For those who don’t know about him, Jim Grant of Grant’s Interest Rate Observer has been a long standing and highly regarded advocate of probity, common sense, and historical memory. Of course, that means he is completely out of fashion. But Grant has a loyal following and even those who differ with his skeptical outlook will concede that he is thoughtful, thorough, and often original in the way he links data and events.
In a Financial Times article, “Kuwait split raises questions over longevity of the dollar,” Grant focuses on underreported move by the Kuwaitis to stop pegging their dinar to the dollar, which begs the question of whether other Gulf states will follow suit (the cynic in me suspects that Kuwait’s shift was a trial balloon on behalf of its oil producing neighbors).
Grant points out (as we have) that the Gulf nations are finding it increasingly painful to buy dollars to support the US currency, as these purchases are made with local currency. Where does that money come from? The government prints it, which increases the money supply, which leads to inflation. Inflation has hit the point where it is becoming uncomfortable, hence the move away from supporting the dollar (as a point of clarification, the alternative to inflation is what is called sterilization, the route China has chosen. The government soaks up the new money created by issuing bonds. It keeps a lid on inflation, but at the price of burgeoning govenment debt).
Grant has enough respect for his reader not to belabor what he regards as obvious. He sets forth his information, and while his point of view is clear, he lets his reader connect the dots. He clearly thinks the gold standard had merits, but doesn’t call for it to be reinstated (that would get him branded as being a kook) and while he clearly sees the dollar’s days as numbered, by invoking the long sweep of history, he manages to avoid looking alarmist.
But the facts Grant presents are alarming. The dollar’s most loyal supporters are beating a stealthy retreat.
When the Roman emperor Constantine struck off a new gold coin, he expected it to give good, durable service. And the extra-durable solidus did – about 700 years’ worth. Modern monetary systems have a somewhat shorter shelf life.
That the current monetary system may not last for the ages was underscored the other day by Kuwait’s decision to uncouple its dinar from the US dollar. For years, the two had been lashed together as a preliminary to the projected creation of a common Persian Gulf currency.
But the more the dollar’s value sagged, the more dollars the members of the Gulf Co-operation Council have had to absorb just to maintain the desired exchange rates. Naturally, the central banks of the participating countries did not acquire their dollars with nothing. They printed the local currencies with which to buy them and the more they printed, the more that inflation welled up. Now Kuwait has chosen to go its own way, leaving Saudi Arabia, Qatar, the United Arab Emirates and Bahrain to ponder their tolerance for open-ended dollar-buying. Little Kuwait just might be the herald of big change, both in the dollar’s fortunes and the world’s monetary organisation. To a degree, the world turns on open-ended dollar buying and the muscular feats of money-printing it calls forth.
Hard-working Asians (and oil-blessed Arabs) consume much less than they produce. Americans, on the other hand, produce much less than they consume. But the savers and spenders do have something in common. The workers are happy to receive dollars, and the consumers are more than happy to print them. Unlike the solidus, a greenback has no intrinsic value. It is faith-based. Here is a new idea in the world. Certainly, the unsystematic world monetary system is a new arrangement. Up until 1971, the dollar was collateralised by gold. If you were a central bank, $35 would get you an ounce on demand. The system gave good, durable service until the US started to run out of bullion. On August 15 1971, the dollar became uncollateralised. Exchange rates started to float – or to sink or be pegged. Governments made it up as they went along.
That the paper dollar finds favour the world over must be counted as one of the greatest achievements in the annals of money. To be sure, the central banks of the Middle East and Asia have had their own reasons for stockpiling the greenback and US securities. But their self-interest doesn’t detract from the rarity of the historical moment. To paraphrase Richard Nixon, the president who closed the US gold window, we are all dollar bulls now.
Or rather, we are up to a point of saturation, a point that Kuwait seems to have finally reached. Its neighbours, too, appear to be on the edge of dollar surfeit. Broad money growth in the Gulf region is running at 20 per cent, in no small part a consequence of rampant dollar absorption.
“Inflation is a hot topic in the kingdom,” the Financial Times reported from Riyadh recently, “as city residents feel the pinch of rental and price increases suddenly feeding into an economy that has grown used to inflation of around 1 per cent a year since the 1970s.” The Saudi statistics gatherers today acknowledge a current rate of 3 per cent.
Since the international gold standard perished in 1914, successive global monetary systems have been brought down by external shocks or internal contradictions. Inflation is the bane of our non-system system. Inflation is a disease of one main cause but varied symptoms. A surfeit of money can cause derangement at the checkout counter (India), in the real-estate market (Russia) or on the stock exchange (China).
By upsetting the integrity of prices, it can disturb the architecture of production. In most of the dollar-buying states, monetary growth is fast enough to upset the eternal rest of Milton Friedman. In all cases, a slower pace of dollar absorption is an integral part of a monetary cure. It will be said that only some members of the dollar-buying bloc want to be cured. The rest – notably, China – are happy to keep on cranking the monetary presses. But the upward track of US interest rates and the downward path of the dollar exchange rate tell a different story. One thing’s for sure, the greenback ain’t the solidus.