Page 2 of 5 OBAMA, CHANGE AND CHINA, Part 3 The New Deal dollar and the Obama dollar By Henry C K Liu This report is the third in a series. Part 1:
The song stays the same Part 2:
A dangerous balance
some of Lehman's trading partners in derivatives transactions had not been
returned as required and had disappeared from the UK as the bankruptcy process
unfolded in New York.
The Bank of America (BoA) is seeking to recover nearly $500 million the bank
"posted as collateral to "support derivative transactions between BofA and the
respective Lehman Entities,'' according to a lawsuit filed in New York State
Supreme Court that alleges the accounts at Lehman that held the collateral were
"frozen'' when the investment house filed for bankruptcy on September 15, 2008.
BoA contends that Lehman "wrongfully refused'' to return the collateral in
violation of its agreement as a trading counterparty.
The dispute was expected to be the first of many since it is not uncommon for
derivative transactions to be part of tangled web, in which trading
counterparties are on the hook to make payments to other trading counterparties
with whom they have no direct agreements. A derivative is a sophisticated
contractual agreement that is dependent on the performance of the notional
value of an underlying security, such as a bond, a stock or a commodity.
The dispute between BoA and Lehman stemmed from the fateful decision by Lehman
officials in New York to transfer $8 billion in cash from the firm's London
offices on the eve of the bankruptcy filing before funds were frozen in London.
The $8 billion cash and securities sweep left Lehman's London offices with no
money to pay employees or to provide cash to hedge funds that made use of the
firm's overseas prime brokerage operations.
The list of hedge funds entangled in the Lehman bankruptcy kept growing by the
day following bankruptcy filling. Besides Bay Harbor, the list of hedge funds
caught in the great $8 billion cash transfer include GLG Partners, Newport
Global Opportunities Fund, Amber Capital and Harbinger Capital Partners.
Texas-based Newport Global, a nearly $700 million fund with close ties to
private equity giant Providence Equity Partners, got squeezed when Lehman
officials apparently failed to comply with the funds' request to move all its
assets to Credit Suisse.
Newport, which used Lehman as a prime broker, notified Lehman on September 10,
2008, five days before bankruptcy filling, to transfer assets held by Lehman's
London affiliate to Credit Suisse. Newport executives had believed the transfer
was completed and were shocked to learn that the assets were never moved before
Lehman filed for bankruptcy. As a result, Newport's assets were frozen in the
wake of the $8 billion transfer. In court papers, Newport says "If these assets
are not located and recovered immediately, there is the very real specter of
serious and irreparable harm to not only the funds, but also to their
respective investors."
IMF reform
As the lender of last resort for distressed central banks, International
Monetary Fund (IMF) loans are denominated in dollars. The US contributes only
18% in funding but commands the deciding vote over the remaining 82%
contribution by all other member governments.
The present focus on the reform of the International Monetary Fund (IMF) is
pinned on the hope that the world's lender of last resort can contribute
substantially to a recovery in 2010 from the greatest economic crisis in a
century. The IMF, headquartered in Washington DC, is an international
organization created in July 1944 during the United Nations Monetary and
Financial Conference at Bretton Woods, New Hampshire. It is charged with the
responsibility of overseeing the global financial system by monitoring those
aspects of macro-economic policies of its 185 member states that have an impact
on exchange rates and balances of payments. In theory, it has been designed as
an organization to stabilize international exchange rates and to facilitate the
balance of payments shortfalls of member states as an international lender of
last resort.
The performance of the IMF during the 1997 Asian financial crisis has since
been broadly and critically condemned as having unnecessarily exacerbated the
pain for and damage to the affected economies, with its imposition of
dilapidating "conditonalities" on debtor nations, such as privatizing
industries and slashing government spending. (See
Crippling debt and bankrupt solutions, Asia Times Online, September 28,
2002). In 2008, faced with a shortfall in revenue itself, the IMF executive
board agreed to sell part of its gold reserves and to curb operating expenses.
The IMF now hopes to at least double its lendable resources from $50 billion to
more than $500 billion so that it is ready to help out and provide confidence
that economies will have access to funds during the crisis. Japan has provided
$100 billion in extra money and the European Union has committed 75 billion
euros (US$99 billion). Emerging economies such as the BRIC nations, Brazil,
Russia, India and China, are expected to provide the bulk of the remaining
funds.
IMF plans to sweeten a $100 billion lending program announced in October that
failed to attract any borrower. The new program of less-restrictive loans is
designed to boost the fund's impaired standing as an authority in containing
the global meltdown and to assuage member-nation concerns about borrowing from
a lender often seen as heavy-handed and intrusive in internal national policies
to protect transnational lenders. IMF loan conditionality is being adjusted so
that economic structural reforms agreed with a country will be monitored in a
broad context. The change is also applicable to low-income countries.
If successful, the new IMF program could help many distressed economies weather
the global economic downturn. If not, global recovery will be delayed and the
IMF will become less relevant.
Lending reforms will be followed by further changes to country representation
at the fund, with emerging markets and low-income countries being given a
bigger voice. The April 2 G-20 summit in London is expected to bring forward
the process of reform of the quota systems that determines country
representation.
Together, the G-20 represents around 90% of global gross national product, 80%
of world trade (including trade within the European Union), as well as
two-thirds of the world's population. It comprises 19 countries: Argentina,
Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy,
Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the UK,
and the United States, plus the European Union, represented by the rotating
European Council presidency, and the European Central Bank. The managing
director of the International Monetary Fund and the president of the World
Bank, plus the chairs of the International Monetary and Financial Committee and
Development Committee of the IMF and World Bank, also participate.
Despite major stimulus packages announced by advanced economies and several
emerging markets, trade volumes have shrunk rapidly, while production and
employment data suggest that global activity continues to contract in the first
quarter of 2009.
Global activity is now projected to contract by 0.5 to 1% in 2009 on an annual
average basis - the first such fall in 60 years. Global growth is still
forecast by the IMF to stage a modest recovery next year, conditional on
comprehensive policy steps to stabilize financial conditions, sizeable fiscal
support, a gradual improvement in credit conditions, a bottoming of the US
housing market, and the cushioning effect from sharply lower oil and other
major commodity prices. Such institutional optimism is not shared broadly.
Obama has no plans for monetary reform
Most importantly, in the US, the world's largest economy, Obama has yet to put
forward any plans for monetary reform, let alone a new international finance
architecture, while FDR's monetary reform was the centerpiece of the New Deal,
albeit it was a distant echo of 19th century agrarian insurgency against the
gold standard.
Since the 1997 Asian financial crisis, there have been vague talks in the
Federal Reserve and the US Treasury about the need for reform of the existing
international finance architecture that is generally accepted as a fundamental
cause of the current and previous financial crises, but the official Obama
strategy appears to be that the teetering banking system must be stabilized
before any fundamental monetary reform can be entertained. The question is left
begging whether the critically impaired global banking system can be stabilized
without fundamental reform of the international financial architecture which
had been the cause the crisis to begin with.
Roosevelt's Executive Order 6102 proclaimed on January 31, 1934, a
$35-per-fine-troy-ounce dollar parity to replace the traditional gold standard
parity of $20.67 per fine ounce (1,504.63 fine milligrams, with 25.8 grains 0.9
fine). To sustain the devaluation of the dollar, FDR suspended the rights of US
citizens to own gold, requiring all to turn in their gold holdings to the
government for payment at $20.67 per ounce. Individuals were permitted to hold
up to $100 in gold coins.
Executive Order 6120, deriving its authority from the 1917 Trading with the
Enemy Act, which gave the president the power to forbid people from "hoarding
gold" during a time of war, also forbade all private contracts to be
denominated in gold. Though the US was not at war in 1934, FDR claimed that the
economic crisis was creating emergency conditions equivalent to war.
Normally, Executive Order 6120 would have been opposed by an outraged
freedom-loving American public as the constitution stipulates that the
executive branch is vested only with the authority to execute laws and policies
enacted by the people's representatives in Congress. Even the Progressives had
never dared move so far as to allow the executive branch to make laws
unconstitutionally and to impose such unconstitutional laws on the people
without their consent.
However, by 1933, the US judiciary branch had upheld government restrictions on
freedom of speech and other civil liberties during World War I and Congress had
surrendered many lawmaking powers to the executive branch, a trend that has
continued today to the extend that the president can now routinely launch
limited foreign wars without having first asked Congress to declare war.
Historians refer to this development as a move toward an imperial presidency.
Most Americans by 1934 had been put in a situation of viewing economic and
political freedom as having been captured by the moneyed interests at the
expense of the common people for whom freedom had come to mean only freedom to
be unemployed and left starving. The people were willing to give the president
whatever he wanted to save them from oppression by the moneyed class and to
restructure market capitalism as a more fair and equitable system.
The US gold-based monetary system at the time of the Great Depression would not
permit the debasement of money caused by increases in the money supply as a
convenient solution to price deflation which could cause and did cause
widespread destruction of wealth and massive unemployment.
If market participants sensed that too many dollars were being issued by
central bank quantitative easing or by Treasury borrowing beyond anticipated
revenue, they could protect their wealth by redeeming dollars for gold from the
government as a legal right and at a rate committed to by government, draining
the government's gold holdings below the accepted gold standard level of a 40%
gold backing for the money supply.
More money supply required more government holdings of gold to maintain the
gold parity. New Deal principles of temporary deficit financing would be
hampered by the rules of the gold standard because the government gold holdings
could not be increased easily and certainly not by money devaluation, as more
money would be required to buy new gold as money is devalued.
Section 9 of Executive Order 6120 stipulated that anyone who refused to comply
could be fined up to $10,000 ($1,533,653 in 2007 money) or be sentenced to a
maximum of 10 years in prison, or both. Foreign governments still could trade
in their US dollars for gold, but only at $35 an ounce instead of the gold
standard rate of $20.67 per ounce. Since international trade at the time did
not generate large foreign holdings of dollars, and the dollar was not the
prime reserve currency and other currencies were also backed by gold at various
rates, the impact while not insubstantial was still limited.
The Gold Standard Act had been enacted in 1900 for the US under President
William McKinley. He had defeated William Jennings Bryan, the brilliant
populist orator, a backer of free silver, who had stampeded the Democratic
convention with one of the most famous speeches in US political history:
There
are two ideas of government. There are those who believe if you just legislate
to make the well-to-do prosperous, their prosperity will leak through on those
below. The Democratic idea has been that if you legislate to make the masses
prosperous, their prosperity will find its way up and through every class that
rest upon it ... Having behind us the producing masses of this nation, and the
world, supported by the commercial interests, the laboring interests and the
toilers everywhere, we will answer their demand for a gold standard by saying
to them: You shall not press down upon the brow of labor this crown of thorns,
you shall not crucify mankind upon a cross of gold.
For the
first time since 1860, the 1900 election turned on a clear issue of major
importance between the two political parties. The question of free silver had
become symbolic of the conflict between capitalism and agrarianism, between the
Hamiltonian concept of a nation dominated by big corporations and the wealthy
elite who controlled them, and on the other side, the
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