Posts Tagged ‘capital controls’

First steps towards currency and trade blocs?

Tuesday, November 24th, 2009

By conventional wisdom, government debt is supposed to be the safest form of debt because governments cannot default on debt repayment due to their powers of taxation and monopoly on creation of money (out of thin air). Conventional wisdom also dictates that the US government debt is the safest of all government debts because the US dollar is the world reserve currency. Since most of the debt accrued by the US is denominated in their own currency (a luxury that no other nation can enjoy), there is no way it can default.

Well, in reality, governments do default on their debt. Russia did in 1998. Many banana nations did as well. But a nation as prestigious as the United States? Today, even the mainstream news media is toying with the heretical idea that the United States government may go bust (see Is sovereign debt the new sub-prime?). Will the US government debt become sub-prime?

If the world’s ultra safest debts becomes bad debts (whether via monetary inflation or outright default), what hope will there be for other debts?

As we wrote in Permanently low interest rates for Uncle Sam?, it is very difficult for the Federal Reserve to raise interest rates. Not only that, the current yields on the US government debt are ridiculously low (some of the yields are even negative). As we said before in What will be the next market panic?, this will piss off America’s creditors immensely. Some Chinese officials, whether fairly or not, are already accusing the US monetary policy as the culprit for price inflation and asset price bubbles in China. Some US officials, on the other hand, will point their finger at the Chinese’s ‘manipulation’ of their currency exchange rate as the cause of the bubbles, thus implying that it’s the Chineses’ fault. Also, as we speak, both the US and China are engaging in low-level trade war, with import restrictions on Chinese tyres and American chickens as the first step. We can see that trade restrictions between the two sides will gradually increase as time goes by.

On top of all that, Asian nations are considering capital controls to stem the danger of asset price bubbles in their home countries (see Asia Considers Capital Controls to Stem Bubble Danger). Assuming that US interest rates are going to remain negative in real terms for an extended period time, the considerations will eventually become a reality.

All these are happening in the context of increasing trade ties between Asian nations and reduce trade ties between the East and the West. All these may be a precursor to currency and trade blocs in the long term. As we quoted Murray Rothbard in our book, How to buy and invest in physical gold and silver bullion, between 1931 and 1945,

The international economic order had disintegrated into the chaos of clean and dirty floating exchange rates, competing devaluations, exchange controls, and trade barriers; international economic and monetary warfare raged between currencies and currency blocs. International trade and investment came to a virtual standstill; and trade was conducted through barter agreements conducted by governments competing and conflicting with one another. Secretary of State Cordell Hull repeatedly pointed out that these monetary and economic conflicts of the 1930s were the major cause of World War II.