November 17, 2011

(FRANKFURT) - "Some leaders at this week's G-20 summit in Cannes suggested resorting to the International Monetary Fund's own notional currency to support the crucial EU bailout fund, Germany said Saturday.

The German government promptly rejected the idea, which involved resorting to the Special Drawing Rights (SDR) -- an international reserve asset created by the IMF in 1969 and based on a basket of international currencies -- to increase the firepower of the European Financial Stability Facility (EFSF). "Some Cannes participants brought up the issue as to whether SDRs might be used to boost the EFSF's efficiency," government spokesman Steffen Seibert said. According to the Frankfurter Allgemeine Zeitung's Sunday issue, several G-20 participants wanted central banks to contribute 50 to 60 billion euros worth of SDRs to finance a beefed-up EFSF.

The Welt Am Sonntag newspaper said the Bundesbank saw it as an attack on its sovereignty. It was the Bundesbank's opposition to the plan -- which the paper said was floated by French President Nicolas Sarkozy, US President Barack Obama and British Prime Minister David Cameron -- that led to German Chancellor Angela Merkel's veto."

Here we go again with the push to allow the IMF to become the ultimate lender of last resort through the issuance of SDR's. It's a back door attempt to solve the current problems through inflation. The fact that Germany immediately vetoed this is not surprising, but the fact that its sponsors were the US, France, and England is. The US has a lender of last resort in the Federal Reserve Bank. But the Fed has to answer to Congress, and it's chairman and Governors are elected.

Not the case with the IMF. An IMF with the power to create reserve assets out of thin air, without oversight, is what inflationists have been looking for since they proposed creating the SDR. As I pointed out in my book The New Gold Standard:

"Special Drawing Rights, or "paper gold" as it is sometimes referred to by those who can keep a straight face, was introduced to the international monetary system in 1967. It was a time when the dollar was under suspicion and gold was increasingly demanded.

In order to "economize" gold, the IMF issued a new reserve "asset" (SDR’s) to supplement gold and take pressure off the dollar. The SDR is a bookkeeping entry, defined in gold yet non-convertible into gold. It serves the same function as gold since it is a reserve, but unlike gold, it can be created by a stroke of the pen.

Policy Makers have chosen the SDR as the reserve "asset" most likely to succeed in replacing gold and the dollar. But just as the dollar was supposed to be as good as gold and was not, the SDR, even if made tangible and convertible into gold and/or other currencies, will suffer the same demise.

The Policy Maker has chosen to ignore the fact that there is no fundamental difference between an artificially ever-expanding reserve currency and an artificially ever-expanding reserve "asset" — both are inflationary and therefore self-destructive.

But the real threat is not that the SDR may fail as the dollar did in bringing monetary stability. The threat is in the damage SDR’s can do if developed within a formal system. Just as the dollar replaced gold as the primary asset, SDR’s have a very real potential for further diminishing both the role of gold and the dollar, and in doing so changing the entire nature and inflationary potential of the IMF.

Basically, monetary reform boils down to the following two alternatives: some countries advocate defaulting on foreign debts via devaluation; and some countries advocate creating more foreign debts via artificial reserve expansion. (The kind of debt creation that is consistent with the Policy Makers’ goals amounts to a method of constantly refinancing government debt below the market rate of interest. Given the past record of government, the principal may never be repaid in full or in real money terms so debt creation actually amounts to slow and less visible, but inevitable debt default.)

The third alternative is simply to not create debts that governments are unable or unwilling to repay. The third alternative is for governments to stop arbitrarily creating debt instruments such as the dollar in its role as reserve currency, and the SDR. These instruments and the currencies printed against them invariably depreciate and cause monetary crises. The third alternative would mean returning to the gold standard which limits credit and monetary creation, which, in today’s "enlightened" era and within our "evolving" economic structure, is considered "passé" and "old-fashioned."

Thus, in the present political context, monetary reform will consist of devaluation and the default on debts, or artificial reserve expansion and the "amortization" of debts or, more probably, a combination of both."

Greece has no option except to default outright or hope to be subsidized by its richer neighbors forever, or at least until it can stand on its own two feet. Greece has no assets to speak of and a meager GDP to grow. But all eyes are now turning to Italy, a country who does have an option. Italy has gold. As I wrote in my article A Plan to Save Europe, nations with gold have collateral and the ability to leverage that gold. Everyone keeps asking where the money is going to come from to re-capitalize the banks and back the excessive debt created by governments.

One answer is gold. Instead of conniving to create another debt instrument like the SDR and call it money, why not use the real thing? After all that's what the gold stored in central bank vaults is for. It is there for emergencies. Italy has about 140 billion in gold. If leveraged at past gold standard ratios that would potentially give Italy 600 to 800 billion dollars in capital. This combined with additional help from other nations, a reduction in its outlays through austerity measures, and even a small tax increase, would snuff out existing fears of contagion in a heart beat.

Gold is the way back to solvency among nations. Not con-games or gimmicks. They've all been tried and the introduction of a new SDR issuance simply perpetuates the game playing and demonstrates to the world that these nations are not yet serious about solving their problems. Shame on Obama, Cameron, and Sarkozy for proposing such schemes.