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The worst has yet to come - Part 3

By Chris Clancy
web posted October 15, 2012

Let's pick up where we left off at the end of Part 2.

In the first half of the 1980s the US dollar (USD) appreciated to the point where American exporters were having a very hard time of it. The driving forces behind the over-strong dollar were the petrodollar system itself and high interest rates.

Through a concerted campaign of protests and lobbying, exporters eventually spurred the White House into action.

To cut a long story short, finance ministers from the world's leading economies at the time, met in the Plaza Hotel in New York City in September 1985. They reached an agreement; by acting in concert they would bring about a controlled fall in the value of the dollar. This would be done by actively intervening in currency markets around the world.

The agreement became known as the Plaza Accord.

Over the next two years things did not work out exactly as planned, but they did achieve their primary objective – a significant devaluation of the USD against its major foreign competitors.

The crucial point is that this agreement was not made in secret – was not made behind closed doors. Their intentions were announced in advance and then carried out in an orderly fashion and in such a way that it did not lead to financial panic in world markets.

However, there is something to bear in mind - this particular method of devaluation was only possible for the USD – simply because of its unique position as the world's reserve currency.  Not so for other countries and their currencies.

Fast forward to present day America. As laid out in Part 2, the petrodollar system is beginning to come apart.

The USA is bankrupt and has been so for a very long time. No big secret here. The only reason foreigners continue to lend, thereby putting off the day or reckoning, is because of the petrodollar system. But the more this system weakens, the more downward pressure there is on the dollar and the closer the USA gets to a belated sovereign debt crisis.

Such a crisis happens when a government cannot repay its debts to foreign lenders.

Once it gets underway events usually move very quickly.

To deal with the situation, governments have a few options, but almost invariably choose to default. This means that lenders will usually not get all of their money back – in some cases they may get nothing.

Also, if governments choose the default option, creditors have no recourse in law. They must suffer any losses.

What form the default takes depends on the circumstances and what agreements, if any, are reached. For example, a country could choose to repudiate all or part of the debt. Alternatively they may choose to restructure their debts in some way through devaluation, alteration of terms and conditions or some combination thereof.

If the worst comes to the worst they may choose, or even be forced, to print their currency out of existence!

There is absolutely nothing new in any of this. The number of countries who have found themselves in a such a position over, say, the last hundred years is quite staggering. In fact, if a continental-type gold cup were to be awarded, it would have to go to the countries which comprise Central and South America!

See here for yourself.

Needless to say, these countries have not disappeared, they are still with us – but they all had to face consequences for their defaults. Not least the immediate plunge into recession which followed and the fact that people will always think twice before ever lending them money again.

However, the fact remains – one way or another - these countries came through it.

At which point the average reader in America may start to wonder – what's all the hand-wringing about – why not just repudiate the lot?

Screw you, we ain't payin'!

Tempting as it may be to think like this, especially given the explosion of hatred towards America of late, such a sudden move would be catastrophic. Not just for America but for the global economy. Whereas other countries can stiff whoever they like and start again, America is not like "other countries". If it were to default everyone else would have to "start again" as well.

Nobody needs a degree in economics to figure out why.

America is still far and away the most powerful economy on the planet. It is also the world's greatest consumer. To put it bluntly, if the American economy goes down the toilet it takes everyone else with it.

A global recession would follow very swiftly – and if anyone thinks things have been tough in the last four years, they better hang on to their hats – the worst would yet be to come!

No.

Default by the USA is not an option – it's not in anyone's economic interest - it's a negative sum game. Therefore the downward slide in the dollar must be managed in such a way as to try and ensure there is no sudden collapse

Which brings us back to the Plaza Accord. The precedent is there, the principle remains the same and it can be done again.

Some say a repeat has already been set in motion – a so-called Plaza Accord Two - but that this time it's being done in secret.

I very much doubt any of this – especially since it is rumoured Obama and some of his loons were the instigators – I doubt most of them even know what the word "petrodollar" means.

But yes, ignoring this nonsense, it can be done again.

Agreed, it was a long time ago. And yes, the reasons are very different this time – to slow down the slide in the dollar – rather can bring it about. Also, much has happened between then and now - many things have changed greatly – not least the economic rise of China.

But what other option is there – do nothing and wait until the SHTF?

Hardly.

Two questions to finish with – both of which address the real prospects for hope and change - as opposed to the pie-in-the-sky variety.

First. If it were possible to again manage a controlled fall in the USD, would this be enough to avoid disaster?

Not by itself – no – it is a necessary condition but not a sufficient one. Other things need to be going on at the same time, which work together to bring down the overall size of the debt - to one which is at least managable. The Romney/Ryan plan aims to achieve this, in the main, by growing the economy using supply-side policies.

Go here for the background.

Second. As the petrodollar system collapses and the USDs role as reserve currency erodes, what will emerge to replace it?

Crystal ball time …

In the short to medium term, "currency swap" agreements may develop into something a bit more ambitious – perhaps resembling an idea floated by Lord Keynes at Bretton Woods – the Bancor – and maybe, for a time, variations on this will operate on a regional basis.

Who knows?

However, in the end there can only be a return to the one true world currency – the choice freely made by people over thousands of years – I refer of course to gold. When asked if he would see a return to the gold standard in his lifetime, Peter Schiff replied quite simply, "Yes, I will - it has to happen."

I take this as a prediction. Given his track record, I wouldn't bet against it. ESR

Chris Clancy lived in China for seven years. Most of this time was spent as associate professor of financial accounting at Zhongnan University of Economics and Law in Wuhan City, Hubei Province. He now lives in Thailand where he spends his time reading, writing, lecturing and, whenever he gets the chance, doing his level best to spread Austrian economics.

 

 

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