UK, US Treasury securities, and blogs (continued)

Well, I've got some sort of response from Iain Dale's commentators, starting with an ad hominem accusation of being emotionally needy (scared, more like!).

Here's my main argument, however inexpertly expressed:

Over the last 12 months, 10 countries have reduced their loans to the US by a combined total of $72 billion; we've increased our commitment by $112 billion, moving us from 10th place to 3rd place in the list of America's creditors. And our own finances aren't that good, either.

America is in hock to foreigners to the tune of 2.18 trillion dollars and rising. Effectively, they're running up a very big credit card bill to maintain domestic living standards. The US Comptroller General has very recently commented that this indebtedness could be used against the US by unfriendly foreign powers.

Our greatly increased support for America's finances is at the cost of some risk to ourselves, because if the borrowing spree continues unabated, we may find we get repaid in dollars that are worth far less than they are today. Can we afford to keep bailing out a spendthrift?

The borrowing is a powerful economic stimulus to China which, despite its relative poverty, is the second biggest creditor to the US. By sending the money back to America in the form of loans (purchase of US Treasury bonds), they avoid having their own currency appreciate. So their wage rates remain fantastically low and they continue to take business and jobs from the West - us included. Think of the transfer of the Swan Hunter shipyard to south India, or the purchase of Rover by China (don't tell me they're desperate to create long-term employment in Birmingham, when the average per capita wage in China is less than £1,000 per year). We're seeing a shift from higher-paid industrial work to lower-paid service jobs - perhaps the economic profile and geographical distribution of the readership of this blog means that it isn't obvious to them. China and others are hoovering up world resources in the dash to industrialise, right down to our iron manhole covers. James Kynge's "China shakes the world" is easy to read and very enlightening about what's going on.

Japan, America's greatest creditor, also buys US bonds to keep excess money out of its own system, so its interest rates are low, so the yen stays low and protects its well-established export markets. Also, a lot of money powering the world's stockmarkets is cheap money borrowed from Japan and invested elsewhere - the so-called "carry trade". All right if it goes on forever - but it can't. You cannot live for the rest of your life on borrowed money.

If currencies were responsibly managed, the trade deficit would cause the US to start to run short of cash, US wages would go down and exports back up, and trade would eventually (if painfully) come back into balance. But the Americans - and others, including ourselves again - respond by increasing the money supply (mostly through bank lending - up another 13% this year on both sides the Atlantic), which leads to price inflation, hence the rise in house prices and the stock markets. But borrowed money has to be repaid someday and then the tide will go out - but this time, we'll be left without much industrial capacity.

There's a fear that to prevent a 3os-style Depression, governments will print money even faster, but this leads to hyperinflation and eventually no one wants the currency at all (cf. Germany in 1923). So we could well have both a slump and high inflation. It may sound dull and technical, but then money is boring - until you haven't got any.

An American Congressional committee recently grilled the chairman of the Federal Reserve (like our Bank of England) and at least one Congressman admitted he realized he didn't understand inflation; the only one who seemed to was Ron Paul, who said that if we can make a living by printing money, we should all quit our jobs and do that. Most of Ron Paul's own investments are in gold and silver; the world's richest investor, Warren Buffett, has been sitting on many billions of dollars of cash for a long time and has recently disclosed that he's hedged by buying into a foreign currency, to protect against financial loss from a falling dollar.

If the value of the dollar (and possibly the pound) starts to collapse through overproduction, we really will notice - it's not just going to be bargain fares to Disneyworld. Americans - rich, expert ones, who manage big funds - are sounding the warnings loudly, clearly and angrily.

The collapse hasn't happened yet, partly because the dollar is the world's standard trading currency. This is changing; already, Iran is demanding payment from Japan in yen, not US dollars. When more countries start to impose similar conditions, the demand for the dollar will drop significantly, and so will its exchange value. China is beginning to de-link from the dollar, in favour of a wider basket of currencies; meanwhile, it's widened the range within which its currency (the renminbi, or Chinese yuan) can move against the dollar. They're not in hurry to appreciate their money, for reasons of international industrial market share; but that's the way the pressure is building.

Although our economy is much smaller than America's, we have (to some extent) similar problems ourselves. Yet here we are, lending money to our bigger cousin. I don't think we can sub him indefinitely, and I don't think we have begun to address the question of our own economic future. Without that, there'll be lots more hoodies to hug.

Michael Panzner relays the alarm

Michael Panzner's latest post discusses a warning from David M. Walker, the nation's chief accountant, about America's vulnerability to potentially unfriendly foreign creditors. This confirms me in my feeling that the recent purchases by the UK of US Treasury securities is extremely significant (see recent posts on Bearwatch).

I have attempted to elicit interest in various quarters, including Iain Dale's influential political blog ("Tuesday open thread", 24 July) but so far I seem to be speaking to the profoundly deaf. Today I submitted the following comment to Iain's Diary, but without much hope of a response - as I have said in an email to Michael Panzner today, the Brits add apathy to financial ignorance:

Okay, one last Cassandra-like call and then I'll admit defeat:

Does it really not matter to your sophisticated political readership that the UK (presumably the Treasury under Gordon Brown) has recently purchased an absolutely massive amount of American Treasury securities, most of it in the last nine months, which quite probably will lose us many billions of pounds through currency depreciation? We have gone in one wild leap from 10th largest holder of American debt, to third place.

The potential downside from this crazy investment (I think it has already lost the equivalent of the first year's interest) worry me less than the implication, which is that the US is using its "special relationship" with the UK to defer (for a short time) the end-stage of a US debt-fuelled global inflationary spiral, with the prospect of a deep economic depression and possibly a wealth-destroying hyperinflation. The problems this would give us make the current floods seem a minor inconvenience.

Or is it that everybody here knows already, and is merely filling the time in the rattling tumbrils with political chit-chat and mutual insult? Is it aristocratic insouciance, or financial ignorance? Surely not the latter, when Americans are discussing their economic problems so openly and extensively.

The rewards of "honest money" and interest-free lending

Some things are so simple that it takes a while to understand them. For me until now, one was the question of how anybody could lend money and not expect interest - for centuries, usury was forbidden under both Christian religious and civil law. In France, interest was illegal until after the Revolution in 1789 - see here.

And then the penny dropped, so to speak. If the supply of money is fixed, and the economy gradually becomes more larger and more efficient, then money gradually becomes more valuable, as The Mogambo Guru explains here. So if real GDP grows at the rate we seem to expect (on average, about 2% per year), then with a fixed money supply, a depositor would earn 2% in real terms, as would a lender. All you would need is adequate security for the return of capital.

Banks would have to cover their running expenses (I believe Swiss banks already do charge depositors for holding their cash really safely), but this would be need to be in the form of explicit costs, which might therefore be better restrained. Borrowers would have no reason to keep switching loans; in fact, the need to charge arrangement fees would act as an incentive to remain loyal to the existing creditor.

But it looks to me like it would mean the end of fractional reserve banking, inflation and periodic banking crises, not to mention the permanent and pervasive importance of money lenders.

Would that really be so bad? If so, then "if you can't beat 'em, join 'em" - would you and other like-minded readers care to join forces with me and start another bank? It seems to be the only game in town.

More on UK purchases of US Treasury securities

I have sent the following email to George Osborne, the shadow Chancellor:

"Please find attached a document from the US Treasury website, detailing major foreign holdings of US Treasury securities (web address top left of document). I emailed this document to the Daily Mail newsdesk yesterday, in the fervent hope that somebody might take an interest.

Between June 2006 and May 2007, the UK has leapt from being the 10th largest foreign holder of American debt to 3rd place (behind Japan and China, both of whom, although increasing in dollar terms, have actually reduced their overall share of foreign commitment to the US).

We have contributed an extra $112.1 billion, i.e. around 55% of the $205 billion total increase in investment by foreigners over that 12 month period. To put it another way, 10 countries have reduced their holdings in dollar terms, by a combined total of $72 billion; we have covered these withdrawals and added another $40 bn.

For comparison purposes, the UK's increase in US Treasury securities is equivalent to some 50% of the £104 billion budget for the NHS for next year (http://www.timesonline.co.uk/tol/comment/columnists/article2039584.ece)

The effect for the UK has been to more than triple its exposure to US Treasury instruments, at a time when the dollar is dropping - and some predict it will fall much further. The potential loss of our national wealth easily matches (and will quite possibly dwarf) that from the sale by Gordon Brown of much of our gold reserves some years ago."

News: huge investment by UK in US Treasury securities

Never mind the conspiracy theorists and the rumoured use of "Caribbean Banking centres" to buy US Treasury bonds; look at this document from the US Treasury, dated 17 July 2007. It shows that in the last 12 months, holdings by foreigners increased by 10.37%, but the UK's holdings shot up over 202% in the same period, from $55.5 billion to $167.6 billion. And the dollar has dropped against the pound at the same time. Can our little island afford such generosity?

Open secrets about banks, credit and inflation

There are things about money that are well-known to some, but not known and understood by all.

• In the USA (and the UK, I understand), notes and coins represent only 3% of all money; the rest is, in effect, various types of IOU.
• Most money is simply created out of nothing, by private banks, as bookkeeping entries.
• Banks lend out money, and also charge interest.
• Since the banks haven't created enough money to cover the interest, they demand it from the borrowers.
• If the total amount of money in the economy stays the same, and banks always charge enough interest to make a profit, then someday banks will own all the money in the world.
• So banks create and lend even more money. Some of this new money is to provide for the interest they have charged on earlier loans.
• Therefore, banks have caused inflation, and as long as they create new money, they will create more inflation.

This is so simple, but so hard to believe. It's like standing up from a game of Monopoly to find that you've been playing for real. And when you read others who explain the money system in these terms, you get the same emotional sequence:

1. amused, complacent toleration
2. a growing sense of unease
3. dawning, half-incredulous understanding
4. appalled outrage

So it is with one of the latest of these explainers, Ellen Hodgson Brown. But there is a world of difference between diagnosis and prescription. Here is hers, and halfway into here is a riposte from Richard Daughty, aka The Mogambo Guru.
Please note that Daughty is not contradicting the diagnosis, only the proposed solution. He is permanently at stage (4) in the above sequence.
Now, what do we do about it? Daughty's usual response "We're freakin' doomed!" reflects his pessimism about attempts to save the system as a whole, but is generally accompanied by recommendations for individual financial survival, namely, investment in commodities such as gold, silver and oil, merely to protect against end-stage inflation.

Michael Panzner on financial liquidity and asset prices

Writing in Seeking Alpha yesterday, Michael Panzner (author of Financial Armageddon - my review here) comments on an article by Yale economics professor Robert J Schiller, which discusses the notion and possible consequences of excess "liquidity" in the world economy. For Panzner's own website promoting his very bearish view on the American economy, see here.