by
Martin Sibileau
About a month ago, in the third-quarter report of a Canadian global
macro fund, its strategist made the interesting observation that “
…Four ideas in particular have caught the fancy of economic policy makers and have been successfully sold to the public…” One of these ideas
“…that
has taken root, at least among the political and intellectual classes,
is that one need not fear fiscal deficits and debt provided one has
monetary sovereignty…”. This idea is currently growing, particularly after Obama’s re-election. But it was only after writing our last
letter,
on the revival of the Chicago Plan (as proposed in an IMF’ working
paper), that we realized that the idea is morphing into another one
among Keynesians:
That because there cannot be a gold-to-US dollar arbitrage like in 1933, governments do indeed have the monetary sovereignty.
Is this true? Today’s letter will seek to show why it is not, and in
the process, it will also describe the endgame for the current crisis.
Without further ado…
After the fall of the KreditAnstalt in 1931, with the world living
under the gold-exchange standard, depositors first in central Europe,
and later in France and England, began to withdraw their deposits and
buy gold, challenging the reserves of their respective central banks.
The leverage that linked the balance sheet of each central bank had been
provided by currency swaps, a novelty at the time, which had openly
been denounced by
Jacques Rueff.
One by one, central banks were forced to leave the gold standard (i.e.
devalue) until in 1933, it was the Fed’s turn. The story is well known
and the reason this process was called an “arbitrage” is simply that
there can never be one asset with two prices. In this case, gold had an
“official”, government guaranteed price and a market price, in terms of
fiat money (i.e. schillings, pounds, francs, US dollars). The
consolidated balance sheets of the central bank, financial institutions
and non-financial sector looked like this before the run:
