The US Federal Reserve, the Yuan, and Gold

Dollars are losing value. But that doesn’t seem to stop people from wanting more of them. In exchange for gold, you can tender 673 US dollars and get a single ounce. This is 7.80 dollars more than the rate on Tuesday. But it’s still lower than the rate at the end of January one score and seven years ago, that is to say, the day Ronald Reagan was first sworn in as President of the United States of America. But that was before the United States had a US$9 trillion public debt…and a financing gap over US$60 trillion. People still had affordable mortgages…and only half as much debt, generally speaking..

The United States was at peace…and still a net-creditor to the rest of the world. Its trade with the rest of the world was still more or less in balance. Derivatives had barely been invented. And the money supply - that is to say the number of dollars in circulation - was hardly a quarter of what it is today (we are just making an educated guess).

You’d think the price of gold ought to be a bit higher. Go figure.

And pity the poor investors in Bear’s hedge fund - all their dollars have disappeared. Yes, dear reader, The Greatest Economic Boom Ever is fuelled by dollar creation…and yuan creation…and yen creation…and euro creation. My god, this boom has seen a genesis of money everywhere. But just as the great boom giveth, it also taketh away. We are preparing an essay for tomorrow on this subject, so we don’t want to give away the whole story, but readers need to be prepared. Just as we watched the geniuses at Bear and the other financial firms create wealth, we can also watch them destroy it. In a flash, billions…no trillions…of presumed, ersatz wealth can vanish.

Money that is created “out of thin air” - courtesy of central banks and financial firms - tends to go back from whence it came. For every genesis of wealth creation…there is an exodus of wealth destruction. Watch out for it…

Hardly a day goes by that someone, somewhere isn't griping about currencies.

In Ontario, embattled Ontario manufacturers rail about the suddenly airborne loonie. Members of the U.S. Congress want to bash China for fiddling with the yuan. And ordinary Argentines would rather hold just about any currency than their own.

So maybe it's time to rethink the whole idea of national currencies. That, at least, is the provocative thesis of Benn Steil, director of international economics at the Council on Foreign Relations in New York.

In an article in Foreign Affairs magazine, Mr. Steil suggests that scores of countries – from the Americas and Asia to Europe and the Middle East – should simply give up on their own currencies and embrace one of the world's global currencies, such as the euro or the U.S. dollar.

With the gold standard gone, marginal currencies simply can't survive against the sheer weight of globalization. Inflation and high interest rates are a constant threat.

“National currencies and global markets simply do not mix,” Mr. Steil argued. “Together they make a deadly brew of currency crises and geopolitical tension and create ready pretexts for damaging protectionism.”

Get rid of monetary nationalism, along with unloved currencies, and you'll rid the system of a major source of instability, he concluded.

Mr. Steil points to Europe in the developed world and Ecuador (which uses the U.S. dollar) in the developing world as shining examples of why fewer currencies are a good thing.

“Europeans used to say that being a country required having a national airline, a stock exchange, and a currency,” he wrote. “Today, no European country is any worse off without them. Even grumpy Italy has benefited enormously from the lower interest rates and permanent end to lira speculation.”

China, he suggested, would do well to give up the yuan in favour of a “pan-Asian” currency that would rival the euro and the dollar, while allowing the country to liberalize its financial and capital markets.

Just about every other country would be better off with the dollar or the euro as they gradually integrate into global financial markets.

Even better, he suggested, would be a new gold-based international monetary system, backed by private gold banks, rather than governments.

Where does that leave a country such as Canada? Its economy is puny compared with the United States or Europe, and the bulk of its trade is with its southern neighbour.

That can be a problem when the currency swings. The loonie's recent surge (past 95 cents U.S.) is nice if you're vacationing in Maine this summer. But it's pretty devastating if you're making auto parts and other manufactured goods for the U.S. market.

The rest of the Canadian economy – oil, most other commodities and the service sector – are humming along fine. The net result is an economy that appears much stronger than the United States' (3.5-per-cent annualized first-quarter growth vs. 0.7 per cent in the U.S.). But pockets of the manufacturing heartland in Ontario and Quebec are hurting badly.

Wouldn't it be nice to have it both ways – stability for exporters and an end to currency swings.

Mr. Steil seems to think so. In an interview, he said Canada isn't like Brazil or Turkey, where the threat of a currency crisis is ever present.

“Canada can certainly sustain a national currency, because Canadians, as well as foreigners, treat the currency as a reliable store of wealth,” he said. “Canada is at no significant risk of a currency crisis.”

But that doesn't mean Canada couldn't do better. Mr. Steil argued that the “economic arguments” for Canada-U.S. monetary integration are compelling.

The main impediments, he suggested, are political, not economic.

And that's part of the problem. The United States, and more specifically, the U.S. Federal Reserve Board, has become a reluctant central bank for the world. Its interest rate decisions affect borrowing costs and investment yields everywhere.

As long as the United States acts responsibly, keeping inflation low and steady, the rest of the world will be okay.

But if you suspect Fed chairman Ben Bernanke is drinking and driving at the wheel of the global economy, you might want to stock up on some gol