. Labour mobility between states is almost zero.

“The single currency should come last. We need to coordinate our economic policies and build up common infrastructure as a first step,” he said.

Mohammed El-Enein, chair of the energy and industry committee in Egypt’s parliament, said Europe’s example could help the Arab world achieve its half-century dream of a unified currency, but the task requires discipline. “We need exactly the same institutions as the EU has created. We need a commission, a court, and a bank,” he said.

The last currency to trade in souks from Marakesh, to Baghdad and Mecca, was the Ottomon Piaster, known as the “kurush”. It suffered chronic inflation as the silver coinage was debased.

There is a logic to an Arab currency. The region speaks one language, has the unifying creed of “Umma Wahida” or One Nation from the Koran, and has not torn itself apart in savage wars – ever – in quite the way that Europe has in living memory.

Yet hurdles are formidable even for the tight-knit group of Gulf states. While the eurozone is a club of rough equals – with Germany, France, Italy, and Spain each holding two votes on the ECB council – the Gulf currency will be dominated by Saudi Arabia. The risk is that other countries will feel like satellites. Monetary policy will inevitably be set for Riyadh’s needs.

Hans Redeker, currency chief at BNP Paraibas, said the Gulf states may have romanticised Europe’s achievement and need to move with great care to avoid making the same errors.

“The Greek crisis has exposed the weak foundations on which the euro is built. The gap in competitiveness between core Europe and the periphery has grown wider and wider. The obvious mistake was to launch EMU without a central fiscal authority and political union, as the Bundesbank warned in the 1990s,” he said.

“The euro was created for political reasons after the fall of the Berlin Wall to lock Germany irrevocably into Europe. It was not done for economic reasons,” he said.

Ben Simpfendorfer, Asia economist for RBS and an expert on the Middle East, told the FIKR conference that the rise of China had paradoxically disrupted the case for pan-Arab economic integration.

There was a natural fit ten years ago between rich oil state and low-wage manufacturers in Egypt and Syria, but cheap exports from China have forced poorer Arab states to retreat behind barriers to shelter their industries. “The rationale for a single currency has become weaker,” he said.

The GCC also agreed to create a joint military strike force – akin to the EU’s rapid reaction force – to tackle threats such as the incursion of Yemeni Shiite rebels into Saudi territory earlier this year.

This is a major breakthrough after years of deadlock on defence cooperation.

The Sunni Gulf states are deeply concerned about the great power ambitions of Shiite Iran and its quest for nuclear weapons, to the point where the theme of a possible war between Iran and a Saudi-led constellation of states has crept into the media debate.

They nevertheless repeated on Tuesday that “any military action against Iran” by Western powers would be unacceptable

For further reading:
"Gulf Arab states move closer to single currency", Associated Press, December 15, 2009
"Gulf Monetary Council to Tackle Single Currency Peg, Launch", The Wall Street Journal, December 15, 2009
"Gulf nations sign monetary pact", Al Jazeera, December 15, 2009
"fairCASH – A Digital Cash Candidate for the proposed GCC Gulf Dinar", Heinz Kreft and Wael Adi, IEEE, 2006

Tuesday, December 15, 2009

Statement Introducing the Free Competition in Currency Act

By Ron Paul
Before the US House of Representatives
Wednesday, December 9, 2009

Madame Speaker, I rise to introduce the Free Competition in Currency Act of 2009. Currency, or money, is what allows civilization to flourish. In the absence of money, barter is the name of the game; if the farmer needs shoes, he must trade his eggs and milk to the cobbler and hope that the cobbler needs eggs and milk. Money makes the transaction process far easier. Rather than having to search for someone with reciprocal wants, the farmer can exchange his milk and eggs for an agreed-upon medium of exchange with which he can then purchase shoes.

This medium of exchange should satisfy certain properties: it should be durable, that is to say, it does not wear out easily; it should be portable, that is, easily carried; it should be divisible into units usable for every-day transactions; it should be recognizable and uniform, so that one unit of money has the same properties as every other unit; it should be scarce, in the economic sense, so that the extant supply does not satisfy the wants of everyone demanding it; it should be stable, so that the value of its purchasing power does not fluctuate wildly; and it should be reproducible, so that enough units of money can be created to satisfy the needs of exchange.

Over millennia of human history, gold and silver have been the two metals that have most often satisfied these conditions, survived the market process, and gained the trust of billions of people. Gold and silver are difficult to counterfeit, a property which ensures they will always be accepted in commerce. It is precisely for this reason that gold and silver are anathema to governments. A supply of gold and silver that is limited in supply by nature cannot be inflated, and thus serves as a check on the growth of government. Without the ability to inflate the currency, governments find themselves constrained in their actions, unable to carry on wars of aggression or to appease their overtaxed citizens with bread and circuses.

At this country's founding, there was no government-controlled national currency. While the Constitution established the Congressional power of minting coins, it was not until 1792 that the US Mint was formally established. In the meantime, Americans made do with foreign silver and gold coins. Even after the Mint's operations got underway, foreign coins continued to circulate within the United States, and did so for several decades.

On the desk in my office I have a sign that says: "Don't steal – the government hates competition." Indeed, any power a government arrogates to itself, it is loathe to give back to the people. Just as we have gone from a constitutionally-instituted national defense consisting of a limited army and navy bolstered by militias and letters of marque and reprisal, we have moved from a system of competing currencies to a government-instituted banking cartel that monopolizes the issuance of currency. In order to reintroduce a system of competing currencies, there are three steps that must be taken to produce a legal climate favorable to competition.

The first step consists of eliminating legal tender laws. Article I Section 10 of the Constitution forbids the States from making anything but gold and silver a legal tender in payment of debts. States are not required to enact legal tender laws, but should they choose to, the only acceptable legal tender is gold and silver, the two precious metals that individuals throughout history and across cultures have used as currency. However, there is nothing in the Constitution that grants the Congress the power to enact legal tender laws. We, the Congress, have the power to coin money, regulate the value thereof, and of foreign coin, but not to declare a legal tender. Yet, there is a section of US Code, 31 USC 5103, that purports to establish US coins and currency, including Federal Reserve notes, as legal tender.

Historically, legal tender laws have been used by governments to force their citizens to accept debased and devalued currency. Gresham's Law describes this phenomenon, which can be summed up in one phrase: bad money drives out good money. An emperor, a king, or a dictator might mint coins with half an ounce of gold and force merchants, under pain of death, to accept them as though they contained one ounce of gold. Each ounce of the king's gold could now be minted into two coins instead of one, so the king now had twice as much "money" to spend on building castles and raising armies. As these legally overvalued coins circulated, the coins containing the full ounce of gold would be pulled out of circulation and hoarded. We saw this same phenomenon happen in the mid-1960s when the US government began to mint subsidiary coinage out of copper and nickel rather than silver. The copper and nickel coins were legally overvalued, the silver coins undervalued in relation, and silver coins vanished from circulation.

These actions also give rise to the most pernicious effects of inflation. Most of the merchants and peasants who received this devalued currency felt the full effects of inflation, the rise in prices and the lowered standard of living, before they received any of the new currency. By the time they received the new currency, prices had long since doubled, and the new currency they received would give them no benefit.

In the absence of legal tender laws, Gresham's Law no longer holds. If people are free to reject debased currency, and instead demand sound money, sound money will gradually return to use in society. Merchants would have been free to reject the king's coin and accept only coins containing full metal weight.

The second step to reestablishing competing currencies is to eliminate laws that prohibit the operation of private mints. One private enterprise which attempted to popularize the use of precious metal coins was Liberty Services, the creators of the Liberty Dollar. Evidently the government felt threatened, as Liberty Dollars had all their precious metal coins seized by the FBI and Secret Service in November of 2007. Of course, not all of these coins were owned by Liberty Services, as many were held in trust as backing for silver and gold certificates which Liberty Services issued. None of this matters, of course, to the government, which hates competition. The responsibility to protect contracts is of no interest to the government.

The sections of US Code which Liberty Services is accused of violating are erroneously considered to be anti-counterfeiting statutes, when in fact their purpose was to shut down private mints that had been operating in California. California was awash in gold in the aftermath of the 1849 gold rush, yet had no US Mint to mint coinage. There was not enough foreign coinage circulating in California either, so private mints stepped into the breech to provide their own coins. As was to become the case in other industries during the Progressive era, the private mints were eventually accused of circulating debased (substandard) coinage, and with the supposed aim of providing government-sanctioned regulation and a government guarantee of purity, the 1864 Coinage Act was passed, which banned private mints from producing their own coins for circulation as currency.

The final step to ensuring competing currencies is to eliminate capital gains and sales taxes on gold and silver coins. Under current federal law, coins are considered collectibles, and are liable for capital gains taxes. Short-term capital gains rates are at income tax levels, up to 35 percent, while long-term capital gains taxes are assessed at the collectibles rate of 28 percent. Furthermore, these taxes actually tax monetary debasement. As the dollar weakens, the nominal dollar value of gold increases. The purchasing power of gold may remain relatively constant, but as the nominal dollar value increases, the federal government considers this an increase in wealth, and taxes accordingly. Thus, the more the dollar is debased, the more capital gains taxes must be paid on holdings of gold and other precious metals.

Just as pernicious are the sales and use taxes which are assessed on gold and silver at the state level in many states. Imagine having to pay sales tax at the bank every time you change a $10 bill for a roll of quarters to do laundry. Inflation is a pernicious tax on the value of money, but even the official numbers, which are massaged downwards, are only on the order of 4% per year. Sales taxes in many states can take away 8% or more on every single transaction in which consumers wish to convert their Federal Reserve Notes into gold or silver.

In conclusion, Madame Speaker, allowing for competing currencies will allow market participants to choose a currency that suits their needs, rather than the needs of the government. The prospect of American citizens turning away from the dollar towards alternate currencies will provide the necessary impetus to the US government to regain control of the dollar and halt its downward spiral. Restoring soundness to the dollar will remove the government's ability and incentive to inflate the currency, and keep us from launching unconstitutional wars that burden our economy to excess. With a sound currency, everyone is better off, not just those who control the monetary system. I urge my colleagues to consider the redevelopment of a system of competing currencies and cosponsor the Free Competition in Currency Act.

For further reading:
"Washington – Tear Down Your Wall Against Currency Competition", Ron Holland, December 15, 2009
"Competition: Good for the Economy, Good for the Currency, Says Ron Paul", Brian Doherty, December 11, 2009
"Ron Paul Calls for Competition in Money", John McManus, December 11, 2009
"Ron Paul's Next Bill: No Chance", Patrick Heller, December 11, 2009
"Academia's War Against Free Market Money", Gary North, December 1, 2008

Wednesday, December 9, 2009

New Underground Economy

By Richard W. Rahn
The Washington Times
Wednesday, December 9, 2009

Key indicator: Avoidance of bank accounts

The underground or "black" economy is rapidly rising, and the fault is mainly due to government policies.

Here is the evidence. The Federal Deposit Insurance Corp. (FDIC) released a report last week concluding that 7.7 percent of U.S. households, containing at least 17 million adults, are unbanked (i.e. those who do not have bank accounts), and an "estimated 17.9 percent of U.S. households, roughly 21 million, are underbanked" (i.e., those who rely heavily on nonbank institutions, such as check cashing and money transmitting services). As an economy becomes richer and incomes rise, the normal expectation is that the proportion of the unbanked population falls and does not rise as is now happening in the United States.

Tax revenues are falling far more rapidly at the federal, state and local level than would be expected by the small drop in real gross domestic product (GDP) and changes in tax law that have occurred since the recession began. The currency in circulation outside the U.S. Treasury, Federal Reserve banks and the vaults of depository institutions - that is, the currency held by individuals and businesses - has grown by 13.3 percent in the last two years, while real nominal (not inflation-adjusted) GDP has not grown at all, and real (inflation-adjusted) GDP incomes have fallen by more than 3 percent. With the growth of electronic means of payment and financial service providers, it would be expected that the currency component of GDP would fall, not rise.

The underground economy refers to both legal activities, such as often found in construction and services industries where taxes are not withheld and paid, and illegal activities, such as drug dealing and prostitution.

Countries such as the United States, Switzerland and Japan historically have had relatively small, nonreporting and/or illegal sectors, a typical estimate being 13 percent of GDP.

Most European countries have had somewhat larger underground sectors (typically 20 percent or so) in part because of the desire to escape higher tax rates. Italy and some of the other Southern European countries are believed to have underground sectors that account for 30 percent or more of all economic activity.

I recall an Italian finance minister telling a few of us at a meeting a couple of decades ago that, for policy purposes, he assumed that "the economy was 40 percent larger than what was reported." In some developing countries and/or highly corrupt countries, underground or "off the books" activities are estimated to be as high as 70 percent of all economic activity.

The FDIC report about the size of the unbanked or underbanked sector in the U.S. should be of concern because those who do not use the banking system often have to pay higher fees to cash checks, pay bills (e.g., money orders, etc.), or transmit funds.

People who keep their savings in cash at home rather than in banks make themselves easier prey for criminals and are more likely to lose their money to fire, flood, or just neglect. Not surprisingly, a majority (71 percent) of the unbanked have household incomes of less than $30,000 per year.

There are many reasons people do not have bank accounts. Banks, because of the "know your customer" and other anti-money laundering regulations, make it difficult for nonestablished people, such as the young and transient, as well as legal and illegal immigrants, to open bank accounts.

Also, many of these same regulations are responsible for the rise in bank fees, which are a particular burden for low-income people. You can be sure that every time Congress passes some new law or the IRS implements some new regulation to "get tax cheats," much of the real burden of these compliance costs will fall on those least able to afford it, while those intent on finding their way around it will do so.

People also avoid having bank accounts because they are vulnerable to asset seizure, judgments, levies, etc. Increasingly, bankers and others who provide financial services are forced by governments to spy and snitch on their own customers, and this is a real turnoff for many people, which causes them to find other ways of maintaining financial privacy.

Many studies have shown that when people believe the taxes they are required to pay are reasonable and the political leaders tend to spend their tax dollars wisely, tax compliance rises, and vice versa. In the United States, there is increased evidence that many tax dollars are not being spent wisely and are often used to pay off political cronies.

Over the past year in particular, the public has become aware that many in Washington who advocate higher taxes and argue that everyone has a responsibility to pay taxes are themselves not complying with the tax laws and regulations.

When you have a secretary of the Treasury and the chairman of the House Ways and Means Committee (the tax writing committee) accused of cheating on their taxes, it greatly undermines the moral authority of the tax collectors, making the common citizens feel like chumps and, hence, much more willing to try to legally avoid or illegally evade taxes themselves.

The evidence is unambiguous; governments cannot increase tax compliance and decrease the size of the underground economy by ever increasing and more onerous regulations.

It is no accident that those governments that allow their citizens a high degree of personal and financial liberty, including financial privacy, and spend taxpayer dollars wisely, honestly and competently, have much smaller underground sectors than corrupt and oppressive governments. Washington, take note.

Richard W. Rahn is a senior fellow at the Cato Institute and chairman of the Institute for Global Economic Growth.

For further reading:
"Tax haven clamp down moving to enforcement phase: OECD", Reuters, December 2, 2009
"Book Review of 'The End of Money and the Struggle for Financial Privacy' (by Richard Rahn)", Timothy Terrell, Quarterly Journal of Austrian Economics, Volume 2 Number 2, Summer 1999

Tuesday, December 8, 2009

Life Takes Virtual Currency

By Roger C. Wood
Fortune Brainstorm Tech
via CNNMoney
Tuesday, December 8, 2009

Living in the post-Visa world

Nine-year-old Boy #1 – “I like Fusion Fall. It’s kind of a mission game; it’s not like a chatting game. Sometimes I like to play chat, that’s why I like Club Penguin. But now I like Fusion better, mostly it’s just more fun to earn Taros and Nanos and Fusion Matter. I like spending Fusion Matter because I can get more HP and cool clothes. And, it loads my clothes super fast.”

Nine-year-old Boy #2 – “I hate Adventurequest because it’s just an RPG and it looks like no one else is there. I like to earn prestige and HP. I get hurt all the time, so I need to buy HP all the time. I haven’t figured out all of the shopkeepers in Fusion Fall, but there are different types. The power shopkeeper seems like the best.”

“Load my clothes”? “Prestige and HP”? “Power shopkeeper”? If you have no idea what these kids are talking about, welcome to the post-VISA world of virtual currency. The very nature of basic transactions will be transformed by this generation and this piece of a kid’s conversation is just the beginning.

No matter what you call it – virtual currency, s-commerce, contextual payments, in-apps buying or stored value – young people want to pay for things in little pieces without leaving the entertainment experience.

For instance, the kids above want their avatar warrior to walk up to an avatar merchant and buy some digital medicine to repair their digital muscles. As Apple's (AAPL) iTunes has shown the world, most people want to buy digital stuff in little tiny pieces, for less than one dollar or euro, without entering a credit card number each time. This is what the interactive media industry calls a “micro-transaction.” Using virtual currency and the concept has forever changed the world.

The primary way to accomplish all of this, while maintaining the security controls of the global personal banking system, is with stored value and virtual currency. Converting real money to virtual currency gives life to all kinds of marketing applications, as we have seen with “frequent flyer points,” one of the most successful forms of virtual currency around the world.

Having consumers load real money into accounts, “storing” the value, then drawing down on the balance in the form of points or credits as required, is a good idea for a lot of reasons.

  • First, it minimizes interest impact from using credit cards for the consumer. In some countries, they don’t even like credit cards. In many parts of the world, interest is considered a sin.
  • Second, it minimizes transaction fees from the Web site.
  • Third, younger consumers want to make their spending modular. This demographic often subconsciously segment their spending into categories like phone, games, clothes, etc. Stored value and virtual currency helps them to facilitate the process.

As millennials — people born after 1978 — begin to play a bigger role in the global economy, we will see a blossoming of innovations using stored value and virtual currency in new and exciting ways. Lending will be restricted, credit will be scarce and young people will adapt faster than older generations. To paraphrase Negroponte, virtual currency will be noticed only by its absence, not its presence.

Virtual currency will be intrinsic to each and every transaction. Maybe one day, we will log on to Yahoo! (YHOO) and check our Yahoo! Coins balance. Then pay for dating services, games and comedy video with the Yahoo! Coins you bought. Or, AOL will give you AOL Coins for sharing TMZ videos and news items from PopEater, which you can then use to buy stuff on Sorority Life or Farmville, while hanging out on Bebo.

It will seem antiquated to use real money to pay for anything. Real money will be something you load into a stored value account for some specific purpose and the virtual currency will be what you actually use to pay for something. Virtual currency won’t really be a topic for discussion. The real excitement will come from the transformation of our lifestyles, business models and how we come to value intangible digital goods.

Below is my version of the five forces driving the irreversible trend towards ubiquitous virtual currency.

One World
American Express (AXP) travelers checks got it. Frequent flyer consortiums got it. In the future, new payment networks will emerge. Kind of like JCB, Visa and MasterCard, but a lot more flexible. When kids see a virtual currency payment network logo, they will assume the virtual currency they hold will be valid, regardless of its origin. It could have been earned on AOL, bought on Arkadium or gifted on Facebook. Kids want “one world” and they will spend their time on digital properties with open payment networks that allow them to move virtual currency around at a fraction of the fees and regulations required for moving real money.

Social Buckets
Our first Web portals (AOL, CompuServe, etc.) essentially were “social circles” didn’t translate in that digital world and were replaced by what I call “social buckets.” There is no universally accepted social rank anymore or transfer of social status from one digital world to another. I’m a god in digital music bucket if enough people download my self-published iMix collections on iTunes, but that celebrity doesn’t translate to YouTube. Ten-year-olds kick my butt on FusionFall (the aforementioned multiplayer game) and my ability to throw a knuckleball in the real world means little to them. I’m certainly no sociologist, but I do think that our concept of social status varies by digital bucket. Virtual currency will be the only common denominator.

Who owns your friends?
Imagine you get together with some friends at the pub. Your friends arrive then proceed to talk, drink and have a good time. Each one of your friends also brings a representative from their financial institution that they will use for individual transactions. Every time one of your friends buys a drink, their financial institution’s guy starts talking to them and you have lost your ability to host effectively. Sound chaotic? Even ridiculous?

This is what it feels like today for a digital media company. Every visitor to their site uses a payment method that oversteps it bounds and dominates the conversation with the consumers. The digital media company brought everyone together, yet the digital payment companies, offer businesses and payment gallery operators start dialogs with the visitors that prevent the digital media company from properly hosting the party. In the future, digital media companies will take control of the conversation with their friends through their own branded payment options.

Size Matters Not
Virtual currency will make the size of the digital media company irrelevant in relation to its potency. Virgin, Airtran and JetBlue are all really small airlines that used effective virtual currency and stored value business models to make a lot of trouble for Continental, Delta and United in long-haul air travel. A small Web site with a great concept of virtual currency and stored value can have a disproportionate impact on the marketplace. Just look at or, versus United Way. I meet lots of 28-year-olds in my work life, and I really don’t know many that donate to the United Way.

Net Worth
Net worth was once judged by the difference between one’s assets and one’s liabilities. Both were valued in relation to money, which represented ounces of gold. What will the world be like when digital goods, images, ideas, concepts are a central part of the equation? I create a character on Blizzard’s World of Warcraft or Eve Online and it’s a hit. Hell, who knows, it might just be the next Avatar, SpiderMan or James Bond. I’d probably make out a little better than if I’d owned, say, a million shares of Washington Mutual stock. Thought products, secured by virtual currency, will likely make the next tycoons. Ralph Lauren, Paul McCartney, the mysterious founders of Skype, Steven Spielberg and even Jay-Z, all created multigenerational wealth through digital assets that none of us can actually touch. I’m sure the folks at TenCent, China’s most popular Internet portal, would agree.

Bye for now, I’m signing into WeeWorld to download a Justin Timberlake digital jacket for my avatar using my green diamonds.

Roger Wood is CEO of ORCA Inc., a provider of electronic payment and transaction solutions for social interactive media.

For further reading:
"Can Virtual Currencies Eclipse Real Currency?", Pixels and Policy, November 6, 2009

Saturday, December 5, 2009

Requiem for the Dollar

By James Grant
The Wall Street Journal
Saturday, December 5, 2009

Ben S. Bernanke doesn't know how lucky he is. Tongue-lashings from Bernie Sanders, the populist senator from Vermont, are one thing. The hangman's noose is another. Section 19 of this country's founding monetary legislation, the Coinage Act of 1792, prescribed the death penalty for any official who fraudulently debased the people's money. Was the massive printing of dollar bills to lift Wall Street (and the rest of us, too) off the rocks last year a kind of fraud? If the U.S. Senate so determines, it may send Mr. Bernanke back home to Princeton. But not even Ron Paul, the Texas Republican sponsor of a bill to subject the Fed to periodic congressional audits, is calling for the Federal Reserve chairman's head.

I wonder, though, just how far we have really come in the past 200-odd years. To give modernity its due, the dollar has cut a swath in the world. There's no greater success story in the long history of money than the common greenback. Of no intrinsic value, collateralized by nothing, it passes from hand to trusting hand the world over. More than half of the $923 billion's worth of currency in circulation is in the possession of foreigners.

In ancient times, the solidus circulated far and wide. But it was a tangible thing, a gold coin struck by the Byzantine Empire. Between Waterloo and the Great Depression, the pound sterling ruled the roost. But it was convertible into gold -- slip your bank notes through a teller's window and the Bank of England would return the appropriate number of gold sovereigns. The dollar is faith-based. There's nothing behind it but Congress.

But now the world is losing faith, as well it might. It's not that the dollar is overvalued -- economists at Deutsche Bank estimate it's 20% too cheap against the euro. The problem lies with its management. The greenback is a glorious old brand that's looking more and more like General Motors.

You get the strong impression that Mr. Bernanke fails to appreciate the tenuousness of the situation -- fails to understand that the pure paper dollar is a contrivance only 38 years old, brand new, really, and that the experiment may yet come to naught. Indeed, history and mathematics agree that it will certainly come to naught. Paper currencies are wasting assets. In time, they lose all their value. Persistent inflation at even seemingly trifling amounts adds up over the course of half a century. Before you know it, that bill in your wallet won't buy a pack of gum.

For most of this country's history, the dollar was exchangeable into gold or silver. "Sound" money was the kind that rang when you dropped it on a counter. For a long time, the rate of exchange was an ounce of gold for $20.67. Following the Roosevelt devaluation of 1933, the rate of exchange became an ounce of gold for $35. After 1933, only foreign governments and central banks were privileged to swap unwanted paper for gold, and most of these official institutions refrained from asking (after 1946, it seemed inadvisable to antagonize the very superpower that was standing between them and the Soviet Union). By the late 1960s, however, some of these overseas dollar holders, notably France, began to clamor for gold. They were well-advised to do so, dollars being in demonstrable surplus. President Richard Nixon solved that problem in August 1971 by suspending convertibility altogether. From that day to this, in the words of John Exter, Citibanker and monetary critic, a Federal Reserve "note" has been an "IOU nothing."

To understand the scrape we are in, it may help, a little, to understand the system we left behind. A proper gold standard was a well-oiled machine. The metal actually moved and, so moving, checked what are politely known today as "imbalances."

Say a certain baseball-loving North American country were running a persistent trade deficit. Under the monetary system we don't have and which only a few are yet even talking about instituting, the deficit country would remit to its creditors not pieces of easily duplicable paper but scarce gold bars. Gold was money -- is, in fact, still money -- and the loss would set in train a series of painful but necessary adjustments in the country that had been watching baseball instead of making things to sell. Interest rates would rise in that deficit country. Its prices would fall, its credit would be curtailed, its exports would increase and its imports decrease. At length, the deficit country would be restored to something like competitive trim. The gold would come sailing back to where it started. As it is today, dollars are piled higher and higher in the vaults of America's Asian creditors. There's no adjustment mechanism, only recriminations and the first suggestion that, from the creditors' point of view, enough is enough.

So in 1971, the last remnants of the gold standard were erased. And a good thing, too, some economists maintain. The high starched collar of a gold standard prolonged the Great Depression, they charge; it would likely have deepened our Great Recession, too. Virtue's the thing for prosperity, they say; in times of trouble, give us the Ben S. Bernanke school of money conjuring. There are many troubles with this notion. For one thing, there is no single gold standard. The version in place in the 1920s, known as the gold-exchange standard, was almost as deeply flawed as the post-1971 paper-dollar system. As for the Great Recession, the Bernanke method itself was a leading cause of our troubles. Constrained by the discipline of a convertible currency, the U.S. would have had to undergo the salutary, unpleasant process described above to cure its trade deficit. But that process of correction would -- I am going to speculate -- have saved us from the near-death financial experience of 2008. Under a properly functioning gold standard, the U.S. would not have been able to borrow itself to the threshold of the poorhouse.

Anyway, starting in the early 1970s, American monetary policy came to resemble a game of tennis without the net. Relieved of the irksome inhibition of gold convertibility, the Fed could stop worrying about the French. To be sure, it still had Congress to answer to, and the financial markets, as well. But no more could foreigners come calling for the collateral behind the dollar, because there was none. The nets came down on Wall Street, too. As the idea took hold that the Fed could meet any serious crisis by carpeting the nation with dollar bills, bankers and brokers took more risks. New forms of business organization encouraged more borrowing. New inflationary vistas opened.

Not that the architects of the post-1971 game set out to lower the nets. They believed they'd put up new ones. In place of such gold discipline as remained under Bretton Woods -- in truth, there wasn't much -- markets would be the monetary judges and juries. The late Walter Wriston, onetime chairman of Citicorp, said that the world had traded up. In place of a gold standard, it now had an "information standard." Buyers and sellers of the Treasury's notes and bonds, on the one hand, or of dollars, yen, Deutschemarks, Swiss francs, on the other, would ride herd on the Fed. You'd know when the central bank went too far because bond yields would climb or the dollar exchange rate would fall. Gold would trade like any other commodity, but nobody would pay attention to it.

I check myself a little in arraigning the monetary arrangements that have failed us so miserably these past two years. The lifespan of no monetary system since 1880 has been more than 30 or 40 years, including that of my beloved classical gold standard, which perished in 1914. The pure paper dollar regime has been a long time dying. It was no good portent when the tellers' bars started coming down from neighborhood bank branches. The uncaged teller was a sign that Americans had began to conceive an elevated opinion of the human capacity to manage financial risk. There were other evil omens. In 1970, Wall Street partnerships began to convert to limited liability corporations -- Donaldson, Lufkin & Jenrette was the first to make the leap, Goldman Sachs, among the last, in 1999. In a partnership, the owners are on the line for everything they have in case of the firm's bankruptcy. No such sword of Damocles hangs over the top executives of a corporation. The bankers and brokers incorporated because they felt they needed more capital, more scale, more technology -- and, of course, more leverage.

In no phase of American monetary history was every banker so courageous and farsighted as Isaias W. Hellman, a progenitor of an institution called Farmers & Merchants Bank and of another called Wells Fargo. Operating in southern California in the late 1880s, Hellman arrived at the conclusion that the Los Angeles real-estate market was a bubble. So deciding -- the prices of L.A. business lots had climbed to $5,000 from $500 in one short year -- he stopped lending. The bubble burst, and his bank prospered. Safety and soundness was Hellman's motto. He and his depositors risked their money side-by-side. The taxpayers didn't subsidize that transaction, not being a party to it.

In this crisis, of course, with latter-day Hellmans all too scarce in the banking population, the taxpayers have born an unconscionable part of the risk. Wells Fargo itself passed the hat for $25 billion. Hellmans are scarce because the federal government has taken away their franchise. There's no business value in financial safety when the government bails out the unsafe. And by bailing out a scandalously large number of unsafe institutions, the government necessarily puts the dollar at risk. In money, too, the knee bone is connected to the thigh bone. Debased banks mean a debased currency. (Perhaps causation works in the other direction too.)

Many contended for the hubris prize in the years leading up to the sorrows of 2008, but the Fed beat all comers. Under Mr. Bernanke, as under his predecessor, Alan Greenspan, our central bank preached the doctrine of stability. The Fed would iron out the business cycle, promote full employment, pour oil on the waters of any and every major financial crisis, and assure stable prices. In particular, under the intellectual leadership of Mr. Bernanke, the Fed would tolerate no sagging of the price level. It would insist on a decent minimum of inflation. It staked out this position in the face of the economic opening of China and India and the spread of digital technology. To the common-sense observation that these hundreds of millions of willing new hands, and gadgets, might bring down prices at Wal-Mart, the Fed turned a deaf ear. It would save us from "deflation" by generating a sweet taste of inflation (not too much, just enough). And it would perform these feats of macroeconomic management by pushing a single interest rate up or down.

It was implausible enough in the telling and has turned out no better in the doing. Nor is there any mystery why. The Fed's M.O. is price control. It fixes the basic money market interest rate, known as the federal funds rate. To arrive at the proper rate, the monetary mandarins conduct their research, prepare their forecast -- and take a wild guess, just like the rest of us. Since December 2008, the Fed has imposed a funds rate of 0% to 0.25%. Since March of 2009, it has bought just over $1 trillion of mortgage-backed securities and $300 billion of Treasurys. It has acquired these assets in the customary central-bank manner, i.e., by conjuring into existence the money to pay for them. Yet -- a measure of the nation's lingering problems -- the broadly defined money supply isn't growing but dwindling.

The Fed's miniature interest rates find favor with debtors, disfavor with savers (that doughty band). All may agree, however, that the bond market has lost such credibility it once had as a monetary-policy voting machine. Whether or not the Fed is cranking too hard on the dollar printing press is, for professional dealers and investors, a moot point. With the cost of borrowing close to zero, they are happy as clams (that is, they can finance their inventories of Treasurys and mortgage-backed securities at virtually no cost). The U.S. government securities market has been conscripted into the economic-stimulus program.

Neither are the currency markets the founts of objective monetary information they perhaps used to be. The euro trades freely, but the Chinese yuan is under the thumb of the People's Republic. It tells you nothing about the respective monetary policies of the People's Bank and the Fed to observe that it takes 6.831 yuan to make a dollar. It's the exchange rate that Beijing wants.

On the matter of comparative monetary policies, the most expressive market is the one that the Fed isn't overtly manipulating. Though Treasury yields might as well be frozen, the gold price is soaring (it lost altitude on Friday). Why has it taken flight? Not on account of an inflation problem. Gold is appreciating in terms of all paper currencies -- or, alternatively, paper currencies are depreciating in terms of gold -- because the world is losing faith in the tenets of modern central banking. Correctly, the dollar's vast non-American constituency understands that it counts for nothing in the councils of the Fed and the Treasury. If 0% interest rates suit the U.S. economy, 0% will be the rate imposed. Then, too, gold is hard to find and costly to produce. You can materialize dollars with the tap of a computer key.

Let me interrupt myself to say that I am not now making a bullish investment case for gold (I happen to be bullish, but it's only an opinion). The trouble with 0% interest rates is that they instigate speculation in almost every asset that moves (and when such an immense market as that in Treasury securities isn't allowed to move, the suppressed volatility finds different outlets). By practicing price, or interest-rate, control, the Bank of Bernanke fosters a kind of alternative financial reality. Let the buyer beware -- of just about everything.

A proper gold standard promotes balance in the financial and commercial affairs of participating nations. The pure paper system promotes and perpetuates imbalances. Not since 1976 has this country consumed less than it produced (as measured by the international trade balance): a deficit of 32 years and counting. Why has the shortfall persisted for so long? Because the U.S., uniquely, is allowed to pay its bills in the currency that only it may lawfully print. We send it west, to the central banks of our Asian creditors. And they, obligingly, turn right around and invest the dollars in America's own securities. It's as if the money never left home. Stop to ask yourself, American reader: Is any other nation on earth so blessed as we?

There is, however, a rub. The Asian central banks do not acquire their dollars with nothing. Rather, they buy them with the currency that they themselves print. Some of this money they manage to sweep under the rug, or "sterilize," but a good bit of it enters the local payment stream, where it finances today's rowdy Asian bull markets.

A monetary economist from Mars could only scratch his pointy head at our 21st century monetary arrangements. What is a dollar? he might ask. No response. The Martian can't find out because the earthlings don't know. The value of a dollar is undefined. Its relationship to other currencies is similarly contingent. Some exchange rates float, others sink, still others are lashed to the dollar (whatever it is). Discouraged, the visitor zooms home.

Neither would the ghosts of earthly finance know what to make of things if they returned for a briefing from wherever they were spending eternity. Someone would have to tell Alexander Hamilton that his system of coins is defunct, as is, incidentally, the federal sinking fund he devised to retire the public debt (it went out of business in 1960). He might have to hear it more than once to understand, but Congress no longer "coins" money and regulates the value thereof. Rather, it delegates the work to Mr. Bernanke, who, a noted student of the Great Depression, believes that the cure for borrowing too much money is printing more money.

Walter Bagehot, the Victorian English financial journalist, would be in for a jolt too. It would hardly please him to hear that the Fed had invoked the authority of his name to characterize its helter-skelter interventions of the past year. In a crisis, Bagehot wrote in his 1873 study "Lombard Street," a central bank should lend without stint to solvent institutions at a punitive rate of interest against sound collateral. At least, Bagehot's shade might console itself, the Fed was faithful to the text on one point. It did lend without stint.

If Bagehot's ghost would be chagrined, that of Bagehot's sparring partner, Thomson Hankey, would be exultant. Hankey, a onetime governor of the Bank of England, denounced Bagehot in life. No central bank should stand ready to bail out the imprudent, he maintained. "I cannot conceive of anything more likely to encourage rash and imprudent speculation..., " wrote Hankey in response to Bagehot. "I am no advocate for any legislative enactments to try and make the trading community more prudent."

Hankey believed in the price system. It might pain him to discover that his professional descendants have embraced command and control. "We should have required [banks to hold] more capital, more liquidity," Mr. Bernanke rued in a Senate hearing on Thursday. "We should have required more risk management controls." Roll over, Isaias Hellman.

So our Martian would be mystified and our honored dead distressed. And we, the living? We are none too pleased ourselves. At least, however, being alive, we can begin to set things right. The thing to do, I say, is to restore the nets to the tennis courts of money and finance. Collateralize the dollar—make it exchangeable into something of genuine value. Get the Fed out of the price-fixing business. Replace Ben Bernanke with a latter-day Thomson Hankey. Find -- cultivate --battalions of latter-day Hellmans and set them to running free-market banks. There's one more thing: Return to the statute books Section 19 of the 1792 Coinage Act, but substitute life behind bars for the death penalty. It's the 21st century, you know.

James Grant is editor of Grant's Interest Rate Observer and the author, most recently, of "Mr. Market Miscalculates".