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Money has been seen as the absolute form of wealth storage in the current crisis, and that shows how human relationships of power are inseparable from money.  The falling US dollar increased in value as the crisis became publicly manifest, and that was because people sold other, less secure, forms of wealth storage -- their income producing assets -- in order to hold US dollars, which is simply a guarantee that US political authority (or EU or Japanese, etc.) will continue to reign supreme and guarantee the existing web of social relationships that currently determines who gets what in the world today.

It is not at all certain that the neo-classical narrative of money emerging "naturally" is true either. Money can emerge naturally, such as the famous cigarettes in war-torn Germany which had more value than the official inflationary currency, but the fact that more explicit, i.e. political, forms of money tend to drive out so-called natural forms, like gold or silver, from circulation show the primacy of the relational dimension over the physical. Social guarantees of wealth are superior to any presumed claims to wealth derived from merely physical characteristics of monetary specie.

I do not argue that credit is not money, but rather that credit only matters because it is another way of securing wealth, which is why money matters at all in the first place.  The more general phenomenon is wealth, not money, so that is where analysis should be focused.

by santiago on Wed Sep 2nd, 2009 at 09:30:48 AM EST
[ Parent ]
santiago:
The falling US dollar increased in value as the crisis became publicly manifest, and that was because people sold other, less secure, forms of wealth storage -- their income producing assets -- in order to hold US dollars, which is simply a guarantee that US political authority (or EU or Japanese, etc.) will continue to reign supreme and guarantee the existing web of social relationships that currently determines who gets what in the world today.

Wasn't there another more prosaic explanation for the rise of the dollar, having to do with a suddenly urgent need to pay for huge amounts of dollar denominated debt?

The West won the world not by the superiority of its ideas or values or religion, but rather by its superiority in applying organized violence.

by marco on Wed Sep 2nd, 2009 at 10:15:39 AM EST
[ Parent ]
Also lots of US investors repatriated their foreign asset holdings.

The EUR/USD exchange rate oscillated about 20% in one direction and then 20% in the other direction in the last 3 months of last year.

En un viejo país ineficiente, algo así como España entre dos guerras civiles, poseer una casa y poca hacienda y memoria ninguna. -- Gil de Biedma

by Migeru (migeru at eurotrib dot com) on Wed Sep 2nd, 2009 at 10:21:20 AM EST
[ Parent ]
Yes, and repatriation of assets is exactly what one would expect in an environment where security for one's wealth is deemed more important than growing one's wealth. It's evidence of the superiority of the dollar (or other similarly politically credible currencies) over so-called "fundamental" values of money and assets.  The social determined rules of wealth are what matters in money, and everything else, including credit, are just proxies for those social determinants.
by santiago on Wed Sep 2nd, 2009 at 10:31:39 AM EST
[ Parent ]
No, the prosaic is the wrong one.  The only reason that you could pay for such debt while also lowering interest rates to zero is if the dollar really did command greater value in times of crisis, which it does. And that is explained by the fact that political power -- a social function -- is a more secure guarantee of wealth than anything else.
by santiago on Wed Sep 2nd, 2009 at 10:25:15 AM EST
[ Parent ]
santiago: The only reason that you could pay for such debt while also lowering interest rates to zero

Sorry, I have a very hard time understanding things financial and economic, to put it mildly -- could you explain a bit more this relationship between the lowering of interest rates and the repayment of these dollar-denominated debts?

The West won the world not by the superiority of its ideas or values or religion, but rather by its superiority in applying organized violence.

by marco on Wed Sep 2nd, 2009 at 10:50:07 AM EST
[ Parent ]
Well, I understand you to mean by "paying for huge amounts of debt" that people had to sell other assets at fire-sale prices in order to pay their bankers, and since their bankers lent in dollars, demand for dollars must increase, driving exchange rates up in favor of the dollar.  (Correct me if I'm not reading you right. I do that a lot I know.)

The only problem with that argument is that it doesn't explain why bankers would want dollars instead of debt assets in the first place.  What makes a currency unit a more desirable entry on a bank's balance sheet than their debt asset did?  Well, we know it's likely because the bankers realized that their debt assets are riskier and less valuable than they thought -- that there's a good chance the borrower simply can't deliver on his commitment to repay them. What was the wealth, then, that the banker reported on its balance sheet? It was really just a commitment -- that is a political or social claim on society's resources -- made by the borrower to the banker. Nothing more.

When a banker (or any other investor) decides it would rather have currency in its vaults instead of debt assets on its books, it is deciding to substitute the political power represented in currency for the social power of a borrower.  

Currency is like the city walls that people hide behind when the brigands come. When the danger is gone, people go back outside to farm and work to increase their wealth, rather than just protect it.  But if the brigand threat is particularly big, the city with biggest walls offers the best protection.
 

by santiago on Wed Sep 2nd, 2009 at 12:10:21 PM EST
[ Parent ]
Sorry, I accidentally deleted the part about interest rates.

Normally, a government, like any social enterprise such as a business, has to increase interest rates -- the amount it pays a borrower for use of its claims to society's resources -- when it tries to borrow huge sums.  Interest rates should have to increase when a government makes sudden, multi-trillion dollar commitments.  But the opposite has happened in the present crisis.  Interest rates have dropped to near zero for US government debt issuances instead.  This means that the security of holding an explicit  guarantee of wealth from American political authorities is so valuable today people are essentially willing to pay for that security by forgoing slightly higher interest rates in other types of non-US government securities. Why is this so? It's because the social rules of wealth in the world today make it possible for American political authorities to credibly promise to just take resources from someone else if need be, at home or abroad, and give to the bearer of its debt, while few other entities would have much credibility making such a promise.

What financiers like to call a risk premium is really just a government premium.  Government -- organized political power -- trumps markets, and bigger, stronger governments trump weaker, smaller ones when  ambiguities about wealth become manifest.

by santiago on Wed Sep 2nd, 2009 at 12:25:31 PM EST
[ Parent ]
Thanks for your thorough explanations.

santiago: (Correct me if I'm not reading you right. I do that a lot I know.)

No, that was pretty much my understanding of it.

santiago: The only problem with that argument is that it doesn't explain why bankers would want dollars instead of debt assets in the first place.

This is probably a totally naïve and perhaps even non-sensical question, but say somehow it were possible to repay those debts in a pre-agreed range of currencies other than dollars, say euros, yen, swiss francs, and pounds, for example.  So, for example, if a borrower owed $100 million, and the easiest currency they could get their hands on was swiss francs, then the creditor (in this hypothetical world) would have to accept those francs as payment for the debts.

In this scenario (if it makes any sense at all), there would not have been such a huge worldwide demand for dollars to repay debts, right?  There would have been demand for a range of currencies, but not exclusively dollars (because even dollar-based debts could be repaid in those other currencies).  And so, even though people would be scurrying for city walls, it wouldn't be just one city's walls, but five or six cities' walls.  And more than likely, I surmise, we would not have seen the disproportionate rise in the value of the dollar.

This hypothetical (if it follows) would not rebut your point that political pwer represented in currency trumps the social power of the borrower, as you put it, in times of crisis.  But it would rebut the claim that the city walls of the U.S. dollar are (considered) stronger than those of other currencies.

Does that make any sense?

The West won the world not by the superiority of its ideas or values or religion, but rather by its superiority in applying organized violence.

by marco on Wed Sep 2nd, 2009 at 01:24:51 PM EST
[ Parent ]
Yes, your question makes sense, and it is a good one.

In this scenario (if it makes any sense at all), there would not have been such a huge worldwide demand for dollars to repay debts, right?

The answer is no, not right. The demand for dollars would have been the same, and that also explains why the idea of currency baskets is problematic too. The reason is that there is nothing -- or not much anyway -- contractual, legal, or otherwise, that requires banks (or other investors or creditors) to keep the currency in their vaults in US dollars today.  They can keep US dollar currency, or they can make other loans or investments, or they can buy other currencies -- it's up to them for the most part, especially in the case of central banks which make decisions about reserve currencies.  So when someone repays a loan to them, creditors have the  option of putting the repayment in vault (or in a deposit with a central or other bank) in US dollars, or they can instantaneous buy a presumably safer foreign currency and put that in their vault instead.

What we observe, however, is that each and every day investors, creditors, and central bankers (including the Chinese who complain so much about it) all decide to hold significant US dollar reserves instead of the many other options available to them.  That is why we know that the political entitlement to wealth of holding a US Dollar is the safer castle wall during a crisis like the present than others forms of securing wealth.

by santiago on Wed Sep 2nd, 2009 at 01:47:21 PM EST
[ Parent ]
santiago: The answer is no, not right. The demand for dollars would have been the same, and that also explains why the idea of currency baskets is problematic too.

I'm probably banging up against my cognitive limits here, but here are two more ways I've been trying to understand this:

1.  Suppose we reduce the situation to an absurdly idealized simple situation, in which there are only two countries/currencies in the world, A and B, and their respective currencies happen to have a 1:1 exchange rate.  Now let's say there were a massive amount of debt denominated in A currency being held by B citizens and entities.  If those B borrowers had to repay that debt in A currency, then they probably would have to exchange large amounts of B currency for A currency, thus driving up the value of A currency with respect to B currency.  Is that correct, so far?

On the other hand, if those B borrowers were allowed to repay their debts in B currency, then the exchange rate would not be affected, or at least, not as drastically.  Is that correct?  Or am I missing some major factors?

If this scenario makes sense (a big if), then I don't see why the dollar would have gone up so suddenly against most major currencies if debt holders could pay back their debts in those currencies.

2. Another take I was wondering about:  What if Switzerland, not the U.S., were the source of all the mad financial shenanigans and most of the debt were denominated in Swiss francs and had to be paid back in Swiss francs (again, another fantasy, but...)  In this scenario, wouldn't we have seen a rush for Swiss francs and a corresponding rise in the value of the CHF?  If so, that would not be evidence for the relative pre-eminence of Swiss political authority in the world, would it?

Lastly, out of curiosity, I looked up the graphs for the last year's exchange rates of the US dollar against other major currencies, which with one exception of the yen, did show a steep rise of the US$ in the aftermath of the crisis.  Now, I believe the precipitous rise of the yen against all major currencies, including the US$, was due to a circumstance that was quite "prosaic", "technical", "artefactual", whatever you want to call it, related to the yen carry trade.  More to the point, the rise of the yen was not evidence of global investors' faith in Japanese political authority, but rather to the abnormally large extent of the yen carry trade.  If that is the case, then how can the rise of the dollar vs. other major currencies (other than the yen) be taken as evidence of faith in the political authority of the U.S.?

santiago: The reason is that there is nothing -- or not much anyway -- contractual, legal, or otherwise, that requires banks (or other investors or creditors) to keep the currency in their vaults in US dollars today.

But are they keeping their currency in US dollars today?  I doubt you can answer that by looking at exchange rates alone, but doesn't the steady decline of the dollar against all other major currencies in the graphs  below suggest that people are not in fact keeping their currency in dollars?

USD vs. Euro

USD vs. Swiss France

USD vs. UK Pound

USD vs. Chinese Renminbi

USD vs. Canadian Dollar

USD vs. Japanese Yen


The West won the world not by the superiority of its ideas or values or religion, but rather by its superiority in applying organized violence.

by marco on Thu Sep 3rd, 2009 at 05:39:47 AM EST
[ Parent ]
marco:

If those B borrowers had to repay that debt in A currency, then they probably would have to exchange large amounts of B currency for A currency, thus driving up the value of A currency with respect to B currency.  Is that correct, so far?

Correct, in the givens of your scenario.

marco:

On the other hand, if those B borrowers were allowed to repay their debts in B currency, then the exchange rate would not be affected, or at least, not as drastically.  Is that correct?

Yes, correct again. And I argue that this is effectively the case in the real world today because of highly liquid markets for currency and virtually costless and instantaneous exchange of currency. People therefore are in possession of a particular currency at any moment because they want it, not because they're required to.

The dollar did not go up in order to repay debts. That was my point.  It went up because people wanted to hold dollars relative to either other currencies or other assets.  However, we know that people were actually selling other assets -- real estate and stocks -- so that means that the dollar must have increased because people, for some reason, wanted to hold cash in US dollars.

Let's go to Switzerland:

What if Switzerland, not the U.S., were the source of all the mad financial shenanigans and most of the debt were denominated in Swiss francs and had to be paid back in Swiss francs (again, another fantasy, but...)  In this scenario, wouldn't we have seen a rush for Swiss francs and a corresponding rise in the value of the CHF?

No, and the reason is because repaying debt is NOT what people do when a country goes into mad financial shenanigans such as occurred in the US (or in Sweden in the early 1990's, for a closer comparison to your Swiss example). What people do is sell assets to hold currency, paying some debt in the process only incidentally.  (No one is clamoring to repay debt right now and creditors have no way of making people accelerate repayment either, so the driving phenomenon is assets sales not debt repayment.) And if safer currencies then the precarious domestic one were available, people, including lenders, will buy and hold those currencies.  In your Swiss example, people would sell Swiss real estate and other assets at fire sale prices and use the proceeds buy Euros or Dollars.  If they could, they would even borrow MORE CHF denominated debt to buy euros or dollars.

The question then, is why didn't that happen when US financial system collapsed last year and why isn't it happening now?  Your graphs tell a story of a surge in the dollar's value followed by a return to pre-crisis prices.  That's not a declining dollar story -- that's a stable currency story. The dollar's fall since the beginning of the year indicates a willingness to invest in productive assets, possibly including foreign assets, instead of holding cash, and that's good news, not bad.

So, if the dollar were perceived to be a weak security for wealth compared to other currencies, we should never have seen any surge in its price at all. Foreigners were not ones selling foreign assets to repay US creditors last year, which is your Swiss story. Foreigners were the net creditors, in fact, as shown by the US current account deficit. Rather, both foreigners and Americans were selling US assets (causing creditors to collect some it).  And they all tended to choose to hold dollars in cash while this was going on instead of immediately converting it to foreign currency or foreign assets. That's evidence that political power trumps everything else when it comes to money.

The Yen?  Following my narrative, Japan is the world's second largest economy, Tokyo is the financial center of Asia, and Japan is therefore the only nation-state comparable in power to the US in a crisis. People believe that the Japanese have the power to make good on their claims and debts, through coercion if not through growth. If people wanted to take some wealth out of Europe and America and go to Asia for protection, Japanese political authority to protect that wealth was the best bet.

by santiago on Thu Sep 3rd, 2009 at 12:31:25 PM EST
[ Parent ]
Thank you very much for answering all these questions so patiently and thoroughly.  This has been a significant help to me.

The West won the world not by the superiority of its ideas or values or religion, but rather by its superiority in applying organized violence.
by marco on Thu Sep 3rd, 2009 at 07:06:05 PM EST
[ Parent ]
Thank you as well for such stimulating and challenging questions.
by santiago on Thu Sep 3rd, 2009 at 10:38:17 PM EST
[ Parent ]
Thanks to both of you for a valuable increase in my understanding of currencies.

Btw, the swedish krona was in the swedish crises mentioned forced from a fixed rate and then dropped substantially vs european and american currencies. In accordance with the explanation.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Fri Sep 4th, 2009 at 07:04:30 AM EST
[ Parent ]
santiago:
The dollar did not go up in order to repay debts. That was my point.  It went up because people wanted to hold dollars relative to either other currencies or other assets.

Firstly, wherever there was an interbank market in dollar loans which froze up - and Norway was a good example - the result of the refusal by banks to roll over these loans was a requirement for dollars to settle the loans.

Hence the need for massive Fed currency swaps - mischaracterised as Fed "bailouts" eg of the poor, mismanaged, economic basket case that is Norway.

One of the key results of this, as far as I could see, was that the dollar appreciated against the relevant currencies.

Secondly, if a US owner of a leveraged foreign asset perceives that the value of the dollar is likely to fall relative to the currency of the asset location, then he is likely to get out of that exposure while the going is good.

I don't so much see that as a flight to safety, rather than as an aversion to foreign exchange risk.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Sep 5th, 2009 at 05:06:33 PM EST
[ Parent ]
The only problem with that argument is that it doesn't explain why bankers would want dollars instead of debt assets in the first place.

I don't see bankers in an active position now. They made their move when loaning, and now is up to borrowers to decide whether to return debt as quickly as possible (hence, pushing cash to bankers) or to keep "assets" for bankers.

The only thing than bankers can (or cannot) do is to lend more. But here they are reasonable enough with cynic value estimates of potentially new loan "assets".

by das monde on Wed Sep 2nd, 2009 at 11:11:28 PM EST
[ Parent ]
Absolutely right.  People are not really trying to pay back their bankers.  They are selling assets, however, and bankers are being repaid incidentally because they hold liens on any of those assets.  They're not being repaid all they were owed, but, nonetheless, they are gaining cash that they could lend if they wanted to.
by santiago on Thu Sep 3rd, 2009 at 11:16:27 AM EST
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