Recently there have been increasing number of pundits calling for bringing the dollar back to gold standard. If you have read the Wall Street Journal and Financial Times in the past few weeks, you would have seen on the opinion pages many anti-Keynesian economists arguing for the virtues of gold standard and a real free market monetary system. Many of them point out the current financial crisis is precisely caused by credit bubble created by an inflationary fiat monetary system. To cure the global financial malaise, they contend that we need a sound money, the value of which is not based on the illusive credit-worthiness of the government, but on the tangible worth of certain precious metal such as gold.
How does gold standard work? It is very simple. Under the gold standard, the value of the dollar will be determined by its exchange rate with gold. Usually government should be the only entity that issues (meaning prints) paper bills at a predetermined exchange rate with gold (which is dictated by the market). For example, gold is now trading at around $800/troy ounce. You can bring one troy ounce of gold to the government, it will print out $800 fresh paper dollar bills for you (maybe minus a small fee, which is called seignorage), and keep the gold in its vault. The government cannot print more paper money than the worth of gold it receives. Individuals can exchange paper money for real gold if they choose to. Under a true gold standard monetary system, the amount of paper money in circulation should be exactly the same as the amount of gold in government reserve (gold stored in its vault).
The advantage of gold standard is that the government has to eventually balance its budget. The government cannot simple print money to spend. It has to borrow money from the private sector at an interest rate that is determined by the free market, not by the Federal Reserve. If the government borrows too much, the market will demand a high interest cost for its borrowing, which deters the government from running up its budget deficit.
Another benefit of gold standard is the elimination of fluctuation in currency exchange rates which should greatly facilitates global trades. When currencies are all pegged to gold, the exchange rate between currencies will be fixed. Nations will not have to be concerned above currency manipulation by their trading partners. Corporations will not have to buy expensive currency hedges when doing business in foreign countries. Wall Street currency traders will lose their jobs (that is a good thing for the economy, less friction cost).
In order for the gold standard to work, the Federal Reserve has to be abolished. Under the gold standard, money supply is completely determined by the market, rendering the Federal Reserve irrelevant. In fact, any Federal Reserve intervention in money supply will undoubtedly break the link between value of the money and value of gold. That is why even before President Nixon completely decoupled US dollar from gold in 1971, gold had been already traded way above the official dollar/gold exchange value.
But gold standard is not without its potential perils. One of the gravest risks of gold standard is that it is highly susceptible to speculation. Speculators who amass huge amount of gold can manipulate the price of gold and wreck havoc on the financial market. By hoarding gold, they can potentially deplete bank reserves and create a run-on-bank. Even sovereign reserve can be depleted by speculators' manipulation (recall the 1997 Asian financial debacle that was largely caused by western financial speculators). That is why in order for gold standard to work, we have to have absolutely strong market oversight and appropriate rules and regulations in place to prevent speculators like Rothchild and George Soros from creating instability in the financial market.
Personally, I do not believe we will ever go back to gold standard. First, no politician will be able to muster the kind of support needed to pass a law to abolish the Federal Reserve. Second, governments around the world are addicted to the easy money afforded by the fiat monetary system. Third, people who support gold standard loath government regulation. I believe stringent government regulations are absolutely critical for gold standard to function properly. Without implementing proper rules and regulations, gold standard will be subjected to constant market manipulation and eventually lose popular support.
Monday, November 24, 2008
Thursday, November 20, 2008
What went wrong for the USA?
What's wrong with America? Who is to blame for the current financial and economic meltdown?
Some people blame the government for running up too much debt. Others blame the poor people for borrowing too much that they cannot afford to pay back. But the real cause is that America's financial industry outgrew the rest of the economy.
Financial industry does not create wealth. Let me repeat it again: financial industry does not create wealth. It only re-distributes wealth. Wealth is created in the real economy, the goods-producing economy. The problem is that America is producing less and less goods, because manufacturing has been increasingly outsourced to overseas. America's economy is becoming an empty shell. If this trend continues, our children will only find jobs in either Walmart, or Wall Street. No wonder we have seen in this country the wealth gap widening, and middle-class disappearing, because the good-paying manufacturing jobs have all but gone overseas. First was the textile industry, then the electronic industry, and now the automobile industry. If the US auto industry should disappear, and most likely it will, I don't know what real stuff America can produce any more.
On the other hand, the financial industry has been growing, and it has been obsessed with growth. It forced main-street companies to move production to low cost countries, so the profit can be larger and stock prices higher. Not only that, the financial industry has been using all kinds of tricks to convince peope to borrow more, because the more we borrow, the more profit for the industry. It uses all kinds of innovative financial engineering to make borrowing easier for everyone. To persuade individuals to borrow, they give us credit cards with rewards. The more you buy, the more you save. If you own a house, they want you to borrow against your house. They call that home equity loan. After you exhausted your home equity, they ask you to borrow against your next paycheck. To persuade government to borrow, they always support lower tax and higher spending. When it comes to persuading corporations to borrow, that is where they get extremely innovative. They design all kinds of financial instruments to allow corporations to borrow easily.
The end result was the enormous growth in credit, which in turn stimulated growth of the entire economy. But this type of growth can't sustain. When individuals, government, and corporations exhausted their ability to borrow further, that is when the house starts to crumble. That is exactly what is happening now.
Don't get me wrong. I have nothing against the financial industry (I for one work for the industry). The financial industry serves a vital function, which is to promote most efficient capital allocation. In a normally functioning financial market, capitals are taken away from failing businesses to support value-creating businesses.
Because of the vital role the financial market plays in real economy, there have to be stringent and adequate rules and regulations. You cannot have a great basketball game if there are no clear rules and referees, no matter how talented the players are. The problem with our current financial system is that government under enormous lobbying pressure does not want to set rules. Existing laws are antiquated because the industry always try to find ways to circumvent them. For example, banks set up SIVs, or Structured Investment Vehicles, to engage in non-regulated investment activities, putting depositors capital under risk. Insurance companies sell innovative quasi-insurance products, such as CDS, credit default swaps, without putting sufficient capital reserve as collateral. That was how AIG got into trouble. AIG's traditional insurance business was doing just fine. It was its non-regulated business (selling CDS) that incurred huge losses and needed $155B bailout from the government.
Some people blame the government for running up too much debt. Others blame the poor people for borrowing too much that they cannot afford to pay back. But the real cause is that America's financial industry outgrew the rest of the economy.
Financial industry does not create wealth. Let me repeat it again: financial industry does not create wealth. It only re-distributes wealth. Wealth is created in the real economy, the goods-producing economy. The problem is that America is producing less and less goods, because manufacturing has been increasingly outsourced to overseas. America's economy is becoming an empty shell. If this trend continues, our children will only find jobs in either Walmart, or Wall Street. No wonder we have seen in this country the wealth gap widening, and middle-class disappearing, because the good-paying manufacturing jobs have all but gone overseas. First was the textile industry, then the electronic industry, and now the automobile industry. If the US auto industry should disappear, and most likely it will, I don't know what real stuff America can produce any more.
On the other hand, the financial industry has been growing, and it has been obsessed with growth. It forced main-street companies to move production to low cost countries, so the profit can be larger and stock prices higher. Not only that, the financial industry has been using all kinds of tricks to convince peope to borrow more, because the more we borrow, the more profit for the industry. It uses all kinds of innovative financial engineering to make borrowing easier for everyone. To persuade individuals to borrow, they give us credit cards with rewards. The more you buy, the more you save. If you own a house, they want you to borrow against your house. They call that home equity loan. After you exhausted your home equity, they ask you to borrow against your next paycheck. To persuade government to borrow, they always support lower tax and higher spending. When it comes to persuading corporations to borrow, that is where they get extremely innovative. They design all kinds of financial instruments to allow corporations to borrow easily.
The end result was the enormous growth in credit, which in turn stimulated growth of the entire economy. But this type of growth can't sustain. When individuals, government, and corporations exhausted their ability to borrow further, that is when the house starts to crumble. That is exactly what is happening now.
Don't get me wrong. I have nothing against the financial industry (I for one work for the industry). The financial industry serves a vital function, which is to promote most efficient capital allocation. In a normally functioning financial market, capitals are taken away from failing businesses to support value-creating businesses.
Because of the vital role the financial market plays in real economy, there have to be stringent and adequate rules and regulations. You cannot have a great basketball game if there are no clear rules and referees, no matter how talented the players are. The problem with our current financial system is that government under enormous lobbying pressure does not want to set rules. Existing laws are antiquated because the industry always try to find ways to circumvent them. For example, banks set up SIVs, or Structured Investment Vehicles, to engage in non-regulated investment activities, putting depositors capital under risk. Insurance companies sell innovative quasi-insurance products, such as CDS, credit default swaps, without putting sufficient capital reserve as collateral. That was how AIG got into trouble. AIG's traditional insurance business was doing just fine. It was its non-regulated business (selling CDS) that incurred huge losses and needed $155B bailout from the government.
Tuesday, November 04, 2008
America, I am so proud of you! Dawn of Hope!
At this moment, 10:33PM EST, Obama has 207 electoral votes. OH, NM and IA are Obama's country. That is just an early indication of a landslide.
1) MLK can now rest in peace. Forty years after his famous "I have a dream" speech, this nation can now look beyond the color of an individual's skin, and judge the person on his or her own merits.
2) The world is now looking at America in awe! America is STILL the beacon of light for the world. It is still the symbol of hope and inspiration.
3) It is so unfortunate that Obama's grandmother could not live to witness his grandson winning this historic election. She died one day before the election. But I am sure she is now smiling in heaven.
4) Now it is time to get to work: we need to give some desperately needed help to the middle class and the poor. Then we need to invest in America's future, by supporting education, healthcare for everyone, alternative energy technologies, and rebuilding of the crumbling infrastructure.
Finally we can all go to sleep with smile. Sweet dream, America, and wake up to the dawn of a new era, an era of new hope.
1) MLK can now rest in peace. Forty years after his famous "I have a dream" speech, this nation can now look beyond the color of an individual's skin, and judge the person on his or her own merits.
2) The world is now looking at America in awe! America is STILL the beacon of light for the world. It is still the symbol of hope and inspiration.
3) It is so unfortunate that Obama's grandmother could not live to witness his grandson winning this historic election. She died one day before the election. But I am sure she is now smiling in heaven.
4) Now it is time to get to work: we need to give some desperately needed help to the middle class and the poor. Then we need to invest in America's future, by supporting education, healthcare for everyone, alternative energy technologies, and rebuilding of the crumbling infrastructure.
Finally we can all go to sleep with smile. Sweet dream, America, and wake up to the dawn of a new era, an era of new hope.
Saturday, November 01, 2008
McCain's tax plan vs. Obama's tax plan (satire)
Let's be frank about it. McCain has a better tax plan than Obama. Not only he gives some tax cut to the poor, he will also cut tax for the wealthy and big corporations, just in case they need it. McCain will cut tax for EVERYONE, not only the middle class and poor.
How will he balance the budget, if he cut taxes? He will freeze all domestic spending except the military. Sure, this will cripple domestic economy. But no worry, our corporations can always do business in other countries. And our military spending will definitely stimulate the economy of our friends in the middle east. Yes, tough economic time is ahead of us here in the US. But that is why we are asking you to put the country first.
Even freezing domestic spending would not balance the budget, because we are already running a half trillion dollar budget deficit. But, don't fret. The government can always borrow. We have been doing that in the last eight years! Why can't we continue doing that?
On the other hand, Obama only gives tax cut to those who need it. He asks the wealthy and the corporations to chip in a little bit more. That is socialism, my friends. Obama will reduce our military spending by ending the war in Iraq, and boost domestic spending to stimulate the US economy. He will give tax credit to small businesses that create jobs in the US, not ship jobs overseas. He will repair the crippling infrastructure, and encourage investment in alternative energy technologies. My friends, that does not work! That is government intervention. You democrats did that in the 90s, the early 60s, and the late 30s. The New Deal. The Great Society. Blah blah blah. Those are false hopes. They work for a while, until we republicans came in to crash them.
My friends, on November 4th, remember to vote for McCain.
How will he balance the budget, if he cut taxes? He will freeze all domestic spending except the military. Sure, this will cripple domestic economy. But no worry, our corporations can always do business in other countries. And our military spending will definitely stimulate the economy of our friends in the middle east. Yes, tough economic time is ahead of us here in the US. But that is why we are asking you to put the country first.
Even freezing domestic spending would not balance the budget, because we are already running a half trillion dollar budget deficit. But, don't fret. The government can always borrow. We have been doing that in the last eight years! Why can't we continue doing that?
On the other hand, Obama only gives tax cut to those who need it. He asks the wealthy and the corporations to chip in a little bit more. That is socialism, my friends. Obama will reduce our military spending by ending the war in Iraq, and boost domestic spending to stimulate the US economy. He will give tax credit to small businesses that create jobs in the US, not ship jobs overseas. He will repair the crippling infrastructure, and encourage investment in alternative energy technologies. My friends, that does not work! That is government intervention. You democrats did that in the 90s, the early 60s, and the late 30s. The New Deal. The Great Society. Blah blah blah. Those are false hopes. They work for a while, until we republicans came in to crash them.
My friends, on November 4th, remember to vote for McCain.
Subscribe to:
Posts (Atom)
Posts
