A New Monetary Order?

June 28, 2012

A few short years ago it was sensible to assume that the global economy was stable and reliable; today we must adjust to a world of financial instability. Consider the following warning from Bill Gross, Managing Director of PIMCO in his June 2012 Letter to Investors:

“The global monetary system…(is) fatally flawed by increasing risky and unacceptable low yields, produced by the debt crisis and policy responses to it. “

The International Monetary Fund (IMF) has downgraded its forecast for world economic growth twice in the past few months, while leading economists debate whether 2012 marks a return to growth, or 1932 all over again.

Monetary Crisis

At the base of today’s debt problems lies a global monetary crisis that cannot simply be wished away. When sovereign debt approaches a critical threshold, generally 80% of GDP, red flags are raised, bond markets and rating agencies start to get nervous. Today, although Greece, Spain and Portugal gather all the headlines, the sovereign debt crisis extends far beyond these nations. Consider that ALL European nations including Germany exceed their own legally defined limits of sovereign debt.

The fatal reality is, levels of debt (sovereign, corporate and personal) through out the  global economy today are rapidly approaching the breaking point, due largely to an inbuilt paradox in the present monetary system.

The entire capitalist monetary system generates interest-bearing debt as a matter of course. Money creation in all its forms, whether vertical (central bank generated currency and related money) or horizontal (bank loans) triggers interest from its inception, and as a result, is subject to the iron laws of compound interest.

The monetary paradox is simple, but deadly. In straightforward terms, the productive capacity of the economy grows arithmetically (in the 2-4% range), debt, however, grows faster, obeying the abstract laws of exponential progression. Compounding interest rates on debt exceed economic growth rates even in good times, and are doing so today despite massive central bank intervention to keep rates at historic lows. Eventually, compounding debt must exceed the system’s ability to meet even the minimum requirements and the system collapses.

“Even if we lived on an infinite planet, the interest rate on a debt-based monetary system could not exceed the growth rate of the economy (both measured in real terms) over the long term without inevitably causing a major default on debt.” (Minsky 1986).

Who knows what will happen ultimately, but what I can tell you for certain is a new monetary regime will emerge as the global economy reacts to these important developments.

While many authors and authorities are speculating on this subject, history demonstrates clearly that monetary regimes are not established from the top down, by rational discourse and planning. Rather they are established from the bottom up by new and better management of credit systems.

The historic Gold Standard was not designed, it simply became common practice as paper currencies came and went during periods of economic crisis and war in the past. As a universal currency, transferable across national boundaries, golds appeal was obvious. Yet, its monetary role evolved from the bottom up, rather than being designed for purpose.

Our present Central Bank managed monetary regime was born by accident in 1971, when U.S. President Richard Nixon took the United States and the Western world off the Gold Standard (implemented at Bretton Woods in 1944). The monetary vacuum created by the abandonment of Gold was filled by Central Banks, based on the (idealistic) theories of Monetarism and the science of economics.

The present monetary system is intellectually exhausted, presenting policy makers with a ‘Hobson’s choice’ of austerity or Keynesian monetary expansion; neither of which has proven capable of driving sustainable growth. A new monetary regime must solve this dilemma, directing society’s plentiful resources to the productive heart of the economy.

The principles that will govern this new monetary order will likely be the following:

1.  A new monetary system must break the cycle of systemic, interest-induced crises, evolving toward a sustainable regime based on value

2. The ultimate goal of monetary policy will settle on societal well-being, abandoning the present goal of economic equilibrium (base balancing of GDP growth and CPI-related inflation metrics).

3. There is no return to a Gold Standard, but money supply must be backed by the productive capacity of the nation. Asset-based money supply will emerge as the only viable alternative to the present Central Bank managed system.

4. The productive assets underpinning the money supply will expand with the introduction of new classes of assets. Total Assets, whether traditional or newer non-traditional assets, whether socially owned or privately owned, will be the bedrock value standard upon which money supply will be rooted.

5. Vertical money supply (currency and related derivatives) created by governments will be backed by the total stock of assets of the nation based on the five capitals, while horizontal money (bank deposits and related derivatives) will be backed by privately owned assets, defined much more broadly than today.

6. The new monetary regime will need to factor in a nations natural and human capital, moving beyond simple exchange value definitions to encompass a full appreciation of the utility value of all asset forms.

We’re in for a wild ride, with no shortage of pain in the short to medium term; however given the growth in new assets and the (presently invisible) undocumented asset potential in all economies, early movers could gain significant advantage on the rebound.


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