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The International Monetary System Beyond 2003 - Part 1

Recent History of the Present Monetary System

November 3, 1997

The present turmoil in the Asian Markets reveals the first significant cracks in the post-Bretten Woods international monetary system.

When President Nixon closed the gold window in 1971, herewith defaulting on American debt and canceling the Bretten Woods agreements, his action did not reflect a planified change based on mature reflection in order to make the whole system survive. It was a bare reaction to stop outflow of gold out of US treasury vaults into Europe. When, later on, FED president Volker raised interest rates to unsustainable levels, we were once more witnessing a reaction to the consequences of unlimited debasement of the US$, that is, inflation which was reflected at that time in prices of goods (today it is reflected in paper value of financial assets).

Volker's traditional recipe worked out well, and his success attracted various governments - those which had experienced similar situations of currency debasement - to the apparently safe haven of the US-Dollar, herewith pegging their own currency to the US$. Some countries ultimately went even further, e.g.: Argentina (officially using indifferently $ bills or Peso bills in everyday life), Russia, etc.

This, in turn, had tremendous consequences on the parameters of the monetary system itself. Just like the deflationary effect of the expansion of the U.S. population and economy way to the west coast in the second half of the 19th century, the large increase of US$ demand abroad in the late '80's and early '90's flawed the general equation of the international monetary system: there was not enough money (US$) to chase the goods in four continents. This mechanism sustained the spiral of price deflation of goods labeled in US$, ultimately leading to the '93 bottom in commodity prices.

Meanwhile, in yet another reaction to these global flows of capital, the US FED lowered interest rates, herewith pumping ever more US$ into an international system which remained willing to absorb all of this paper - the monetary aggregate M1 did not move up significantly, and price inflation remained at historically low levels until the mid 90's, that is, until a time when the post Bretton Woods international monetary system was to come right unto its main crossroad: the decision by the Europeans of whether or not to go ahead with the Euro.

The creation of a common European currency (fomerly Ecu) had indeed been the main target of the Maastricht treaty signed in 1989. At that time capital flows went to Asia, feeding the Asian Tigers' economies and the Japanese stock market. The 1987 stock market crash was only an unexpected and temporary illustration of Japanese money returning back home to Japan. It occurred when Asian fund managers understood that the 1985 Plaza agreement was for real, and that the US$ would dive vs. the Yen. So, all this was happening in an environment of big capital flow to Asia. The Japanese stock market turned out to be a bubble not much later, and Japan started its own deflationaly spiral, but the Tigers went on. In writing the Maastricht treaty, European politicians reacted in the very usual manner: they intended to create an alternative pole of attraction for international capital vs. Asian currencies and the US$, that being the Euro. This new currency, created out of thin air and based on the reputation of the Deutsche Mark (which made up almost 50% of the former Ecu), was meant to be "stronger" than any other world currency, including US$ and Yen. Unlike the yen, it was to be backed by gold at 25% of circulating bills, and based on a 40-years uninterrupted history of strength of the German Mark. However, most of the central bankers and top economists around the world didn't believe in this story: A well industrialized continent like Europe couldn't afford to have a strong currency unless they didn't care about exporting fewer goods at uncompetitive prices in a deflationary environment.

History proved them right. With double-digit unemployment figures and ever increasing government spending, the hypotheses of a "strong Euro" looks more like a dream of aging politicians within the old continent than anything that could prove to be at least somewhat realistic. Moreover, the unexpected cost of German Wiedervereinigung (reunification with formerly East Germany) boosted public debt of Germany by more than DM 1,000 Billion (at present value - more to come), and consequently weakened the heretofore solid foundation of German economy and its currency.

Therefore, by 1995 two cardinal questions arose for the European policymakers: (1) Should they go ahead with the Maastricht project or not, and (2) if yes, should it be a strong currency (vs. US$ and yen) or a weak one?

Throughout 1995, 1996 and since then, the answer of the European political class to question #1 was clearly yes. The central bankers, on the other side, would agree only if they were in complete control of the currencies, without any interaction from government. This was the scheme sold to the investment community, and it seemed to work ... until early 1997. In January 1997, a report by the European Monetary Institute (EMI), the Frankfurt based institution which will undergo its programmed mutation to become the European Central Bank (ECB) by 1999, released a study on the "upcoming monetary policy" of the ECB at the same time it presented the future Euro bills to the public.

It was a tough wake up for international capital: Many of the standard assets backing the DM under Bundesbank rules were simply lacking, because "accurate rating of these assets was impossible when issued at the European level". They were replaced by other, rather questionable securities entitled "Category 2", such as "unnegociable bonds, stock market shares, various company liabilities to merchant banks, and last but not least, government bonds from any European country. This was nothing less than the death sentence for the historical monetary policy of the Bundesbank, and it clearly implied that power and control of the Euro would be in the hands of the politicians, and not of the central bankers. German finance minister Theo Weigel's later attempt to revalue the Bundesbank's gold reserves in order to tax the Bundesbank's capital gains was merely a confirmation of this changing of the guard.

The international investment community didn't need much time to understand what was happening: the Euro will be a weak currency. Worse than that, the conversion rate of individual currencies into the Euro was to be determined only by January 1, 1999 (this deadline has recently been changed to April 1998). Therefore, buying European government bonds looked just like buying an option of a weak currency without a strike price ... with the risk going to the bond holder, and the benefits going to the government. International capital therefore had no other choice but to flee Europe, and it did so crossing the Atlantic Ocean to the safe haven of US$ denominated assets, herewith driving up the US$ vs. European currencies. A notable exception was the British Pound, which moved ahead along with the US$ ... until Tony Blair hinted at a possible participation of Great Britain in the Euro.


The "flight to quality" into the U.S. induced such a tremendous rise in the US$ that those currencies pegged to the greenback came under pressure. The underlying assets in Asia and South America became overvalued. They are not worth as much as implied by the present value of the US$. It is important to understand that the flight from the Euro into the US$ is the first and main reason for the present currency crisis in Asia.

Alan Greenspan recently stated at the CATO Institute: "Today's Central Bankers have the capability of creating or destroying unlimited supplies of money and credit". As a matter of fact, they can do so, be it the FED or now even the upcoming ECB. However, throughout recent monetary history, we have seen that the central bankers were actually only reacting in response to unexpected or self-inflicted events implying huge international capital flows. They cannot regulate capital flows in any way, and most likely don't even understand what is happening nor why. The effect of their reaction usually makes things worse, as there is no way to conceal the interests of any given government with the interests of international capital.

Subsequent to this brief historical review, we will examine the elements of the present equation of international capital in the light of recent changes in international monetary policy:

  • US$ 100 Trillion estimated total world assets, including real estate;
  • US$ 30 Trillion worldwide liquidity held by pension funds which traditionally invest in long term assets: formerly gold, today government bonds;
  • US$ 15-18 Trillion cash, mainly in Japan;
  • US$ 3-4 Trillion "hot money" in offshore trusts.

We will see that these elements will most likely lead to a single world currency in the very early third millennium. This single world currency is already "in the cards", but it is not yet admitted by our governments on an official basis.

For those readers wishing to delve more deeply, I suggest reading the following sources (other than our classics: Gold-Eagle and Kitco websites):

Armstrong (M.) The World Capital Market Review. Princeton, USA (monthly) cf. PEI's website at

Bandulet (B.) Was wird aus unserem Geld? Langen Mueller Herbig Verlag, Muenchen (Germany), 1997, 286 pp.

Faber (M.), Davidson (J.D.), Lord Rees-Mogg, Belkin (M.) in: Strategic Investment. Baltimore (monthly) cf. website at

Hirt (W.) Wirtschaft Aktuell. Zurich (monthly) Kershaw (P.) Economic Solutions. 1994 (courtesy to the Swiss American Corp - this book is enclosed in their information package, cf. advertisement on this server)

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