Sooner or later, people in charge of money seem to say the wrong things. Wim Duisenberg was the fool three years ago. The head of the European Central Bank said something stupid, (we do not recall what), and suddenly, the euro hit the skids.

Now it is John Snow's turn. Not that he said anything much more asinine than Duisenberg or than his own fellow Americans at the Federal Reserve; McTeer, Bernanke, and the rest of the bunch seem to have a special gift for it. Nor did he say anything that was untrue. A currency does depend on 'faith,' after all.

But Soros was selling and the dollar was falling; the press needed a simple, understandable reason: the U.S. Treasury secretary had 'let the cat out of the bag,' they said, revealing to the world that the current administration no longer backed a strong dollar policy.

Here at the Daily Reckoning, we are more keenly aware of the dollar than most other kibbitzers. Since we take our meager income in dollars and spend it in euros; we feel each drop in its value like a whiskey spill; it practically brings tears to our eyes.

But we are resigned to it. Not just the 25% drop the dollar has suffered at the hands of Wim Duisenberg's euro this year...but a lot more. In 1985-'87, the dollar lost 50% against the German mark. That was before Alan Greenspan took his post...and before the greatest spree of dollar creation in history.

You see, dear reader, poor John Snow is not to blame for the dollar's fall any more than Alan Greenspan deserved the credit for its rise. Today, we let the cat out of the bag ourselves - the dollar is going down, no matter what U.S. monetary officials say.

Decent men and women are not normally interested in the working of the international monetary mechanism anymore than they are interested in the workings of the digestive tract. We wouldn't blame them for setting aside today's column in disgust or boredom. But there is a time and place for everything. Suddenly, the world's money system is in the news...and at risk. Readers are urged to send the young and weak out of the room...fortify themselves with a shot of whiskey...and continue reading. It isn't pretty, but it is necessary, sometimes, to understand how these things work.

There was a time when America had honest money. Both the Gold Standard and the Bretton Woods agreement required nations to settle their debts in real money - number 79 on the periodic table - which none of them could create at will. Even in its late, corrupted version, under the Bretton Woods agreement, international accounts could still be settled in gold. If a country bought more from abroad than it sold, it could be forced to make good the difference in metal. America might have the dollar. Germany might have the mark. But the world's money was gold.

Then began a remarkable chapter in the history of monetary chicanery. The Nixon Administration 'closed the gold window,' at the Fed, meaning that foreign nations could no longer turn in their excess paper dollars in exchange for gold. The Dollar Standard was begun. With no access to gold, nations settled their international trade and currency imbalances in dollars...and built up dollar reserves, in place of gold reserves, for that purpose.

During the 20 years of the Bretton Woods agreement - 1949 to 1969 - total international reserves - money held in central banks to settle accounts and protect the currency - went up only 55%. Since then, the increase has exceeded 2000%, most of it coming since Alan Greenspan took over the Fed in 1987.

The Fed did not merely increase the supply of dollars in the U.S. - it increased the entire world's money supply, which set the wheels of international commerce turning. So fast did they turn that a pile-up on the highway of the globalized economy was almost inevitable.

Richard Duncan explains:

"This explosion of reserve assets has been one of the most significant economic events of the last 50 years. Today, Asian central banks hold approximately $1.5 trillion in US dollar- denominated reserve assets. Most of the world's international reserves come into existence as a result of the United States current account deficit. That deficit is now $1 million a minute. Last year, it amounted to $503 billion or roughly 2% of global GDP. The combined international reserves of the countries with a current account surplus increase by more or less the same amount as the US current account deficit each year. So central bankers must worry not only about their existing stockpile of dollar reserves, but also about the flow of new US dollar reserves they will continue to accumulate each year so long as their countries continue to achieve a surplus on their overall balance of payments."

Since the breakdown of Bretton Woods, the U.S. has been able to do something that other nations could only dream of; it could settle its debts in 'money' that it could create, as Fed governor Ben Bernanke recently explained, at near zero cost. The rest of the world could sell as much as they wanted to the U.S. - on credit, which Americans could by creating more dollars.

What a marvelous system this was! And not just for Americans. In fact, while they appeared to be its greatest beneficiaries - for weren't they getting something for nothing? - they were actually its biggest victims.

For a very long while, the whole world was snowed. People believed that a dollar was as good as gold. Foreigners were willing to take as many of them as were offered, the last one at the same value as the first. And they were willing to work far into the night, for minimal wages, to produce things they could exchange for dollars.

The first major beneficiary of the new system was Japan. The Japanese wore their company uniforms and sang their company songs...and transformed their island into Japan, Inc., a nation that whose heart beat with a single purpose - to sell to Americans. But what could they do with all the dollars they earned?

Duncan continues...

"This arrangement has had the benefit of allowing much more rapid economic growth, particularly in large parts of the developing world, than could have occurred otherwise. It also has put downward pressure on consumer prices and, therefore, interest rates in the United States as cheap manufactured goods made with very low-cost labour have been imported into the United States in rapidly increasing amounts. However, it is now becoming increasingly apparent that The Dollar Standard has also resulted in a number of undesirable and potentially disastrous consequences.

First, it is clear that countries which built up large stockpiles of international reserves through current account or financial account surpluses have experienced severe economic overheating and hyper-inflation in asset prices that ultimately resulted in economic collapse. Japan and the Asia crisis countries are the most obvious examples of countries that suffered from that process. Those countries were able to avoid complete economic depression only because their governments went deeply into debt to bailout the depositors of their bankrupt banks.

"Second, flaws in the current international monetary system have also resulted in economic overheating and hyper-inflation in asset prices in the United States as that country's trading partners have reinvested their dollar surpluses (i.e. their reserve assets) in dollar-denominated assets. Their acquisitions of stocks, corporate bonds, and US agency debt have helped fuel the stock market bubble, facilitated the extraordinary misallocation of corporate capital, and helped drive US property prices to unsustainable levels.

"Third, the credit creation The Dollar Standard made possible has resulted in overinvestment on a grand scale across almost every industry worldwide. Overinvestment has produced excess capacity and deflationary pressures that are undermining corporate profitability around the world."

Will it surprise you, dear reader, to find that getting something for nothing hurts the gettor more than the gettee? There is something so elegantly correct about it. Three decades of the Dollar Standard have produced jobs, factories, savings, profits - mostly overseas.

More to come...

Part II - SNOW JOB

re-examining the underpinnings of the U.S. economy...

Baltimore is full of strange and curious things; it is home to bouffante hairdos, the Formstone Preservation Society and other wonders. Filmmaker John Waters makes the city his home, he says, because it is the tackiest metropolis in America. He is inspired by it in the way that other artists are moved to poetry by Paris or Rome.

But what caught our eye last night was not art but advertising. A block or two from the huge billboard with the provocative headline - Who's the Father? DNA Paternity Testing... - sits another intriguing sign of the times:

BANKRUPTCY!
Chapter 7 -- $50
Chapter 11 -- $100

In America, in the springtime of the third year of George W. Bush's rule, we conclude, bankruptcy has become as popular as weight-loss.

The sign is not merely an invitation, but a reproach. Bankruptcy rates are hitting records despite the best efforts of those who manage the economy.

In his Congressional testimony last week, Alan Greenspan sailed through his customary delusions - that additional mortgage debt is good for consumers...that technology has brought a New Era to the economy...and that modest productivity increases have some exceptional quality as yet unnamed.

He was cruising in the wake of John Snow, U.S. Treasury secretary who made the following remarkable comment to the G7 finance ministers:

"...the United States is not growing fast enough and neither are you, but we are growing a lot faster than you...We get complaints from our friends around the world who say, 'your current account deficit is so high.' And our response is: 'Yeah. You know why? Because you don't buy enough from us. And because we provide the highest risk-adjusted returns on capital in the world, so your capital flows over here. So why don't you take steps to improve your domestic economy so you'll be stronger and buy more from us? And you might think as well about steps to improve return on invested capital, and then capital would flow your way as well as to the United States."

"The fact is," and the head of the Treasury department may have been tempted to toss his head back a few degrees as he made this point, "the American economy is strong. The underpinnings are good."

And yet, on the corner of Charles and Lombard streets, bankruptcy is such a good business it is worth advertising for new clients.

There are other signs that the underpinnings of the U.S. economy are not as good as Mr. Snow thinks. In addition to bankruptcies and unemployment, business profits as a percentage of GDP have fallen to their lowest level in about 40 years.

No mention of this has been made by either the Treasury secretary or the Fed chief. And yet, without profits, why would people invest in new machinery, new ventures, new employees? How could the economy grow? Why would stocks go up?

Another question worth asking: what is going on? How is it possible for an economy to be 'strong' with people going broke at a record rate...and businesses unable to make any money?

And why would profits decline - even as productivity increases and technological marvels proliferate?

Hearing no answer from the authorities, we offer one ourselves:

Daily Reckoning readers may recall from last week that the world's central banks' reserves increased only 55% in the last 20 years of the Bretton Woods/Gold Standard period - '49 - '69. But then, the Gold Standard was replaced by the Dollar Standard. Dollars being easier to replicate than bars of gold, central bank reserves rose 2000% in the next 33 years.

That kind of money was bound to tempt people; all over the world bankers, consumers and investors gave way to an orgy of credit excess like looters at a liquor warehouse. Soon, they were all drenched in the stuff.

The Nixon Administration put a final end to the Bretton Woods/Gold Standard in 1971. Four years later, stocks bottomed out in America and the Great Boom began.

Trillions of dollars sloshed around the world, creating booms...and then busts. Japanese companies - selling to Americans - were the first ones to get soaked. Then, Japanese share prices sprouted...followed by kudzu-like growth in Japanese real estate...and bonds. Then, other Asian nations boomed - and busted. And then, it was America's turn. Stocks had begun to pullulate in the late '70s...by the late '90s they burst into spectacular, intoxicating full flower...succeeded, as in Japan, by real estate and bonds. Since 2000, U.S. stocks have wilted somewhat, but the heady growth in real estate and bonds continues.

Americans had what appeared to be a big advantage; they were the ones who got to create 'money...out of thin air.' But there was a price to be paid for being so close to the source of such stimulating libations; Americans dipped their cups in more deeply than anyone. And while they drank, the source of their wealth slipped away.

"For generations it has been an economic truism and a matter of simple common sense," begins Dr. Kurt Richebächer, "that in essence, a person or a nation can only become richer if it consumes less than it produces." [For more, see Dr. Richebächer's latest report: http://www.agora-inc.com/reports/RCH/OnTheMoney/ ]

What America produced and exported was cash and credit. Trillions of dollars' worth. Foreigners produced cars, televisions, food, vacations - anything and everything that they could trade for dollars. This is the trade of which Secretary Snow is so proud. It has resulted in a mountain of empty containers at U.S. ports (they come in loaded...they do not leave, because America has little to export, except money) and mountains of dollars piled up overseas.

The treasury secretary seemed not to notice it, but it also ruined the profitability of U.S. businesses, stifled real incomes of American workers and pushed millions of jobs overseas. American businesses pay their workers in dollars. Normally, they could expect the money to come back to them - as the employees spent it on the goods they produced. Instead, it goes into the hands of foreign producers, who do overseas what might have otherwise been done at home - build factories, hire workers and make profits.

And what did they do with their profits? As Mr. Snow tells us, they bought U.S. dollar assets - thus enabling Americans to keep buying. In the late '90s, they bought stocks. Recently, especially for the Japanese, the buying has shifted to U.S. bonds.

While the effects of so much apparent prosperity continue to splash here and there, the world begins to wonder about the source of it. The dollar has lost 31% of its value against the euro in the last 18 months. Against gold, it has lost a similar amount. Has the Great Boom of the last quarter century already turned into a Great Bust?

George Soros told CNBC recently that he had sold (SHORT) the dollar and bought gold. Other investors might be wise to do the same.

Bill Bonner

3 June 2003

Editor's Note: Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter publishing companies, and the author of the free daily e-mail The Daily Reckoning (www.dailyreckoning.com).