Cyprus Goes Cashless The Hard Way

By Jon Matonis
Forbes
Sunday, March 24, 2013

http://www.forbes.com/sites/jonmatonis/2013/03/24/cyprus-goes-cashless-the-hard-way/

The rolling crisis in Cyprus should reach a crescendo this week. If the parliament votes yes on some type of deposit confiscation, it would mean the people of Cyprus have elected to go “all in” on the euro and link their fate with the fate of the single currency.

When given a clear opportunity to leave the eurozone, Cypriots will probably decide to stay rather than rebuild their banking infrastructure from scratch.

With the latest maneuverings and after going full-circle with a range of alternatives, it appears that European bailout terms could be met by a 20-25% levy on deposits only in excess of the guaranteed 100,000 euros. Cypriot Finance Minister Michael Sarris said yesterday that a deposit levy was back on the table as a way to come up with the 5.8 billion euros needed by the new March 25th deadline for the larger rescue amount to be approved.

Writing for SkyNews, Ed Conway described the raid on bank deposits as “a step across the financial Rubicon.” Indeed, it has ramped up expectations as to what is now within the range of options for other EMU member states. Politely calling it a levy or deposit tax doesn’t alter the fact that it still amounts to brazen theft. Others have called it legalized bank robbery.

The Statist quote of the day goes to Naomi Fowler, Taxcast producer for Tax Justice Network, who said, “I think Cyprus is a cautionary tale to citizens that their government’s adventures in tax havenry will cost them dearly.” She advocates for global penalties against the provision of financial privacy which to this observer warps the very meaning of the word justice.

“Only put money in the banking system that you can afford to lose,” advises financial commentator Max Keiser. This is no more true than last weekend in Cyprus when bank depositors had electronic transfers blocked and were initially told to prepare for a confiscatory levy of up to 9.9% of their deposit balances across the board. The government then ordered banks to keep ATMs stocked since cash and credit cards were the only remaining methods of transacting. However, it is not clear how much longer the credit cards will be functioning in the country.

With banks in Cyprus now scheduled to re-open on March 26th after eight days of consecutive closure, this would make the Cypriot banking-system shutdown tied with the U.S. (March 6-13th, 1933) for longest number of shutdown days, following only first place Argentina (April 20-29th, 2002) at 10 days. Should the crisis extend beyond eight days and the European Central Bank pulls the liquidity it has been pumping into Cypriot banks, the ATMs may become cashless.

“The future of the euro zone has been put on the line for a few billion euros. Yet, the assumption of Cyprus not being a systemic risk rests on a single expectation: that it stays in the euro zone,” according to Stephen Fidler at The Wall Street Journal. “Should it exit, all bets are off.” However, other countries should be sufficiently discouraged from taking that route if they see live television images of a full-blown banking panic and an economic collapse within an EU member nation.

For now, the general attitude among the troika appears to be let’s experiment with Cyprus and if things go badly, it’s not such a long-term big deal because Cyprus is too small to matter. That could prove to be an optimistic fantasy.

With capital controls to prevent a mass exodus from Cyprus banks now fait accompli regardless of the bailout decision, Jeremy Warner at the Telegraph says that it is the end of the single currency in all but name:

Yet the point is that if capital controls are introduced, it basically makes Cypriot euros into a national currency, rather than part of wider monetary union. The capital controls will severely limit your ability to get your euros out of Cyprus, rending them essentially worthless in the wider eurozone. It would be a bit like telling Scots they can’t spend their UK pounds in England. Monetary union is many things, but above all it is about free movement of money and a uniform value wherever it is spent. When these functions are disabled, then you cease to be part of a single currency.

The era of free capital movement is behind us. Capital controls are about government keeping your money within easy reach should they ever want it. A decentralized and nonpolitical currency like Bitcoin starts to look attractive by providing a safer destination for wary depositors, allowing them to store their money securely in a digital account on their own computers, away from the big governments and politicians’ reach. It is possible to purchase bitcoins in Cyprus at LocalBitcoins.com.

“Money flows to where confidence exists” says Alan Safahi, CEO of ZipZap, Inc., a global cash network with over 700,000 locations in the world. “As bitcoin gains more acceptance, consumer confidence increases and more money will flow to bitcoins, causing a continuous rise in price due to limited supply which then increases consumer confidence even more,” adds Safahi.

As this trend continues, ZipZap, which processes more purchases of bitcoin than any other cash network stands to benefit tremendously from this trend. “The growth opportunity is not limited to Europe. We are seeing a significant increase in volume in the past few days from consumers in the U.S.,” says Safahi.

The emerging trend towards bitcoin as a flight to safety seems to be accelerating despite the recent regulatory guidance from FinCEN (Financial Crimes Enforcement Network). As part of the Treasury Department, FinCEN’s guidance on enforcement would extend traditional money laundering rules to most types of virtual currencies, including bitcoin. Although bitcoin proponents emphasize that a test case has not emerged yet.

“It’s almost a badge of respect when the Treasury starts regulating you,” said James Rickards, author of Currency Wars. “You must be doing something right.”

“Gold is a great way to preserve wealth, but it is hard to move around,” added Rickards. “You do need some kind of alternative and Bitcoin fits the bill. I’m not surprised to see that happening.”

How Cryptocurrencies Could Upend Banks' Monetary Role

By Jon Matonis
American Banker
Friday, March 15, 2013

http://www.americanbanker.com/bankthink/how-cryptocurrencies-could-upend-banks-monetary-role-1057597-1.html

Peter Šurda

I recently had a fascinating chat with the economist Peter Šurda to discuss how nonpolitical cryptocurrencies like bitcoin could alter the future of fractional reserve banking.

Peter is also a software developer experienced in the online payments industry and will present at the Bitcoin 2013: The Future of Payments conference in San Jose in May. His 2012 master's thesis at Vienna University of Economics and Business was entitled Economics of Bitcoin: Is Bitcoin an Alternative to Fiat Currencies and Gold? He's an abstract thinker, but the implications of his work are tantalizing: that digital money like Bitcoin opens up possibilities for banking without central planners or a lender of last resort, where interest rates and reserve requirements are driven purely by the market.

The debate between the full reserve bankers and the fractional reserve bankers is an old one and it has been explored in depth by the Austrian school of economics. More recently, the debate has been broadened to include the dynamics of introducing the bitcoin cryptocurrency, which is the functional equivalent of digital gold, since its supply is predictable and fixed. (There are currently 10.9 million bitcoins in circulation with a total fixed supply of 21 million expected to be mined before 2140, 99% of them by the year 2032.) The Austrian school economist Michael Suede and the technologist Eli Gothill have speculated that fractional reserve banking can indeed appear within a bitcoin monetary environment. This is where we join up with Peter.

JON MATONIS: I enjoyed your blog post, "Market Forces and Fractional Reserve Banking." Do you consider fractional reserve banking to be compatible with Austrian economics?

PETER ŠURDA: First of all, I would like to separate fractional reserve banking and credit expansion. On one hand, there are ways of increasing the money supply, in the broader sense, which do not require fractional reserve banking or changes in the monetary base such as a system based on the principle of mutual credit like LETS [local exchange trading systems], or a fiat currency that uses bitcoin as reserves (i.e. they are not claims in the sense that Ludwig von Mises uses them, but they act as full substitutes). From the opposite direction, fractional reserve banking does not necessarily lead to credit expansion.

I agree with the full reservists that credit expansion has the effects described by the Austrian Business Cycle Theory. However, I agree with the free bankers that fractional reserve banking is not necessarily a violation of property rights and other ways of increasing the money supply also are not necessarily a violation of property rights.

So I think that the economic and legal analysis are two separate issues and need to be addressed separately. I avoided the legal analysis in my thesis and concentrated on Austrian Business Cycle Theory and policy issues, but in an earlier draft I have several pages about legal aspects too, and I discussed the topic with [the legal theorist] Stephan Kinsella.

JON MATONIS: How does a nonpolitical cryptocurrency like bitcoin alter the landscape in the "full reserve" versus "fractional reserve" banking debate?

PETER ŠURDA: Austrians have made arguments in the past that lead to the conclusion that fractional reserve banking does not necessarily lead to credit expansion, even though they never explicitly formulated it this way and might not have realized the connection. The reason is that if credit instruments do not decrease transaction costs over the monetary base, they are unlikely to act as a part of the money supply. Bitcoin shows that this is not only a hypothetical but empirically possible to implement. With Bitcoin, it is much less likely that credit expansion will occur.

In other words, we need to separate two things. Why do people want to hold fractional reserve banking instruments, which may include the interest payments as one of the reasons, and why do people want to use fractional reserve banking instruments as a medium of exchange which, I argue, requires that the fractional reserve banking instruments decrease transaction costs. That they historically manifested themselves through a common instrument is an empirical quirk and not an economic rule. The ability to loan money is beneficial. Contrary to many Austrians, I agree that maturity transformation can be beneficial, and if the loan ends up being a liquid instrument, it also can be beneficial. But if it is so liquid that it becomes a part of the money supply, that's when it has a detrimental effect on the economy.

For full reservists, Bitcoin shows that the question of fractional reserve banking is less important than they thought. Fractional reservists, on the other hand, need to think about the nature of the mechanisms equilibrating the money supply. I tried to explain the issue to [the economists] George Selgin and David Glasner in comments on their websites, but I wasn't successful in getting my point through.

JON MATONIS: If bitcoin is digital gold, does that portend a future where a bitcoin standard (akin to the gold standard) can emerge or partial bitcoin backing for other currencies?

PETER ŠURDA: They probably can emerge, but the more important question is whether they would be preferred to bitcoin. Only something that provides a significant improvement would be preferred. I only know two potential candidates for that: Ripple and OpenTransactions.

JON MATONIS: In a bitcoin world, is fractional reserve banking only possible with offline substitutes (such as physical coins or cards, which can be traded hand-to-hand, containing the private key to a bitcoin address) or an intentional "fork" in the block chain ledger?

PETER ŠURDA: Hypothetically, the reserves can be offline and the substitute can be a clearing system like Ripple, so there are other possibilities too. But if I understand your point correctly, offline "substitutes" might have a higher chance of actually becoming full substitutes because they might have more obvious advantages.

JON MATONIS: As the recent block chain fork episode demonstrates, there is a need for offline bitcoin transactions to continue. Is this demand sufficient for a money substitute to evolve, such as offline substitutes with full or partial bitcoin backing?

PETER ŠURDA: This is primarily an empirical question, so we can't be completely sure about that. I think the probability for this is significantly lower than with the currencies that we've known historically. The end result is also path-dependent; for instance, it depends on how quickly bitcoin matures and/or adapts to changes compared to the potential substitute.

Fractional reserve banking does not come into existence magically. It must follow economic rules. With gold and similar commodities, fractional reserve banking comes into existence for these reasons: On the demand side, there is a demand for money substitutes, because they provide something that money proper does not; and on the supply side, money substitutes carry maintenance costs for the issuer (e.g. storage of gold) and these need to be offset somehow. The issuer can charge on holding (e.g. demurrage of bank notes), transacting (e.g. check clearing), or, obviously, externalize the costs through fractional reserves. From the point of view of an individual user, fractional reserve banking appears to be the least costly alternative. So obviously fractional reserve banking wins.

Putting it together: If there is a general demand for money substitutes, this leads to fractional reserve banking. Unless it's illegal. Then it might not. Solution: Have money which does not lead to the creation of money substitutes. Bitcoin shows that at least hypothetically, this is possible. I might even go a bit further and make this statement: If on a free market money substitutes do not develop even though there is no legal or technical obstacle for them, it means that the choice of money is Pareto-optimal since no change in the monetary system leads to an increase in utility.

JON MATONIS: Does a demand for positive return on bitcoin balances lead to an environment of competitive bank lending with risk-adjusted interest rates? And will this lead to an environment of fractional reserve banking with depositors offered higher interest rates in exchange for the additional risk premium of running a fractional portfolio?

PETER ŠURDA: Yes, I would say it does, but until there are industry niches that primarily use bitcoin, it is probably not much different from gambling.

This might lead to negotiable credit instruments with maturity-mismatching or maturity transformation, depending on which economic school you use for terminology. However, I don't think this feature alone is sufficient for these instruments to be accepted as full substitutes whereas George Selgin appears to think it is. Now, whether to call such a situation "fractional reserve banking" even though no credit expansion occurs is unclear. I lean towards yes, but there could be other interpretations.

JON MATONIS: How do you see bitcoin changing interest rate structures and lending practices?

PETER ŠURDA: Using Bitcoin for loans only makes sense for those businesses that use bitcoin as a unit of account, unless, of course, you're just speculating on the market but don't actually sell any goods or services. I think this will only occur at much higher levels of liquidity or until we can be quite sure that it deserves the label "money." Until these higher levels of liquidity are reached, the price of bitcoin will probably be quite volatile, which reduces the likelihood that people use it as a unit of account.

However, there could be niche market segments that use bitcoin as a primary medium of exchange and [bitcoin] mining is the most obvious candidate. For these, the unit of account function would make sense even if the global market penetration is lower.

Assuming one of these thresholds is crossed and the money supply remains inelastic (i.e. no significant credit expansion), the interest rate of bitcoin should be a good reflection of the time preference of those market participants that use it as a unit of account. Bitcoin also makes it much easier for lending to occur in a decentralized manner, I think. Rather than a small number of "too big to fail" institutions, we should see smaller specialized teams that act as facilitators without owning the liabilities or being liable themselves.

JON MATONIS: Can a free market fractional reserve system (as opposed to a central banking fractional reserve system) coexist with full reserve banking? Or will one drive out the other?

PETER ŠURDA: I think that if money substitutes emerge, fractional reserve banking will out-compete 100% reserve banking in the market. I deal with this a bit in an earlier draft of the thesis. If they don't emerge, on the other hand, we'll have a money supply equivalent to the monetary base and debt will not cause changes in the money supply. It would be viewed as merely highly liquid credit. I don't think they can coexist for a long time assuming the same underlying money in the narrower sense, of course.

ECB: “Roots Of Bitcoin Can Be Found In The Austrian School Of Economics”

By Jon Matonis
Forbes
Saturday, November 3, 2012

http://www.forbes.com/sites/jonmatonis/2012/11/03/ecb-roots-of-bitcoin-can-be-found-in-the-austrian-school-of-economics/

The ECB (European Central Bank) has produced the first official central bank study of the decentralized cryptographic money known as bitcoin, Virtual Currency Schemes. Ignoring for a moment the ECB's condescending and derogatory use of the virtual currency phrase and scheme phrase, the study produced at least one landmark achievement.

In claiming that "The theoretical roots of Bitcoin can be found in the Austrian school of economics," the ECB forever linked Bitcoin to the proud economic heritage of Menger, Mises, and Hayek as well as to Austrian business cycle theory. This recognition is also a direct testament to the monetary theory work of Friedrich von Hayek who inspired many with his 1976 landmark publication of Denationalisation of Money.

Bitcoin fully embodies the spirit of denationalized money as it seeks no authority for its continued existence and it recognizes no political borders for its circulation. Indeed according to the report, proponents see Bitcoin as "a good starting point to end the monopoly central banks have in the issuance of money" and "inspired by the former gold standard."

Economists from the 19th and mid-20th centuries can be forgiven for not anticipating an interconnected digital realm like the Internet with its p2p distributed architecture, but modern economists cannot be. From their own conclusions (on page 48) which inaccurately lump Bitcoin together with Linden Dollars, here is what the modern-day economists at the ECB are still not getting:

1. ECB concludes that if money creation remains at a low level, bitcoin does not pose a risk to price stability. This is incorrect on two levels. One, the creation of new bitcoin is capped at 21 million with eight current decimal places so it grows through adoption and usage rather than monetary expansion. And two, as with gold, silver, and other commodities having a monetary component, price stability is a function of the market not central planners;

2. ECB concludes that bitcoin cannot jeopardize financial stability due to its low volume and limited connection with the real economy. Conversely, bitcoin will tend to increase financial stability and overall soundness. Bitcoin's connection with the real economy is only a concern for the regulated and taxed economy, whereas bitcoin independently may thrive in the $10 trillion shadow or "original" economy. Besides, with its repeated market interventions, no one has done more to jeopardize financial stability than the ECB itself;

3. ECB concludes that bitcoin is currently not regulated and supervised by any public authority. It would be more accurate to say that State-sponsored regulation is largely irrelevant because of the inherent design properties of a peer-to-peer distributed computing system. But happily, this is still a conclusion that I can agree with and recommend that it remains the case;

4.  ECB concludes that bitcoin could represent a challenge for public authorities, given the legal uncertainty and potential for performing illegal activities. While public authorities will certainly be challenged by the introduction of a monetary unit that cannot be manipulated for political purposes, bitcoin in some cases does have the ability to provide tracking capability that far exceeds that of national cash or money substitutes. What authorities will find most troubling though, with bitcoin, is that money flows between individuals and businesses will no longer be exploitable for purposes of unlimited identity tracking and unconstitutional 'fishing expeditions';

5. ECB concludes that bitcoin "could have a negative impact on the reputation of central banks, assuming the use of such systems grows considerably and in the event that an incident attracts press coverage, since the public may perceive the incident as being caused, in part, by a central bank not doing its job properly." Pretentious as it may seem, the ECB is stating here that central banks as protector of the general public with respect to payments have a role to play because it is their reputation that suffers in the event of a bitcoin-related security incident. Firstly, that is an assumed responsibility -- not a delegated responsibility; and reputational impact aside, I would prefer to rely on lex mercatoria;

6. ECB concludes that bitcoin does indeed fall within central banks' responsibility as a result of characteristics shared with payment systems. Of course it does not. Central banks are a form of centralized economic planning so their stated responsibilities are suspect from the outset. Bitcoin represents an intangible math puzzle whose existence is solely restricted to transfer rights on a cloud-based public ledger. It more closely resembles an air guitar than a payment system for purposes of oversight.

Now, in affirming the superior attributes of bitcoin in the role of financial innovation, the ECB correctly identifies why the profligate issuers of national fiat currencies will ultimately feel threatened by such a decentralized nonpolitical unit. The report acknowledges the following with respect to bitcoin: (a) "higher degree of anonymity compared to other electronic payment instruments," (b) "lower transaction costs compared with traditional payment systems, and (c) "more direct and faster clearing and settlement of transactions" from the absence of intermediaries.

Overall, the fear of the monetary overlords is palpable as the study concludes by basically promising continued scrutiny and oversight. Also forecast for the plebeians is a possible remedy to the global scope and unclear jurisdiction of the regulatory challenge:

"One possible way to overcome this situation and obtain some quantitative information on the magnitude of the funds moved through these virtual currency schemes could be to focus on the link between the virtual economy and the real economy, i.e. the transfer of money from the banking environment to the virtual environment. Virtual accounts need to be funded either via credit transfer, payment card or PayPal and therefore a possibility would be to request this information from credit institutions, card schemes and PayPal."

However, Michael Parsons, a former executive with Emirates Bank (Dubai), Moscow Narodny Bank, and KPMG Moscow, believes that those efforts will prove futile and he explains, "Bitcoin is 'regulated' by its peers and mathematics. And Bitcoin is not a currency like fiat money. It is a value  transfer system which is given value only by its users. So the ECB, FED, etc. have no mandate to control a 'virtual currency' just because they call it (bitcoin) that! It will just go underground. Bitcoin is like Light and Air. Free to use and transfer. Owned and issued by the people and NOT the State!"

It evokes an image of central bankers huddled comfortably on the safe shoreline as they look out into the horizon and see the dangerous, unstable virtual currencies approaching. The opposite is actually the truth because it is the central bankers who are floating precipitously out at sea. As James Turk famously said about bitcoin's analog cousin, "When standing in a boat and looking at the shore, it is the boat (currencies) – and not the land (gold) – that is bobbing up and down."

The Gloom of Central Banking

By Tuur Demeester
MacroTrends.be
November 2012

Gloom of Central Banking  

Introduction

On october 29th, the ECB published a 55-page report titled “Virtual Currency Schemes”. With this dysphemistic title, the central bank refers to private, unregulated initiatives of virtual currency. With 183 references in the text, it seems obvious that specifically the fast growing peer to peer currency Bitcoin is under scrutiny.

In what follows, I sketch an evolution of how central banks—the monopolists of the current fiat money paradigm—have dealt with the threat of free market competition coming from the internet, and how they are now reacting to the sudden appearance of an enigmatic rival.

Be warned that this is a subjective take on the issue. People from central bank and government circles will no doubt accuse me of being unbalanced and unfair in my interpretations and conclusions. So be it. my goal here is to scrape off the veneer of these reports and thus catch a glimpse of what may actually be happening behind the closed doors of Basel and Brussels.

Europe's Central Banks Halt Gold Sales

By Jack Farchy
Financial Times, London
Sunday, September 26, 2010

http://www.ft.com/cms/s/0/b9859c7e-c99b-11df-b3d6-00144feab49a.html

Europe's central banks have all but halted sales of their gold reserves, ending a run of large disposals each year for more than a decade.

The central banks of the eurozone plus Sweden and Switzerland are bound by the Central Bank Gold Agreement, which caps their collective sales.

In the CBGA's year to September, which expired on Sunday, the signatories sold 6.2 tonnes, down 96 per cent, according to provisional data.

The sales are the lowest since the agreement was signed in 1999 and well below the peak of 497 tonnes in 2004-05.

The shift away from gold selling comes as European central banks reassess gold amid the financial crisis and Europe's sovereign debt crisis.

In the 1990s and 2000s, central banks swapped their non-yielding bullion for sovereign debt, which gives a steady annual return. But now central banks and investors are seeking the security of gold.

The lack of heavy selling is important for gold prices both because a significant source of supply has been withdrawn from the market, and because it has given psychological support to the gold price. On Friday bullion hit a record of $1,300 an ounce.

"Clearly now it's a different world. The mentality is completely different," said Jonathan Spall, director of precious metals sales at Barclays Capital.

European central banks are unlikely to sell much more gold in the new CBGA year, according to a survey by the Financial Times.

Although many central banks declined to detail their sales plans, the responses of some, along with numerous interviews with bankers and consultants, suggest it is unlikely there will be a return to the trend of the past decade, when CBGA signatories sold on average 388 tonnes a year.

The central banks of Sweden, Slovakia, Ireland, and Slovenia said they had no plans to sell, while Switzerland reiterated a previous statement to the same effect.

The CBGA was first signed after gold miners protested that central banks' rush to sell was depressing prices.

In previous years signatories haggled for individual allowances to sell under the CBGA, but the most recent renewal of the agreement in 2009 contained no such quotas, according to Darko Bohnec, vice governor of Slovenia's central bank.

For further reading:
"Germany's Central Bank Plans to Cap Gold Sales to 6.5 Tons Under Accord", Bloomberg, September 27, 2010

Suiting Up for a Post-Dollar World

By John Browne
Euro Pacific Capital, Inc.
Friday, June 25, 2010

http://www.europac.net/externalframeset.asp?from=home&id=18958&type=browne

The global financial crisis is playing out like a slow-moving, highly predicable stage play. In the current scene, Western governments are caught between the demands of entitled welfare beneficiaries and the anxiety of bondholders who fear they will be stuck with the bill. As the crisis reaches an apex, prime ministers and presidents are forced into a Sophie's choice between social unrest and bankruptcy. But with the "Club Med" economies set to fall like dominoes, the US Treasury market is not yet acting the role we would have anticipated.

Our argument has always been that the US benefits from its reserve-currency status, allowing it to accumulate unsustainable debts for an unusually long period without the immediate repercussions of inflation or higher borrowing costs. But this false sense of security may be setting us up for a truly monumental crash.

There is fresh evidence that time is running out for the dollar-centric global monetary order. In fact, central banks outside the US are already making swift and discrete preparation for a post-dollar era.

To begin, the People's Bank of China has just this week decided to permit a wider trading range between the yuan and the dollar. This is the first step toward ending the infernal yuan-dollar peg. While the impetus behind this abrupt change remains a mystery, I have a sneaking suspicion that, as my colleague Neeraj Chaudhary explained in his commentary last week, the nationwide labor strikes were a prime motivator.

In response to the 2008 credit crunch, the Fed printed so many dollars that the People's Bank of China was forced to drive Chinese inflation into double digits to maintain the peg. The pain has fallen on China's workers, who have seen their wages stagnate while prices for everything from milk to apartments have skyrocketed. This week's move indicates that, regardless of its own policy motives, the Communist Party can no longer afford to keep pace with the dollar's devaluation. The result will be a shift in wealth from America to China, which may trigger a long-anticipated run on the dollar, while creating investment opportunities in China.

Just days before China's announcement, Russian President Dmitry Medvedev rattled his monetary sabre by telling the press of his intention to lead the world toward a new monetary order based on a broad basket of currencies. Giving strength to his claim, the Central Bank of Russia announced that it would be adding Canadian and Australian dollars to its reserves for the first time. Analysts suggest that the IMF may follow suit. While Russia floats in the limbo between hopeless kleptocracy and emerging economy, it does possess vast natural resources and a toe-hold in both Europe and Asia. In other words, it will be a strategically important partner for China as it tries to cast off dollar hegemony.

Speaking of Europe, the major powers there are moving toward a post-dollar world by rejecting President Obama's calls to jump on America's debt grenade. The prescriptions coming from Washington translate loosely to: our airship is on fire, so why don't you light a candle under yours so that we may crash and burn together. Given that dollar strength is largely seen as a function of euro weakness (as Andrew Schiff discussed in our most recent newsletter, debt troubles in the eurozone's fringe economies have created a distorted confidence in the greenback. However, as you might imagine, Europe has higher priorities than being America's fall guy. Led by an ever-bolder Germany, the European states are wisely choosing not to throw themselves on our funeral pyre, but to wisely clean house in anticipation of China's rise.

In another ominous sign for the dollar, the Financial Times reported Wednesday that after two decades as net sellers of gold, foreign central banks have now become net buyers. What's more, more than half of central bank officials surveyed by UBS didn't think the dollar would be the world's reserve in 2035. Among the predicted replacements were Asian currencies and the euro, but - by far - the favorite was gold. This is supported by Monday's revelation by the Saudi central bank that it had covertly doubled its gold reserves, just about a year after China made a similar admission. There is no reason to assume these are isolated incidents, or that the covert trade of dollars for gold doesn't continue. To the contrary, this is compelling evidence that foreign governments are outwardly supporting the status quo while quietly preparing for the dollar's almost-inevitable devaluation. What people like Paul Krugman believe to be a return to medieval economics may, in fact, be the wave of the future.

In peacetime, hardened troops will likely tolerate a blowhard general for an extended period; but when the artillery opens up with live ordnance, an ineffectual leader risks rapid demotion. The newspapers are now riddled with hints that foreign governments have lost faith in Washington and the dollar reserve system. It seems to me only natural that after a century of war, inflation, and socialism, the next hundred years would belong to those people who hold the timeless values of hard money and fiscal prudence. Unfortunately, our policymakers are not those people.

John Browne is the Senior Market Strategist for Euro Pacific Capital, Inc. Reprinted with permission.

For a more in-depth analysis of our financial problems and the inherent dangers they pose for the U.S. economy and U.S. dollar, read Peter Schiff's 2008 bestseller "The Little Book of Bull Moves in Bear Markets" and his newest release "Crash Proof 2.0: How to Profit from the Economic Collapse." Click here to learn more.

Gold Reclaims Its Currency Status as the Global System Unravels

By Ambrose Evans-Pritchard
The Telegraph, London
Sunday, June 20, 2010

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7841961/Gold-reclaims-its-currency-status-as-the-global-system-unravels.html

We already know that the eurozone money markets seized up violently in early May as incipient bank runs spread from Greece to Portugal and Spain, threatening the first big sovereign default of our era. Jean-ClaudeTrichet, the president of the European Central Bank (ECB), talked days later of "the most difficult situation since the Second World War, and perhaps the First."

The ECB's latest monthly bulletin gives us some startling details. It reveals that the bank's "systemic risk indicator" surged suddenly to an all-time high on May 7 as measured by EURIBOR derivatives and stress in the EONIA swaps market, exceeding the strains at the height of the Lehman Brothers crisis in September 2008. "The probability of a simultaneous default of two or more euro-area large and complex banking groups rose sharply," it said.

This is a unsettling admission. Which two "large and complex banking groups" were on the brink of collapse? We may find out in late July when the stress test results are published, a move described by Deutsche Bank chief Josef Ackermann as "very, very dangerous."

And are we any safer now that the EU has failed to restore full confidence with its E750 billion (L505 billion) "shock and awe" shield -- that is to say after throwing everything it can credibly muster under the political constraints of monetary union? This is the deep angst that lies behind last week's surge in gold to an all-time high of $1,258 an ounce.

The World Gold Council said on Friday that the central banks of Russia, the Philippines, Kazakhstan, and Venezuela have been buying gold, and Saudi Arabia's monetary authority has "restated" its reserves upwards from 143 to 323 tonnes. If there is any theme to the bullion rush, it is fear that the global currency system is unravelling. Or, put another way, gold itself is reclaiming its historic role as the ultimate safe haven and benchmark currency.

It is certainly not inflation as such that is worrying big investors, though inflation may be the default response before this is all over. Core CPI in the US has fallen to the lowest level since the mid-1960s. Unlike the blow-off gold spike of the Nixon-Carter era, this rally has echoes of the 1930s. It is a harbinger of deflation stress.

Capital Economics calculates that the M3 money supply in the US has been contracting over the past three months at an annual rate of 7.6 percent. The yield on two-year Treasury notes is 0.71 percent. This is an economy in the grip of debt destruction.

Albert Edwards from Societe Generale says the Atlantic region is one accident away from outright deflation -- that ninth Circle of Hell, "abandon all hope, ye who enter." Such an accident may be coming. The ECRI leading indicator for the US economy has fallen at the most precipitous rate for half a century, dropping to a 45-week low. The latest reading is -5.70, the level it reached in late-2007 just as Wall Street began to roll over and crash. Neither the Fed nor the US Treasury were then aware that the US economy was already in recession. The official growth models were wildly wrong.

David Rosenberg from Gluskin Sheff said analysts are once again "asleep at the wheel" as the Baltic Dry Index measuring freight rate for bulk goods breaks down after a classic triple top. The recovery in US railroad car loadings appears to have stalled, with volume still down 10.5 percent from June 2008.

The National Association of Home Builders' index of "future sales" fell in May to the lowest since the depths of slump in early 2009. RealtyTrac said home repossessions have reached a fresh record. A further 323,000 families were hit with foreclosure notices last month. "We’re nowhere near out of the woods," said the firm.

It is an academic question whether the US slips into a double-dip recession or merely grinds along for the next 12 months in a "growth slump." For Europe, nothing short of a sustained global boom can lift the eurozone out of the deflationary quicksand already swallowing up the South.

Spain had to pay a near-record spread of 220 basis points over German Bunds last week to clear away an auction of 10-year bonds, roughly what Greece was paying in March. Leaked transcripts of a closed-door briefing to the Cortes by a central bank official revealed that Spanish companies have been shut out of the capital markets since Easter. Given that the Spanish state, juntas, banks, and firms have together built up foreign debts of E1.5 trillion, or 147 percent of GDP, and must roll over E600 billion of these debts this year, this is a crisis unlikely to cure itself.

Read the rest of the article.

For further reading:
"The gold standard: generator and protector of jobs", Hugo Salinas Price, June 16, 2010

The Recovery Starts With Sound Money

By Judy Shelton
Atlas Sound Money Project
Thursday, May 27, 2010

http://www.soundmoneyproject.org/?p=1703

The willingness to work for the sake of future prosperity is a universal human quality, but people must believe there is a link between effort and reward.

The euro is beset with fiscal calamities that threaten its downfall, and markets in the U.S. are roiled by uncertainty over the government’s financial regulatory legislation. But don’t worry. Treasury Secretary Timothy Geithner meets with European finance officials today to discuss the economic situation. According to a Treasury Department statement, they will focus on “measures being taken to restore global confidence and financial stability.” So everything is under control.

Right.

What government policy makers in the U.S. and Europe fail to realize is that far from being seen as capable of delivering economic salvation, they are increasingly perceived as primary contributors to global financial ruin. Whether it’s the fiscal recklessness of spendthrift politicians or the refusal of government officials to acknowledge failings—distorting mortgage markets through Fannie Mae and Freddie Mac, skewing assessments of credit risk through loose monetary policy—the influence of government over the real economy is proving disastrous.

No wonder people are flocking to gold as they flee government-supplied money. Neither the dollar nor the euro inspires much global confidence; despite the dollar’s relative safe-haven status, neither currency holds out the promise of financial stability.

How can the real economy, i.e., the private sector, where genuine wealth is actually produced, continue to function in the absence of reliable money? Europeans will be wary of the euro from now on, given that the European Central Bank has relaxed its standards for safeguarding monetary integrity by absorbing Greek debt. Meanwhile, the perilous fiscal condition of the U.S. has convinced many that our government will resort to future inflation to reduce its own untenable debt burden.

It’s hard to see how economic recovery can proceed when citizens suspect that the monetary foundation beneath them is crumbling away. The willingness to work and sacrifice for the sake of future prosperity is a universal human quality—the hallmark of entrepreneurial faith—but people must believe there is a link between effort and reward. Money forges that link by providing a dependable store of value; in doing so, it performs a vital social function.

The private sector is fully capable of recovering from economic downturn if individuals have a meaningful tool of measurement for evaluating alternative choices in a competitive environment. Comparisons based on accurate, free-market price signals yield optimal economic outcomes. But what we are witnessing today is a clash between the real economy’s will to resurrect itself and the persistent failure of government, here and abroad, to deliver an appropriate platform of sound money based on sound finances.

Even as the first inklings of rebounding growth can be discerned—increased retail sales, higher corporate profits—it takes only the latest headline about government failure to come to grips with deficit spending and accumulating sovereign debt to snuff out any potential market rally. Pledges to achieve balanced budgets by some distant future date do little to convince people that anything has really changed.

Tough rules to enforce fiscal discipline were part of the original plan for persuading Europeans to abandon national monies in favor of adopting a common currency. Limits on deficit spending and government debt were clearly stipulated in the Stability and Growth Pact—no more than a 3% budget deficit, maximum debt equal to 60% of GDP. But these criteria were quietly jettisoned years ago and have now been flagrantly breached en masse by European nations responding to the financial crisis with bailout packages and fiscal stimulus.

In the U.S., frustrations over Washington’s seeming inability to resist fiscal profligacy have found voice in the tea party movement. As national sentiment grows in favor of limited government and constrained powers, legislation has been introduced in nine states to nullify federal legal tender laws; the Fed’s monopoly on supplying the money U.S. citizens must use is being challenged by authorizing payment in gold and silver.

Invoking the 10th Amendment strictures of the Constitution, proponents argue that the Founding Fathers never intended to grant federal government both the right to borrow money as well as the power to manipulate the value of the monetary unit of account. Money linked to gold and silver retains its value, which prevents the medium of exchange from falling victim to the federal government’s inherent conflict of interest if it can fund its own debt with money created from thin air. Updated for our times, a number of the legal tender proposals specify that citizens would be allowed to tap electronic exchange-traded funds (ETFs) backed 100% by gold or silver to conduct digital transactions with state government.

The idea of rising above the administrative dictates of fallible government to reclaim the virtues of sound money is profoundly liberating—and could prove economically empowering. Who believes that officials in Brussels or Frankfurt will safeguard the value of euro-denominated savings in the face of political pressures? Who expects the “Financial Stability Oversight Council,” led by the Treasury secretary as prescribed in the regulatory overhaul bill, to spot the next asset bubble before it ruptures with catastrophic financial consequences for American retirement accounts? The transition to a firmer monetary footing to support entrepreneurial capitalism could be initiated by linking major global reserve currencies to gold and silver—commodities long associated with monetary functions. It would logically begin with the dollar. As a first step, U.S. citizens could ask Congress to authorize the limited issuance of gold-backed Treasury bonds that would provide for payment of principal at maturity in either ounces of gold or the face value of the security, at the option of the holder.

The level of public confidence in fiat dollar obligations versus gold would be revealed through auction bidding, with yield spreads clearly reflecting aggregate expectations of their comparative values. In the same way that inflation-indexed Treasury bonds measure expectations about future changes in the Consumer Price Index, gold-backed Treasury bonds would provide a barometer of the Fed’s credibility.

By linking the dollar to gold, Americans would establish a vital beachhead for sound money and provide a model that other nations could emulate.

Ms. Shelton, author of “Money Meltdown” (Free Press, 1994), is a senior fellow at the Atlas Economic Research Foundation and co-director of the Atlas Sound Money Project.

This article was originally published in The Wall Street Journal.

Euro 'will be dead in five years'

By Edmund Conway
The Telegraph
Saturday, June 5, 2010

http://www.telegraph.co.uk/finance/financetopics/budget/7806064/Euro-will-be-dead-in-five-years.html

The euro will have broken up before the end of this Parliamentary term, according to the bulk of economists taking part in a wide-ranging economic survey for The Sunday Telegraph.

The single currency is in its death throes and may not survive in its current membership for a week, let alone the next five years, according to a selection of responses to the survey – the first major wide-ranging litmus test of economic opinion in the City since the election. The findings underline suspicions that the new Chancellor, George Osborne, will have to firefight a full-blown crisis in Britain's biggest trading partner in his first years in office.

Of the 25 leading City economists who took part in the Telegraph survey, 12 predicted that the euro would not survive in its current form this Parliamentary term, compared with eight who suspected it would. Five declared themselves undecided. The finding is only one of a number of remarkable conclusions, including that:

• The economy will grow by well over a percentage point less next year than the Budget predicted in March.

• The Government will borrow almost £10bn less next year than the Treasury previously forecast, despite this weaker growth.

• Just as many economists think the Bank of England will not raise rates until 2012 or later as think it will lift borrowing costs this year.

But the conclusion on the euro is perhaps the most remarkable finding. A year ago or less, few within the City would have confidently predicted the currency's demise. But the travails of Greece, Spain and Portugal in recent weeks, plus German Chancellor Angela Merkel's acknowledgement that the currency is facing an "existential crisis", have radically shifted opinion.

Two of the eight experts who predicted that the currency would survive said it would do so only at the cost of seeing at least one of its members default on its sovereign debt. Andrew Lilico, chief economist at think tank Policy Exchange, said there was "nearly zero chance" of the euro surviving with its current membership, adding: "Greece will certainly default on its debts, and it is an open question whether Greece will experience some form of revolution or coup – I'd put the likelihood of that over the next five years as around one in four."

Douglas McWilliams of the Centre for Economics and Business Research said the single currency "may not even survive the next week", while David Blanchflower, professor at Dartmouth College and former Bank of England policymaker, added: "The political implications [of euro disintegration] are likely to be far-reaching – Germans are opposed to paying for others and may well quit."

Four of the economists said that despite the wider suspicion that Greece or some of the weaker economies may be forced out of the currency, the most likely country to leave would be Germany.

Peter Warburton of consultancy Economic Perspectives said: "Possibly Germany will leave. Possibly other central and eastern European countries – plus Denmark – will have joined. Possibly, there will be a multi-tier membership of the EU and a mechanism for entering and leaving the single currency. I think the project will survive, but not in its current form."

Read the rest of the article.

For further reading:
"Whatever Germany does, the euro as we know it is dead", By Jeff Randall, The Telegraph, May 20, 2010

Europe Prepares Nuclear Response to Save Monetary Union

By Ambrose Evans-Pritchard
The Telegraph, London
Sunday, May 9, 2010

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/7702335/Europe-prepares-nuclear-response-to-save-monetary-union.html

Are Europe's leaders grasping the nettle at last? Faced with the imminent disintegration of monetary union, they appear poised to create the beginnings of an EU debt union and authorize the European Central Bank to step in immediately to stabilize the eurozone bond markets.

"It is an absolute general mobilization: we have decided to give the eurozone a veritable economic government," said French president Nicolas Sarkozy, once again basking as Europe's action man. "Today we have an attack on the whole of the eurozone. This is a systemic crisis: the response must be systemic. When the markets open on Monday morning we will be ready to defend the euro."

Great caution is in order. German Chancellor Angela Merkel has so far said little. The descriptions of the deal agreed by EU leaders in the early hours of Saturday are coming from the French bloc and EU bureaucrats. How many times during the Greek saga of the last four months have we heard claims from Brussels that turned out to be a distortion of what Germany had actually agreed, causing each relief rally to falter within days? They had better get it right this time.

But if the early reports are near true, the accord profoundly alters the character of the European Union. The walls of fiscal and economic sovereignty are being breached. The creation of an EU rescue mechanism with powers to issue bonds with Europe's AAA rating to help eurozone states in trouble -- apparently €60bn, with a separate facility that may be able to lever up to €600bn -- is to go far beyond the Lisbon Treaty. This new agency is an EU Treasury in all but name, managing an EU fiscal union where liabilities become shared. A European state is being created before our eyes.

No EMU country will be allowed to default, whatever the moral hazard. Mrs Merkel seems to have bowed to extreme pressure as contagion spread to Portugal, Ireland, and -- the two clinchers -- Spain and Italy. "We have a serious situation, not just in one country but in several," she said.

The euro's founding fathers have for now won their strategic bet that monetary union would one day force EU states to create the machinery needed to make it work, or put another way that Germany would go along rather than squander its half-century investment in Europe's power-war order.

Whether the German nation will acquiesce for long is another matter. Popular fury over the Greek rescue has already cost Mrs Merkel control over North Rhine-Westphalia and with it the Bundesrat, dooming her reform agenda. The result was a rout.Events are getting out of hand, and not just on the streets of Athens.

For now, the world has avoided a financial cataclysm that would have been as serious and far-reaching as the collapse of Lehman Brothers, AIG, Fannie and Freddie in September 2008, and perhaps worse given the already depleted capital ratios of banks and the growing aversion to sovereign debt

Bond risk on European banks as measured by the iTraxx financial index reached even higher levels late last week than in the worst moments of the Lehman crisis. The safe-haven flight into two-year German Schatz was flashing the most extreme stress warnings since the instruments where created forty years ago."We're seeing herd behavior in the markets that are really wolfpack behavior," said Anders Borg, Sweden's Finance Minister.

Credit specialists in Frankfurt, London, and New York feared a blow-up by Thursday afternoon, when ECB president Jean-Claude Trichet said the bank's council had not even discussed the `nuclear option' of buying Club Med bonds. The ECB seemed to be on another planet.

It was the fall-out from that press conference -- at a moment when markets were losing all confidence in EU leadership -- that had much to do with the DOW's 1000 point drop in New York hours later. This is not to blame Mr Trichet. He did not have a mandate to go further at that stage. The Bundesbank had blocked him, knowing full-well that ECB purchases of bonds is the end of monetary discipline and the start of a Primrose Path to Hell. As they say in Frankfurt, a central bank should be like pudding: "the more you beat it, the harder it gets".

It is pointless to fault either camp is this clash of Latin and Teutonic mores. The euro was never an "optimal currency area", which is to say it was never an "optimal legal and cultural area". It was a late 20th Century version of the same Hegelian reflex of imposing ideas from above -- making facts fit the theory -- that has so cursed Europe. Schopenhauer said Hegel had "completely disorganized and ruined the minds of a whole generation". Little did he know how long the spell would last.

But I digress. There is a difference between quantitative easing by the US Federal Reserve and the Bank of England for liquidity purposes, and use of this policy to soak up the debt of governments dependent on external finance to cover structural deficits. The lines are of course blurred. One purpose can leak into the other.

But whatever the objections of the Bundesbank, it seems that Europe's elected leaders pulled rank this weekend -- and high time too says the French Left. The reaction in Germany already been fierce. "The ECB is going crank up the printing presses," said Anton Börner, head of Germany's export federation. "In five to ten yeas we will have a weak currency, with rising inflation and higher rates of inflation that will act as a break on growth."

I don't agree with Mr Börner. The M3 money supply is contracting in the eurozone, pointing to the risk of a Japan-style slide into deflationary perma-slump, although the panic response to that down the road may well be to call in the printers. But there is no doubt that Mr Börner represents German opinion.

The EU is invoking the "exceptional circumstances" clause of Article 122 of the Lisbon Treaty, arguing that the euro is subject to an "organized worldwide attack". This is a legal minefield. A group of professors has already filed a case at Germany's Constitutional Court, claiming that the Greek bail-out is illegal and that the EMU is degenerating into a zone of monetary disorder.

Read the rest of the article.

Hobson's Choice for Germany, ECB

By Richard Barley
The Wall Street Journal
Wednesday, April 28, 2010

http://online.wsj.com/article/SB10001424052748704471204575210413650656220.html

The euro-zone crisis risks spinning out of control. The Standard & Poor's downgrades of Greece to junk status and Portugal by two notches to A-minus, although only confirmation of what markets prices were already saying, may have broken already fragile investor confidence. The single currency's fate is now in the hands of the German government and the European Central Bank. None of the choices on offer are good ones.

Germany must decide whether to commit its highly reluctant taxpayers to a vast Greek bailout. If the package is too small, markets will conclude the euro zone is unwilling and unable to support its members, triggering contagion to other countries and a possible break-up of the euro zone. But if Germany agrees a big enough package to draw a line under Greece's funding problems for several years, as investors seem to be demanding, it must do so aware it is unlikely to get all its money back. After all, investors now suspect Greece's problem is one of solvency rather than simply liquidity.

The ECB's challenge is no less crucial: It must decide whether to continue accepting Greek government debt as collateral for its lending operations if all three major ratings firms downgrade it to junk. Under ECB rules, already weakened once to accommodate Greece, eligibility requires at least one investment-grade rating. Moody's Investors Service still rates Greek debt four notches above junk. It may retain that investment-grade rating if an aid package materializes—after all, global banks remained investment-grade even after Lehman's collapse, thanks to government support. But S&P's three-notch downgrade shows how quickly the situation can change.

Read the rest of the article.

For further reading:
"Opa! Greek Government Announces Yet Another Bailout, But Who is Really Getting Bailed Out?", The Agonist, May 3, 2010
"Germany Clears Rescue for Greece", The New York Times, May 3, 2010
"Greek Money Mystery", Adrian Ash, May 3, 2010
"The Euro Trap", Paul Krugman, April 29, 2010
"Sovereign Debt Crisis Past the Point of No Return?", Financial Advisory, April 28, 2010
"ECB may have to turn to 'nuclear option' to prevent Southern European debt collapse", Ambrose Evans-Pritchard, April 27, 2010
"The Euro Can Survive a Greek Default", Daniel Gros, April 26, 2010

One Currency Doesn't Require 'One Europe'

By Judy Shelton
Atlas Sound Money Project
Friday, March 19, 2010

http://www.soundmoneyproject.org/?p=992

The euro has gained stature as an alternative to the U.S. dollar. Preserving it will require letting profligate state like Greece pay their own way.

The creation of the euro was either the greatest historic achievement of the last century—or its worst delusion.

Not to be glib, but the answer is both: The euro represents a magnificent step toward fulfilling money’s highest purposes—to serve as a medium of exchange, a unit of account, and a store of value—but it’s also fraught with problems borne of wrongly commingled economic objectives and political aspirations.

Hence, Europe’s single currency is proving both a boon and a bane to free market capitalism. While it facilitates economic transactions across borders and helps to optimize investment, the euro’s vulnerability to the bad behavior of individual member nations calls into question its ultimate dependability.

How—or whether—our allies across the Atlantic manage to resolve the fundamental conflict between providing sound money and bailing out spendthrift governments will have a crucial impact in determining Europe’s future. And our own.

At issue is whether government should be involved in the fundamental task of issuing a reliable form of money. Given that politicians have a penchant for short-term fiscal indulgence at the expense of long-term monetary stability, there is an obvious conflict of interest.

The Europeans opted to deal with this conundrum by designating a monetary authority—the European Central Bank—as a supranational institution ostensibly immune to political pressures that might emanate from member states. Focusing on “price stability” as its paramount objective, the ECB has done a laudable job resisting calls for easier monetary policy; in the 12 years since the euro was introduced, it has delivered inflation averaging about 2% annually and has gained stature as an alternative global reserve currency to the U.S. dollar.

But what to do now? With Greece flummoxed by strikes and social upheaval as it wrestles with a 12.7% budget deficit and potential debt default, it’s not clear to what extent fiscal profligacy will be resolved through monetary laxity. Asked whether the ECB would bail out Greece and other struggling European nations, ECB President Jean-Claude Trichet responded in a Fox Business Network interview last Friday: “It is not the ECB which is at stake; it is the governments of Europe. They have said in their summit that they stood ready to do whatever was necessary to maintain financial stability in the euro area. I stick to that statement myself.”

While Mr. Trichet is trying to draw a line between the monetary institution that stands behind the euro and the governments of the 16 nations that comprise the euro area—and whose central bank governors sit on the ECB’s Governing Council, its main decision-making body—it is not so easy to separate them.

The whole purpose of forging a single currency, after all, was to foster greater European economic integration. And the broader notion behind that concept, some five decades in the making, is that economic integration begets political integration. For a continent that suffered two devastating wars in the last century, it seems a most worthy goal; indeed, brochures distributed by the European Commission for purposes of explaining the history behind the euro carry the title: “One Currency for One Europe.”

If there were any doubt that Europe’s political fate is intertwined in the euro’s continued viability, it was dispelled by French President Nicolas Sarkozy’s observation, apropos of the Greek situation, earlier this month. “We cannot let a country fall that is in the euro zone,” he told French farmers. “Otherwise, there was no point in creating the euro.”

The United States faced a similar dilemma early in its own history. Confronted with the need to have a common currency among the newly-established states that had become a single sovereign nation following the Revolutionary War, yet wary of granting money powers to a federal Congress, the Founding Fathers chose to place limits on government to prevent it from abusing the public trust. Excessive money issuance through “bills of credit” issued by state governments to serve as legal tender had already proven to lead to financial disaster; unless money was defined in precise terms to determine its value, it could not function as a meaningful unit of account.

In other words, money was to be a standard in the same way that official weights and measures were standards. States could not debase money for political reasons or to surreptitiously reduce their debts. In the debate over the government’s proper monetary role in 1784, Thomas Jefferson asserted, “If we determine that a dollar shall be our unit, we must then say with precision what a dollar is.”

In the Constitution adopted three years later, legal tender coinage was limited to gold and silver. Congress was given the power to coin money and to “regulate” its value—that is, to specify the legal value of the coins in terms of a number of dollars. While Congress was permitted to borrow money on the credit of the United States, this was strictly a fiscal power that had nothing to do with creating money.

All of which suggests that Europe—and America—would do well to tap the wisdom of the past in seeking to fulfill its political destiny without sacrificing its monetary integrity. Contrary to George Soros’s pronouncement that the euro is flawed because there is “a common central bank, but you don’t have a common treasury,” the way to save the euro is to remove it even further from the compromising process of government fiscal policy.

It’s interesting that Mr. Trichet, lamenting that “finance lost contact with its raison d’etre” in a March 12 speech at Stanford University, invoked lessons from an earlier era. “There is a widespread perception that banking crises in times when money was convertible into gold had apocalyptic consequences for bank depositors. This is not true. The estimated average loss on assets born by depositors in banks that were closed down as a consequence of financial crisis was minuscule.”

Mr. Trichet cited the importance of well-capitalized banks to defend against financial innovation that has come to “serve itself” rather than the real economy, and placed his faith in more international regulation. While he is right to worry about our increasingly wag-the-dog world of speculative finance, the way to reconnect financial flows with productive enterprise is to empower individuals through honest money.

Capitalism needs a sound monetary foundation to function properly. It’s something our Founders worked out a long time ago.

Ms. Shelton, a senior fellow at the Atlas Economic Research Foundation, is author of “Money Meltdown: Restoring Order to the Global Currency System” (Free Press, 1994).

This article was originally published in The Wall Street Journal.

Proposed European Monetary Fund Advances

By Jack Ewing and Matthew Saltmarsh
The New York Times
Monday, March 8, 2010

http://www.nytimes.com/2010/03/09/business/global/09iht-euro.html

FRANKFURT — Greece’s fiscal problems seemed to be nudging Europe toward closer integration Monday, as the European Commission endorsed a German proposal for a European monetary fund to prevent future debt crises, while officials called for new regulations to prevent speculators from exploiting countries’ economic woes.

But details of the fund proposal were vague, and any plan faced political and legal impediments. A plan would also come too late to help Greece even if all European Union members agreed to it, analysts said.

Read the rest of the article.

For further reading:
"EU, ECB lock horns over IMF-style rescue fund", Marcin Grajewski, Reuters, March 8, 2010
"Germany and EU plan 'European IMF'", The Local, March 8, 2010
"Plans emerge for 'European Monetary Fund'", Andrew Willis, euobserver.com, March 8, 2010

Greek Saga Won't Kill the Euro But the End May Begin Here

By Liam Halligan
The Telegraph, London
Saturday, February 13, 2010

http://www.telegraph.co.uk/finance/comment/liamhalligan/7230255/Greek-saga-wont-kill-the-euro-but-the-end-may-begin-here.html

Could the endgame of this Greek tragedy be a eurozone breakup? The single currency's supporters maintain that such an outcome is mere mythology.

Greece accounts for only 3 percent of the 16 member states' combined GDP, they say, and has lower debts than some of the banks bailed-out during sub-prime. A loan of E20 billion (£17.5 billion) would do the trick, we're told. That's less than the British government injected into either Lloyds or the Royal Bank of Scotland.

Such analysis sounds vaguely plausible. But its naïve and politically dishonest. Then again, the single currency was built on political dishonesty. That's because, at the heart of the eurozone project there was always a fundamental contradiction -- one that the architects of monetary union never dared to address. Now its being highlighted for them, whether they like it or not.

While the European Central Bank controls eurozone interest rates and the money supply, the size of each country's fiscal deficit results from the spending and taxation decisions of its own sovereign government.

How can you enforce collective fiscal discipline in a currency union of individual sovereign states, each answerable to their own electorate? The truthful answer is you can't -- not unless you subjugate the autonomy of democratically-elected politicians and, by proxy, their voters.

Voters don't like that. Neither do politicians. Faced with a choice between seriously annoying their own voters and seriously annoying the ECB, the most ardently "pro-European" lawmakers, even those with years of Brussels trough-nuzzling under their belt, will always side with their own. That's why the eurozone will ultimately break up -- whether Greece is bailed out or not.

The eurocrats blame "speculators" for the single currency's woes. That's a bit like sailors blaming the sea. The eurozone is ultimately doomed because, in the end, economic logic wins and the will of each country's electorate bursts through. This current Greek saga won't end the eurozone -- but future historians will identify it, perhaps, as the beginning of the end.

Many have said it's hardly surprising that Greece -- with its history of financial profligacy and capital flight -- has emerged as the eurozone's Achilles heel. A more germane observation is that, while fiscally wayward, Greece is also the birthplace of democracy. If the Greek population wants to get upset, throw out its elected politicians and reject austerity, it must be allowed to do so. I think they'd be mad, but it must be their choice.

If Berlin and Brussels try to impose their own view on Greece and the "cuts" come from outside, the situation will become absolutely incendiary. Protests will turn into full-blown riots. Greece will endure very serious social unrest. Deep-seated rivalries and suspicions between countries will be re-ignited. And for what?

Read the rest of the article.

For further reading:
"The Greek Tragedy That Changed Europe", The Wall Street Journal, February 13, 2010
"A Theory of International Currency and Seigniorage Competition", Yiting Li, September 2005
"How to Cut the Seigniorage Cake into Fair Shares in an Enlarged EMU", Jørgen Drud Hansen and Roswitha M. King, December 22, 2004
"The Enlargement of the European Union and the Redistribution of Seigniorage Wealth", Holger Feist, January 2001
"Eurowinners and Eurolosers: The difference of seigniorage wealth in EMU", Hans Werner-Sinn and Holger Feist, June 1, 1997

Euro Trashed?

By John Browne
Euro Pacific Capital, Inc.
Wednesday, February 10, 2010

http://www.europac.net/externalframeset.asp?from=home&id=18180&type=browne

The European experiment with a trans-sovereign currency is facing its first acid test. The flashpoint today is Greece, which looks set to default on its debt barring some outside intervention. While many commentators have been squawking about the immediate crisis as if it were the end of life on Earth, I would like to zoom out and discuss the history and longer-term outlook for the euro and its parent, the European Union.

The launch of the euro was a major milestone in the sixty year process of European federalization. Economic considerations have always led the charge, from a normalization of tariffs to a free-trade area to a customs union. Still, the launch of a pan-European fiat currency and central bank without a unified political apparatus behind it was always considered a risky move.

Since its launch, the euro has outperformed expectations, establishing itself both as the world’s secondary reserve currency and the second most traded currency after the U.S. dollar. Because of this stellar introduction, the euro has been proposed as the new primary reserve currency in place of a devaluing U.S. dollar. However, its unusual foundation presents risks to which most investors are unaccustomed.

In essence, the euro was created as a lever to encourage a complete European political union rather than as a currency representing a call on an already unified economy, as with the U.S. dollar. Jean Monnet, one of the EU’s founding fathers, is reported as saying, “Europe’s nations should be guided towards the super-state without their people understanding what is happening. This can be accomplished by successive steps, each disguised as having an economic purpose but which will inevitably, and irreversibly, lead to federation.”

The currency has largely succeeded in creating the will for a federal Europe among the member states’ political classes; however, the citizens have voted again and again to maintain their countries’ independence since 2005. Thus, the Union was already losing momentum when the latest financial crisis struck.

The combination of tight credit markets and high debt-to-GDP ratios caused bond yields for the EU members collectively known as PIGS (Portugal, Ireland, Greece, and Spain) to fly upward. As a result, Greece is now in acute jeopardy of officially defaulting on its debts. Because a political union was never implemented, Greece cannot be compelled to slash its budget, nor can it assume the Union will prevent its fiscal failure.

This explains why investors are making short-term trades out of the euro and into the dollar. While the Greek deficit-to-revenue ratio is roughly equal to that of California in 2009, the latter functions with an implicit (although untested) guarantee that the U.S. government will step in before they are forced to default. The EU offers no such backing to its member-states. In fact, recent questions have arisen out of Germany, the primus-inter-pares of EU members, concerning the legality of the European Central Bank (ECB) or the European Union ever giving direct aid to the Greek government.

While many assume that either Germany, an ad-hoc group of European states, or the IMF will bail out Greece, such a result would represent a temporary fix rather than a policy precedent. The move would pose more questions than it answers. If Greece were to be thrown a lifeline what would happen if Portugal, and then Spain, were to ask for equal consideration? Will Greece be spared expulsion from the eurozone if it fails to take the austerity measures necessary to restore solvency? If not, what message does that send to Ireland, which chose to slash its budget rather than wait for a bailout?

These problems did not spring from the æther. The architects of the euro, in pursuit of their political agenda, willfully disregarded the historical divide between the Nordic economies, which have practiced low inflation and fiscal discipline, and the Mediterranean, high-debt, easy-money economies. While there were strict economic, monetary, and budgetary criteria for entry into the currency, one can reasonably suspect that enforcement was lax or the numbers were fudged. After all, the southern states’ balance sheets tilted deep into the red soon after acceptance in the Union. Now, however, the ECB prevents them from monetizing the debt.

So, we are witnessing the results of this inherent contradiction.

If the EU becomes the “bailout union,” a free-ride area where entitlement spending in Greece is underwritten by German taxpayers, then the euro will stabilize in the short-term, as investors face reduced uncertainty. However, this will lock the Union on a trajectory to gradual monetary collapse – the path currently being followed by the U.S. dollar.

If Greece is left to face the consequences of its profligacy, then the integrity of the euro will be preserved. The key in this scenario is whether Greece leaves the euro, or the Union, when it defaults. If it does, we could see weaker economies cast out one-by-one until Europe returns to a system of national currencies, with perhaps a rump euro uniting the Nordic block. If Greece defaults but remains in the block, then short-term shock will give way to a renewed confidence in the euro as a lasting reserve currency.

The future of the EU is being tested severely, together with much of the wealth of investors who have diversified into its currency. Likely, this crisis will draw the EU member states into a covert political struggle over the future of Europe. As this battle ebbs and flows, both the euro and the U.S. dollar likely will suffer great volatility. Those of us parked in the safe harbor of gold may benefit greatly from this transatlantic turbulence.

John Browne is the Senior Market Strategist for Euro Pacific Capital, Inc. Reprinted with permission.

For a more in-depth analysis of our financial problems and the inherent dangers they pose for the U.S. economy and U.S. dollar, read Peter Schiff's 2008 bestseller "The Little Book of Bull Moves in Bear Markets" and his newest release "Crash Proof 2.0: How to Profit from the Economic Collapse." Click here to learn more.

More importantly, don't let the great deals pass you by. Get an inside view of Peter's playbook with his new Special Report, "Peter Schiff's Five Favorite Investment Choices for the Next Five Years." Click here to download the report for free. You can find more free services for global investors, and learn about the Euro Pacific advantage, at www.europac.net.

For further reading:
"Things Fall Apart in Eurozone", John Browne, Euro Pacific Capital, Inc., January 12, 2010