THE SILENT DOLLAR CRASH & PARALLEL INVESTMENT UNIVERSES
http://financialsense.com/fsu/editorials/2006/0502.html
by Econotech
May 2, 2006


When Will the Mainstream Recognize the Silent Dollar Crash?

When measured in the price of gold, the dollar and U.S. financial assets have already crashed. For example, relative to gold, as of Friday』s close, since their last relative highs in June-July 2005, the U.S. dollar index has declined 39%, the 10-year Treasury bond 43%, and the S&P 500 31%. These declines have become free-fall in the last month or so.

Yet as of now, the financial markets and mainstream media barely seem to acknowledge this silent yet huge dollar crash, rather quite the opposite. In terms of risk premia, credit spreads and volatility, global financial markets continue to be more euphoric than at any time in the past twenty years, as I pointed out on 3/24 link. The IMF's April "World Economic Outlook" link raised its global growth forecast for 2006 0.5% to 4.8%, which would be the fourth straight year above 4%.

In the U.S., this complacency is perhaps mainly because the housing market has not collapsed, though mortgage applications are down over 20% from last summer, and inventories have built up to 5-6 months for single family homes and 7 months for condos. Forward-looking indicators such as NAHB home sales expectations and housing market index and the U of Michigan home buying intentions are at their lowest levels in years. There are numerous anecdotal news stories of previously hot real estate markets slowing down, e.g. link.

As the IMF "Outlook" report notes, "the withdrawal of equity from the housing market--which amounted to 7.5 percent of household disposable income in the first three quarters of 2005," has been critical for the U.S. economy.

Since gold was money for millenia up until 35 years ago, it is still possible that, should the real estate market decline accelerate, large segments of the U.S. population may start to put two and two together and finally realize what the core problem really is, rather than being diverted into blaming various 「others.」 (See my 4/4 article link.)

Parallel Investment Universes That Have Not Yet Intersected

To me there appears to be three parallel investment universes. There is the mainstream Wall Street world, where investor euphoria remains at a 20-year high, especially in terms of credit and emerging market spreads.

Then there is officialdom, represented by the G-7 recently handing to the IMF the hot potato of trying to do something about the seemingly intractable global economic imbalances, which imho will be a futile effort without fundamental monetary/financial system reforms that as of yet are not being even remotely considered.

Finally, there is the growing Internet world of wealth preservation investors focused on gold and other commodities. (A few of these web sites are listed in my links section.)

Unlike in the TMT equity bubble of the late 1990s, when the existence of a bubble was at least open to debate on Wall Street, these parallel universes have not intersected at all in this credit cycle. Specifically, there is simply no acknowledgement on Wall Street as of yet that the price of gold may be signaling a dramatically changed financial situation.

To Wall Street, commodity inflation is directly linked to very strong growth in emerging markets, especially that of China, which again has been higher than expected, but it doesn』t go beyond that, to the role of excess dollar credit as indicated by the price of gold, because it can't, due to self interest.

The IMF has recently released two of its key periodic reports, "World Economic Outlook" and "Global Financial Stability Report." I may have missed it, but I do not recall the more than doubling in the gold price over the past few years mentioned even once in these otherwise authoritative and exhaustive reports, from which I will quote liberally in the next few sections.

Rather than try to deal with the fact, it's as if the rise in gold simply hasn't happened or has no meaning as far as Wall Street and the global monetary authorities are concerned.

"Exogenous" Shocks are Endemic to Highly Leveraged Speculative Finance Globalization

The IMF's April 2006 「Global Financial Stability Report」 link says 「it is difficult to make a case that realistic economic developments all by themselves could—at least over a 6–12 month time horizon—seriously affect the global financial system in a systemic way.」

But the IMF's new "Outlook" report also says "the baseline forecast is for continued strong growth, although risks remain slanted to the downside, the more so since key vulnerabilities—notably the global imbalances—continue to increase."

The IMF "Stability" report notes that 「sudden and negative developments—such as military confrontation, major terrorist attacks, a sharp fall in the supply of crude oil or other vital sources of energy, and maybe, more realistically, a significant rise in protectionism—could change the rational framework for global asset allocation and trigger a disorderly unwinding of global imbalances. These uncertainties, however, are difficult, if not impossible, to quantify.」 It also talks about avian flu in this manner.

Just because they can not be easily modeled, there is no reason to consider these "exogenous」 shock risks from "outside" the global market system, rather they are endemic to the current version of hyper speculative globalization, especially because the enormous use of financial leverage gives less leeway for major problems.

No Let Up to Higher Energy Prices, While Oil Companies Maximize Shareholder Value

In particular, the energy game continues to play out with no end in sight. The April 29 FT lead headline says, 「Bush woos Asian energy allies to thwart Moscow.」 Immediately after meeting with Bush, China』s President flew to Saudi Arabia then Nigeria to sign major deals, and of course China has close energy ties with Iran. Hedge funds and other speculators are taking advantage of these very real energy problems, making the situation worse, as Enron had done earlier (hyper speculation nowadays almost always tends to be of the destabilizing herd mentality type).

Chapter 2 of the IMF "Outlook" report says: "IMF staff believes that the IEA』s [International Energy Agency] and OPEC』s projections in the 1.2 mbd range for non-OPEC supply growth in 2006 may be optimistic. Even if OPEC』s capacity increases by a projected 1 mbd, spare capacity will likely continue to remain low, and consist mostly of the heavy grades, for which refining capacity is limited."

It then makes the following key point: "The IEA estimates that investment in the oil sector is probably 20 percent below what is needed to meet projected demand over the medium to long term. In contrast, oil-exporting countries and major oil companies argue that they are investing as rapidly as is appropriate ... To date, oil corporations appear to have used a large part of their profits to distribute to shareholders, buy back shares, accumulate cash reserves, or acquire other companies ... new investment, while significant in nominal terms, may not be large in real terms."

I.e. according to the IMF, oil companies have been using their robust cash flow to enhance "shareholder value," my term, not the IMF's. How effectively energy companies invest their currently high profits to actually increase energy supplies eventually will be a critical test for the current version of speculative finance globalization, far surpassing in importance the outrageous "compensation" their CEOs have been granting themselves.

Why Aren't Non-Financial Corporations Investing Their Record Cash Flows?

This behavior by energy companies is consistent with the more general use of record profits and cash flows by corporate America in this economic cycle. The IMF notes in Chapter 4 of the "Outlook," worldwide "the strong increase in profits has been used by nonfinancial corporates to acquire financial assets—including a substantial amount of liquid assets (「cash」 for short) during 2003–04—or to repay debt, rather than to finance new capital investments or to increase distributions to shareholders through dividends."

"While higher profits explain part of the rise in NFCS [non-financial corporate sector] excess saving in recent years, the decline in nominal capital spending explains around three-quarters of the increase in NFCS net lending since 2000 in the G-7 countries. Simply put, firms have been investing a smaller share of their profits in upgrading and expanding their capital stock."

Interestingly, the IMF also notes that "a closer examination reveals that the increase in profits is mainly due to lower tax and interest payments and, in some countries, to higher profits received from foreign operations, rather than to a rise in gross operating surplus."

Indeed, this economic cycle has seen profound shifts from previous ones. Again, according to the IMF "Outlook," "capital is flowing from emerging markets to industrial countries (notably the United States), the opposite of what would be predicted by economic theory." And, according to the IMF "Stability" report, "the transfer of risk, at least in part, to the household sector [from the corporate one] has somewhat changed the nature of moral hazard from 「too big to fail」 for some key financial institutions to whole market segments being 「too important to fall.」"

Inflation Risks Still Exist

Btw, the IMF "Outlook" also notes "increased financial investment in commodity markets," i.e. more hyper speculation by hedge funds, etc., as one of the three "factors [that] are contributing to the current upsurge" in commodity prices overall.

In Chapter 3 of the "Outlook," the IMF makes another key point: "globalization cannot be relied upon to keep a lid on inflationary pressures in present circumstances. Strong global growth and diminishing economic slack have reduced the restraining impact of declining import prices on inflation, and with strong global growth expected to continue, the primary risk is that a further upturn in import prices could result in stronger inflationary pressures going forward, particularly in countries that are well advanced in the economic cycle. The possibility of further, partly globalization-related, commodity price increases adds to these upside risks from the external sector."

The Liquidity Risks in the Secondary Markets for Structured Credit Products

The IMF "Stability" report notes liquidity risks. Specifically, 「credit derivative products have significantly enhanced the 「transferability」 of credit risks by allowing for the increased specificity of credit exposures, to meet different investor demands, particularly in the 「primary」 risk transfer markets. However, once transferred, secondary market liquidity risks and related contagion effects remain, and may constitute the most significant stability risk emanating from the structured credit markets.」

Again, 「the potential for secondary [credit derivative] market liquidity disruptions, often related to the homogeneity of market participants in a particular segment and to gaps between real and perceived liquidity, remains a stability concern.」

Concluding, 「in the structured credit markets, we believe the risk of liquidity disturbances is material. Whether and how these new risks materialize, and the severity of their impact, will critically depend on the degree to which the diversity of market participants increases, the various structural frictions are reduced, and market surveillance is improved.」

G-7-IMF Effort to Address Global Economic Imbalances Too Little Too Late?

Roach at Morgan Stanley, who has for years focused on global economic imbalances but whose call for a "new global [financial] architecture" link is probably too little too late imho, has just become more optimistic today because he believes "the world is finally taking its medicine--or at least considering the possibility of doing so" link.

At present I do not share Roach's new-found optimism. It has taken the U.S. more than thirty years to get itself into its current economic/financial situation, I believe that it will take a long time to reverse it, capabilities and habits can not change over night. Given the daunting arithmetic of the U.S. current account and fiscal deficit going forward, and because profound, long-lasting structural changes to the global economy have been made, I can not see any feasible size dollar devaluation that would have a significant impact on the U.S. balance of payments.

As for other views, Roach's colleague Xie is perhaps the only i-bank macroeconomist, and MIT economics PhD, who routinely incorporates the dominant role of global speculative finance in his core analysis of global imbalances, e.g. "the global financial system is running the global economy," link.

Gross at Pimco continues to point out the U.S. dollar risk, "need I say more than to sell U.S. assets and buy Asian ones denominated in their local currencies," link. Some old-time continental European-trained economists, e.g. Richebächer, Faber link, have come from a more 「sound money」 tradition than their American counterparts.

The mainstream academic international economists, while usually more honest than Wall Street, also continue to have trouble coming to grips with the key issues, saying for years that the current global imbalances are unsustainable, but otherwise at a loss as to how this situation can continue so long, let alone when it might change, again simply not acknowledging what gold might be signaling, e.g., in recent separate swipes at the global imbalances piñata by Eichengreen link, Krugman, and Summers link, and global inequality by Wolf (at the FT) and Krugman.

How Long Will China and Saudi Arabia Finance U.S. Twin Deficits, Hence Its Military Policy?

As I said in my April 20 article link, 「to much of the world, the U.S. appears to be unilaterally, "pre-emptively" embarked on policies which seem to have the effect, well-intended, unintended or otherwise, of helping to destabilize key regions, such as the Mideast, Iran, central Asia, North Korea, the former Soviet republics, etc. East Asia and Saudi Arabia are in effect financing the ability of the U.S. to pursue these unilateral policies by holding huge amounts of very low-yielding U.S. debt securities which will most likely significantly depreciate.

Stability in these key regions is critical to the paramount interest of most of these Eurasian nations, economic development. In addition, most of East and South Asia have huge internal infrastructure development needs, on the order of $400 billion per year, which are not being met, about equal to the amount it is adding to its forex reserves.

Thus, taking into account other costs and benefits (access to U.S. market, technology, management, etc), how much longer will the rest of the world finance U.S. military policy? How Iran is resolved might go some way to resolving that question.」

As I put it in my 3/24 article link, "especially if the geopolitical stuff below, such as in the Mideast or friction with China, starts to really go against the U.S., and a Eurasian "balancing coalition" starts to form, around national and energy security issues, against the sole U.S. "superpower" hegemon, then "feedback loops" with the above areas could accelerate. E.g. having to raise interest rates, which would further jeopardize the real estate market, thus consumer spending, thus capex spending, starting a downward spiral in the dollar."

How Much Longer the Golden Age of Goldman Sachs?

There needs to be some very creative thinking on how to solve these huge issues, and to date there isn』t, as far as I can see. Instead, the market euphoria that I noted in my March 24 Economic/Financial Monitor link has continued, especially in the commodity and emerging markets.

「The Economist」 has two puff pieces on Goldman Sachs in its current issue. The lead says, 「The average pay-packet of its 24,000 staff last year was $520,000—and that includes a lot of assistants and secretaries.」 Even with such high 「compensation,」 return on equity is near 40%.

Meanwhile, the recent first quarter U.S. employment cost index again confirms that the rest of the population has been going nowhere for the past five years. (Inflation as defined by the Fed would be if real wages ever went up merely in line with productivity, rather than everything that Goldman trades currently going parabolic.)

Goldman makes much of its money in proprietary trading, i.e. speculating. Despite the cover's sub-head, "Goldman Sachs and the culture of risk," the leader says, "If the much vaunted systems do not work, then the central banks will have to step in (as the Federal Reserve did with LTCM)." Why, what risk culture is that?

U.S. Goes from High-Tech Leader to Global Hyper Speculator

In the late 1990s, the U.S. 「brand image」 was built on high-tech leadership and productivity, which presumably was why the rest of the world would be willing to finance ever larger U.S. twin deficits. Now look at the ongoing troubles of Intel and Microsoft. Notwithstanding the huge success of Google, E-Bay and a few others, mainly oriented to media and advertising, tech investing generally has been reduced nowadays to playing short-term product and inventory/capacity cycles, e.g. fiber optic/telecom lately.

(Former technology hedge fund manager Kessler trotted out a version of his 「margin surplus」 views from his "Running Money" book once again recently in WSJ op-ed, no surprise there, the Silicon Valley slice-and-dice horizontal asset-light outsourcing business model certainly has helped hedge funds and venture capitalists. Such a cost-cutting model is also favored by the Wal-Marts of the world, whose merchant mentality simply has very little conception of the true costs of real innovation, readily apparent in books on that company.

Prestowitz has a more accurate view of what such a model has meant for the U.S. in his "Three Billion New Capitalists," soon in paperback, which incidentally is one of the very few mainstream books to mention the effects of the dollar's role as reserve currency, also see the "Curse of the Dollar" section in my 4/20 article.)

Emerging Market Growth Drives Financial System, Not Vice Versa

In the past five years, the Goldman's of the world have greatly benefited from the extraordinary growth of China, India and the rest of the developing world helping to drive the world economy, rather than the other way. China』s development has been heavily dependent on huge foreign direct investment (FDI), not speculative 「hot money,」 the latter still might be its undoing (as it was in the so-called Asian Financial Crisis of 1997-98), especially given China's inadequate financial/corporate governance systems. China President Hu recently visited Microsoft and Boeing, not Wall Street.

The global speculative financial system 「free rides」 on this real growth, it doesn』t create it, as is commonly thought in the U.S. The sooner corporate America realizes this the better, since despite all its problems, it is a main repository of critical technology and know-how needed to help solve the world's most pressing issues, such as sustainable energy development.

The rest of the world knows what really drives growth, even while it continues to play along, for now, with the U.S. dominated hyper speculative monetary/financial system. The central banks of Sweden and others now seem to be looking to diversify out of this game.

I'm not a libertarian, but I recommend the April 25 and Feb 15 speeches by Rep. Ron Paul, "What the Price of Gold is Telling Us," link and "The End of Dollar Hegemony" link.

Paul is one of the very few principled politicians seemingly left in Washington. Hopefully someone with a little more clout will finally figure out what he has before it』s too late, but I』m not holding my breath waiting.

HON. RON PAUL OF TEXAS
Before the U.S. House of Representatives

April 25, 2006

What the Price of Gold is Telling Us

The financial press, and even the network news shows, have begun reporting the price of gold regularly. For twenty years, between 1980 and 2000, the price of gold was rarely mentioned. There was little interest, and the price was either falling or remaining steady.

Since 2001 however, interest in gold has soared along with its price. With the price now over $600 an ounce, a lot more people are becoming interested in gold as an investment and an economic indicator. Much can be learned by understanding what the rising dollar price of gold means.

The rise in gold prices from $250 per ounce in 2001 to over $600 today has drawn investors and speculators into the precious metals market. Though many already have made handsome profits, buying gold per se should not be touted as a good investment. After all, gold earns no interest and its quality never changes. It static, and does not grow as sound investments should.

It more accurate to say that one might invest in a gold or silver mining company, where management, labor costs, and the nature of new discoveries all play a vital role in determining the quality of the investment and the profits made.

Buying gold and holding it is somewhat analogous to converting one savings into one hundred dollar bills and hiding them under the mattress-- yet not exactly the same. Both gold and dollars are considered money, and holding money does not qualify as an investment. There a big difference between the two however, since by holding paper money one loses purchasing power. The purchasing power of commodity money, i.e. gold, however, goes up if the government devalues the circulating fiat currency.

Holding gold is protection or insurance against government proclivity to debase its currency. The purchasing power of gold goes up not because it a so-called good investment; it goes up in value only because the paper currency goes down in value. In our current situation, that means the dollar.

One of the characteristics of commodity money-- one that originated naturally in the marketplace-- is that it must serve as a store of value. Gold and silver meet that test-- paper does not. Because of this profound difference, the incentive and wisdom of holding emergency funds in the form of gold becomes attractive when the official currency is being devalued. It more attractive than trying to save wealth in the form of a fiat currency, even when earning some nominal interest. The lack of earned interest on gold is not a problem once people realize the purchasing power of their currency is declining faster than the interest rates they might earn. The purchasing power of gold can rise even faster than increases in the cost of living.

The point is that most who buy gold do so to protect against a depreciating currency rather than as an investment in the classical sense. Americans understand this less than citizens of other countries; some nations have suffered from severe monetary inflation that literally led to the destruction of their national currency. Though our inflation-- i.e. the depreciation of the U.S. dollar-- has been insidious, average Americans are unaware of how this occurs. For instance, few Americans know nor seem concerned that the 1913 pre-Federal Reserve dollar is now worth only four cents. Officially, our central bankers and our politicians express no fear that the course on which we are set is fraught with great danger to our economy and our political system. The belief that money created out of thin air can work economic miracles, if only properly anaged,?is pervasive in D.C.

In many ways we shouldn be surprised about this trust in such an unsound system. For at least four generations our government-run universities have systematically preached a monetary doctrine justifying the so-called wisdom of paper money over the oolishness?of sound money. Not only that, paper money has worked surprisingly well in the past 35 years-- the years the world has accepted pure paper money as currency. Alan Greenspan bragged that central bankers in these several decades have gained the knowledge necessary to make paper money respond as if it were gold. This removes the problem of obtaining gold to back currency, and hence frees politicians from the rigid discipline a gold standard imposes.

Many central bankers in the last 15 years became so confident they had achieved this milestone that they sold off large hoards of their gold reserves. At other times they tried to prove that paper works better than gold by artificially propping up the dollar by suppressing market gold prices. This recent deception failed just as it did in the 1960s, when our government tried to hold gold artificially low at $35 an ounce. But since they could not truly repeal the economic laws regarding money, just as many central bankers sold, others bought. It fascinating that the European central banks sold gold while Asian central banks bought it over the last several years.

Since gold has proven to be the real money of the ages, we see once again a shift in wealth from the West to the East, just as we saw a loss of our industrial base in the same direction. Though Treasury officials deny any U.S. sales or loans of our official gold holdings, no audits are permitted so no one can be certain.

The special nature of the dollar as the reserve currency of the world has allowed this game to last longer than it would have otherwise. But the fact that gold has gone from $252 per ounce to over $600 means there is concern about the future of the dollar. The higher the price for gold, the greater the concern for the dollar. Instead of dwelling on the dollar price of gold, we should be talking about the depreciation of the dollar. In 1934 a dollar was worth 1/20th of an ounce of gold; $20 bought an ounce of gold. Today a dollar is worth 1/600th of an ounce of gold, meaning it takes $600 to buy one ounce of gold.

The number of dollars created by the Federal Reserve, and through the fractional reserve banking system, is crucial in determining how the market assesses the relationship of the dollar and gold. Though there a strong correlation, it not instantaneous or perfectly predictable. There are many variables to consider, but in the long term the dollar price of gold represents past inflation of the money supply. Equally important, it represents the anticipation of how much new money will be created in the future. This introduces the factor of trust and confidence in our monetary authorities and our politicians. And these days the American people are casting a vote of o confidence?in this regard, and for good reasons.

The incentive for central bankers to create new money out of thin air is twofold. One is to practice central economic planning through the manipulation of interest rates. The second is to monetize the escalating federal debt politicians create and thrive on.

Today no one in Washington believes for a minute that runaway deficits are going to be curtailed. In March alone, the federal government created an historic $85 billion deficit. The current supplemental bill going through Congress has grown from $92 billion to over $106 billion, and everyone knows it will not draw President Bush first veto. Most knowledgeable people therefore assume that inflation of the money supply is not only going to continue, but accelerate. This anticipation, plus the fact that many new dollars have been created over the past 15 years that have not yet been fully discounted, guarantees the further depreciation of the dollar in terms of gold.

There no single measurement that reveals what the Fed has done in the recent past or tells us exactly what it about to do in the future. Forget about the lip service given to transparency by new Fed Chairman Bernanke. Not only is this administration one of the most secretive across the board in our history, the current Fed firmly supports denying the most important measurement of current monetary policy to Congress, the financial community, and the American public. Because of a lack of interest and poor understanding of monetary policy, Congress has expressed essentially no concern about the significant change in reporting statistics on the money supply.

Beginning in March, though planned before Bernanke arrived at the Fed, the central bank discontinued compiling and reporting the monetary aggregate known as M3. M3 is the best description of how quickly the Fed is creating new money and credit. Common sense tells us that a government central bank creating new money out of thin air depreciates the value of each dollar in circulation. Yet this report is no longer available to us and Congress makes no demands to receive it.

Though M3 is the most helpful statistic to track Fed activity, it by no means tells us everything we need to know about trends in monetary policy. Total bank credit, still available to us, gives us indirect information reflecting the Fed inflationary policies. But ultimately the markets will figure out exactly what the Fed is up to, and then individuals, financial institutions, governments, and other central bankers will act accordingly. The fact that our money supply is rising significantly cannot be hidden from the markets.

The response in time will drive the dollar down, while driving interest rates and commodity prices up. Already we see this trend developing, which surely will accelerate in the not too distant future. Part of this reaction will be from those who seek a haven to protect their wealth-- not invest-- by treating gold and silver as universal and historic money. This means holding fewer dollars that are decreasing in value while holding gold as it increases in value.

A soaring gold price is a vote of o confidence?in the central bank and the dollar. This certainly was the case in 1979 and 1980. Today, gold prices reflect a growing restlessness with the increasing money supply, our budgetary and trade deficits, our unfunded liabilities, and the inability of Congress and the administration to reign in runaway spending.

Denying us statistical information, manipulating interest rates, and artificially trying to keep gold prices in check won help in the long run. If the markets are fooled short term, it only means the adjustments will be much more dramatic later on. And in the meantime, other market imbalances develop.

The Fed tries to keep the consumer spending spree going, not through hard work and savings, but by creating artificial wealth in stock markets bubbles and housing bubbles. When these distortions run their course and are discovered, the corrections will be quite painful.

Likewise, a fiat monetary system encourages speculation and unsound borrowing. As problems develop, scapegoats are sought and frequently found in foreign nations. This prompts many to demand altering exchange rates and protectionist measures. The sentiment for this type of solution is growing each day.

Though everyone decries inflation, trade imbalances, economic downturns, and federal deficits, few attempt a closer study of our monetary system and how these events are interrelated. Even if it were recognized that a gold standard without monetary inflation would be advantageous, few in Washington would accept the political disadvantages of living with the discipline of gold-- since it serves as a check on government size and power. This is a sad commentary on the politics of today. The best analogy to our affinity for government spending, borrowing, and inflating is that of a drug addict who knows if he doesn quit hel die; yet he can quit because of the heavy price required to overcome the dependency. The right choice is very difficult, but remaining addicted to drugs guarantees the death of the patient, while our addiction to deficit spending, debt, and inflation guarantees the collapse of our economy.

Special interest groups, who vigorously compete for federal dollars, want to perpetuate the system rather than admit to a dangerous addiction. Those who champion welfare for the poor, entitlements for the middle class, or war contracts for the military industrial corporations, all agree on the so-called benefits bestowed by the Fed power to counterfeit fiat money. Bankers, who benefit from our fractional reserve system, likewise never criticize the Fed, especially since it the lender of last resort that bails out financial institutions when crises arise. And it true, special interests and bankers do benefit from the Fed, and may well get bailed out-- just as we saw with the Long-Term Capital Management fund crisis a few years ago. In the past, companies like Lockheed and Chrysler benefited as well. But what the Fed cannot do is guarantee the market will maintain trust in the worthiness of the dollar. Current policy guarantees that the integrity of the dollar will be undermined. Exactly when this will occur, and the extent of the resulting damage to financial system, cannot be known for sure-- but it is coming. There are plenty of indications already on the horizon.

Foreign policy plays a significant role in the economy and the value of the dollar. A foreign policy of militarism and empire building cannot be supported through direct taxation. The American people would never tolerate the taxes required to pay immediately for overseas wars, under the discipline of a gold standard. Borrowing and creating new money is much more politically palatable. It hides and delays the real costs of war, and the people are lulled into complacency-- especially since the wars we fight are couched in terms of patriotism, spreading the ideas of freedom, and stamping out terrorism. Unnecessary wars and fiat currencies go hand-in-hand, while a gold standard encourages a sensible foreign policy.

The cost of war is enormously detrimental; it significantly contributes to the economic instability of the nation by boosting spending, deficits, and inflation. Funds used for war are funds that could have remained in the productive economy to raise the standard of living of Americans now unemployed, underemployed, or barely living on the margin.

Yet even these costs may be preferable to paying for war with huge tax increases. This is because although fiat dollars are theoretically worthless, value is imbued by the trust placed in them by the world financial community. Subjective trust in a currency can override objective knowledge about government policies, but only for a limited time.

Economic strength and military power contribute to the trust in a currency; in today world trust in the U.S. dollar is not earned and therefore fragile. The history of the dollar, being as good as gold up until 1971, is helpful in maintaining an artificially higher value for the dollar than deserved.

Foreign policy contributes to the crisis when the spending to maintain our worldwide military commitments becomes prohibitive, and inflationary pressures accelerate. But the real crisis hits when the world realizes the king has no clothes, in that the dollar has no backing, and we face a military setback even greater than we already are experiencing in Iraq. Our token friends may quickly transform into vocal enemies once the attack on the dollar begins.

False trust placed in the dollar once was helpful to us, but panic and rejection of the dollar will develop into a real financial crisis. Then we will have no other option but to tighten our belts, go back to work, stop borrowing, start saving, and rebuild our industrial base, while adjusting to a lower standard of living for most Americans.

Counterfeiting the nation money is a serious offense. The founders were especially adamant about avoiding the chaos, inflation, and destruction associated with the Continental dollar. That why the Constitution is clear that only gold and silver should be legal tender in the United States. In 1792 the Coinage Act authorized the death penalty for any private citizen who counterfeited the currency. Too bad they weren explicit that counterfeiting by government officials is just as detrimental to the economy and the value of the dollar.

In wartime, many nations actually operated counterfeiting programs to undermine our dollar, but never to a disastrous level. The enemy knew how harmful excessive creation of new money could be to the dollar and our economy. But it seems we never learned the dangers of creating new money out of thin air. We don need an Arab nation or the Chinese to undermine our system with a counterfeiting operation. We do it ourselves, with all the disadvantages that would occur if others did it to us. Today we hear threats from some Arab, Muslim, and far Eastern countries about undermining the dollar system- not by dishonest counterfeiting, but by initiating an alternative monetary system based on gold. Wouldn that be ironic? Such an event theoretically could do great harm to us. This day may well come, not so much as a direct political attack on the dollar system but out of necessity to restore confidence in money once again.

Historically, paper money never has lasted for long periods of time, while gold has survived thousands of years of attacks by political interests and big government. In time, the world once again will restore trust in the monetary system by making some currency as good as gold.

Gold, or any acceptable market commodity money, is required to preserve liberty. Monopoly control by government of a system that creates fiat money out of thin air guarantees the loss of liberty. No matter how well-intended our militarism is portrayed, or how happily the promises of wonderful programs for the poor are promoted, inflating the money supply to pay these bills makes government bigger. Empires always fail, and expenses always exceed projections. Harmful unintended consequences are the rule, not the exception. Welfare for the poor is inefficient and wasteful. The beneficiaries are rarely the poor themselves, but instead the politicians, bureaucrats, or the wealthy. The same is true of all foreign aid-- it nothing more than a program that steals from the poor in a rich country and gives to the rich leaders of a poor country. Whether it war or welfare payments, it always means higher taxes, inflation, and debt. Whether it the extraction of wealth from the productive economy, the distortion of the market by interest rate manipulation, or spending for war and welfare, it can happen without infringing upon personal liberty.

At home the war on poverty, terrorism, drugs, or foreign rulers provides an opportunity for authoritarians to rise to power, individuals who think nothing of violating the people rights to privacy and freedom of speech. They believe their role is to protect the secrecy of government, rather than protect the privacy of citizens. Unfortunately, that is the atmosphere under which we live today, with essentially no respect for the Bill of Rights.

Though great economic harm comes from a government monopoly fiat monetary system, the loss of liberty associated with it is equally troubling. Just as empires are self-limiting in terms of money and manpower, so too is a monetary system based on illusion and fraud. When the end comes we will be given an opportunity to choose once again between honest money and liberty on one hand; chaos, poverty, and authoritarianism on the other.

The economic harm done by a fiat monetary system is pervasive, dangerous, and unfair. Though runaway inflation is injurious to almost everyone, it is more insidious for certain groups. Once inflation is recognized as a tax, it becomes clear the tax is regressive: penalizing the poor and middle class more than the rich and politically privileged. Price inflation, a consequence of inflating the money supply by the central bank, hits poor and marginal workers first and foremost. It especially penalizes savers, retirees, those on fixed incomes, and anyone who trusts government promises. Small businesses and individual enterprises suffer more than the financial elite, who borrow large sums before the money loses value. Those who are on the receiving end of government contracts--especially in the military industrial complex during wartime-- receive undeserved benefits.

It a mistake to blame high gasoline and oil prices on price gouging. If we impose new taxes or fix prices, while ignoring monetary inflation, corporate subsidies, and excessive regulations, shortages will result. The market is the only way to determine the best price for any commodity. The law of supply and demand cannot be repealed. The real problems arise when government planners give subsidies to energy companies and favor one form of energy over another.

Energy prices are rising for many reasons: Inflation; increased demand from China and India; decreased supply resulting from our invasion of Iraq; anticipated disruption of supply as we push regime change in Iran; regulatory restrictions on gasoline production; government interference in the free market development of alternative fuels; and subsidies to big oil such as free leases and grants for research and development.

Interestingly, the cost of oil and gas is actually much higher than we pay at the retail level. Much of the DOD budget is spent protecting ur?oil supplies, and if such spending is factored in gasoline probably costs us more than $5 a gallon. The sad irony is that this military effort to secure cheap oil supplies inevitably backfires, and actually curtails supplies and boosts prices at the pump. The waste and fraud in issuing contracts to large corporations for work in Iraq only add to price increases.

When problems arise under conditions that exist today, it a serious error to blame the little bit of the free market that still functions. Last summer the market worked efficiently after Katrina-- gas hit $3 a gallon, but soon supplies increased, usage went down, and the price returned to $2. In the 1980s, market forces took oil from $40 per barrel to $10 per barrel, and no one cried for the oil companies that went bankrupt. Today increases are for the reasons mentioned above. It natural for labor to seek its highest wage, and businesses to strive for the greatest profit. That the way the market works. When the free market is allowed to work, it the consumer who ultimately determines price and quality, with labor and business accommodating consumer choices. Once this process is distorted by government, prices rise excessively, labor costs and profits are negatively affected, and problems emerge. Instead of fixing the problem, politicians and demagogues respond by demanding windfall profits taxes and price controls, while never questioning how previous government interference caused the whole mess in the first place. Never let it be said that higher oil prices and profits cause inflation; inflation of the money supply causes higher prices!

Since keeping interest rates below market levels is synonymous with new money creation by the Fed, the resulting business cycle, higher cost of living, and job losses all can be laid at the doorstep of the Fed. This burden hits the poor the most, making Fed taxation by inflation the worst of all regressive taxes. Statistics about revenues generated by the income tax are grossly misleading; in reality much harm is done by our welfare/warfare system supposedly designed to help the poor and tax the rich. Only sound money can rectify the blatant injustice of this destructive system.

The Founders understood this great danger, and voted overwhelmingly to reject mitting bills of credit,?the term they used for paper or fiat money. It too bad the knowledge and advice of our founders, and their mandate in the Constitution, are ignored today at our great peril. The current surge in gold prices-- which reflects our dollar devaluation-- is warning us to pay closer attention to our fiscal, monetary, entitlement, and foreign policy.



Meaning of the Gold Price-- Summation

A recent headline in the financial press announced that gold prices surged over concern that confrontation with Iran will further push oil prices higher. This may well reflect the current situation, but higher gold prices mainly reflect monetary expansion by the Federal Reserve. Dwelling on current events and their effect on gold prices reflects concern for symptoms rather than an understanding of the actual cause of these price increases. Without an enormous increase in the money supply over the past 35 years and a worldwide paper monetary system, this increase in the price of gold would not have occurred.

Certainly geo-political events in the Middle East under a gold standard would not alter its price, though they could affect the supply of oil and cause oil prices to rise. Only under conditions created by excessive paper money would one expect all or most prices to rise. This is a mere reflection of the devaluation of the dollar.

Particular things to remember:


If one endorses small government and maximum liberty, one must support commodity money.

One of the strongest restraints against unnecessary war is a gold standard.

Deficit financing by government is severely restricted by sound money.

The harmful effects of the business cycle are virtually eliminated with an honest gold standard.

Saving and thrift are encouraged by a gold standard; and discouraged by paper money.

Price inflation, with generally rising price levels, is characteristic of paper money. Reports that the consumer price index and the producer price index are rising are distractions: the real cause of inflation is the Fed creation of new money.

Interest rate manipulation by central bank helps the rich, the banks, the government, and the politicians.

Paper money permits the regressive inflation tax to be passed off on the poor and the middle class.

Speculative financial bubbles are characteristic of paper money-- not gold.

Paper money encourages economic and political chaos, which subsequently causes a search for scapegoats rather than blaming the central bank.

Dangerous protectionist measures frequently are implemented to compensate for the dislocations caused by fiat money.

Paper money, inflation, and the conditions they create contribute to the problems of illegal immigration.

The value of gold is remarkably stable.

The dollar price of gold reflects dollar depreciation.

Holding gold helps preserve and store wealth, but technically gold is not a true investment.



Since 2001 the dollar has been devalued by 60%.

In 1934 FDR devalued the dollar by 41%.

In 1971 Nixon devalued the dollar by 7.9%.

In 1973 Nixon devalued the dollar by 10%.

These were momentous monetary events, and every knowledgeable person worldwide paid close attention. Major changes were endured in 1979 and 1980 to save the dollar from disintegration. This involved a severe recession, interest rates over 21%, and general price inflation of 15%.

Today we face a 60% devaluation and counting, yet no one seems to care. It of greater significance than the three events mentioned above. And yet the one measurement that best reflects the degree of inflation, the Fed and our government deny us. Since March, M3 reporting has been discontinued. For starters, I like to see Congress demand that this report be resumed. I fully believe the American people and Congress are entitled to this information. Will we one day complain about false intelligence, as we have with the Iraq war? Will we complain about not having enough information to address monetary policy after it too late?

If ever there was a time to get a handle on what sound money is and what it means, that time is today.

Inflation, as exposed by high gold prices, transfers wealth from the middle class to the rich, as real wages decline while the salaries of CEOs, movie stars, and athletes skyrocket-- along with the profits of the military industrial complex, the oil industry, and other special interests.

A sharply rising gold price is a vote of o confidence?in Congress?ability to control the budget, the Fed ability to control the money supply, and the administration ability to bring stability to the Middle East.

Ultimately, the gold price is a measurement of trust in the currency and the politicians who run the country. It been that way for a long time, and is not about to change.

If we care about the financial system, the tax system, and the monumental debt wee accumulating, we must start talking about the benefits and discipline that come only with a commodity standard of money-- money the government and central banks absolutely cannot create out of thin air.

Economic law dictates reform at some point. But should we wait until the dollar is 1/1,000 of an ounce of gold or 1/2,000 of an ounce of gold? The longer we wait, the more people suffer and the more difficult reforms become. Runaway inflation inevitably leads to political chaos, something numerous countries have suffered throughout the 20th century. The worst example of course was the German inflation of the 1920s that led to the rise of Hitler. Even the communist takeover of China was associated with runaway inflation brought on by Chinese Nationalists. The time for action is now, and it is up to the American people and the U.S. Congress to demand it.

--------------------------------------------------------------------------------

HON. RON PAUL OF TEXAS
Before the U.S. House of Representatives

February 15, 2006


The End of Dollar Hegemony

A hundred years ago it was called 「dollar diplomacy.」 After World War II, and especially after the fall of the Soviet Union in 1989, that policy evolved into 「dollar hegemony.」 But after all these many years of great success, our dollar dominance is coming to an end.

It has been said, rightly, that he who holds the gold makes the rules. In earlier times it was readily accepted that fair and honest trade required an exchange for something of real value.

First it was simply barter of goods. Then it was discovered that gold held a universal attraction, and was a convenient substitute for more cumbersome barter transactions. Not only did gold facilitate exchange of goods and services, it served as a store of value for those who wanted to save for a rainy day.

Though money developed naturally in the marketplace, as governments grew in power they assumed monopoly control over money. Sometimes governments succeeded in guaranteeing the quality and purity of gold, but in time governments learned to outspend their revenues. New or higher taxes always incurred the disapproval of the people, so it wasn』t long before Kings and Caesars learned how to inflate their currencies by reducing the amount of gold in each coin-- always hoping their subjects wouldn』t discover the fraud. But the people always did, and they strenuously objected.

This helped pressure leaders to seek more gold by conquering other nations. The people became accustomed to living beyond their means, and enjoyed the circuses and bread. Financing extravagances by conquering foreign lands seemed a logical alternative to working harder and producing more. Besides, conquering nations not only brought home gold, they brought home slaves as well. Taxing the people in conquered territories also provided an incentive to build empires. This system of government worked well for a while, but the moral decline of the people led to an unwillingness to produce for themselves. There was a limit to the number of countries that could be sacked for their wealth, and this always brought empires to an end. When gold no longer could be obtained, their military might crumbled. In those days those who held the gold truly wrote the rules and lived well.

That general rule has held fast throughout the ages. When gold was used, and the rules protected honest commerce, productive nations thrived. Whenever wealthy nations-- those with powerful armies and gold-- strived only for empire and easy fortunes to support welfare at home, those nations failed.

Today the principles are the same, but the process is quite different. Gold no longer is the currency of the realm; paper is. The truth now is: 「He who prints the money makes the rules」-- at least for the time being. Although gold is not used, the goals are the same: compel foreign countries to produce and subsidize the country with military superiority and control over the monetary printing presses.

Since printing paper money is nothing short of counterfeiting, the issuer of the international currency must always be the country with the military might to guarantee control over the system. This magnificent scheme seems the perfect system for obtaining perpetual wealth for the country that issues the de facto world currency. The one problem, however, is that such a system destroys the character of the counterfeiting nation』s people-- just as was the case when gold was the currency and it was obtained by conquering other nations. And this destroys the incentive to save and produce, while encouraging debt and runaway welfare.

The pressure at home to inflate the currency comes from the corporate welfare recipients, as well as those who demand handouts as compensation for their needs and perceived injuries by others. In both cases personal responsibility for one』s actions is rejected.

When paper money is rejected, or when gold runs out, wealth and political stability are lost. The country then must go from living beyond its means to living beneath its means, until the economic and political systems adjust to the new rules-- rules no longer written by those who ran the now defunct printing press.

「Dollar Diplomacy,」 a policy instituted by William Howard Taft and his Secretary of State Philander C. Knox, was designed to enhance U.S. commercial investments in Latin America and the Far East. McKinley concocted a war against Spain in 1898, and (Teddy) Roosevelt』s corollary to the Monroe Doctrine preceded Taft』s aggressive approach to using the U.S. dollar and diplomatic influence to secure U.S. investments abroad. This earned the popular title of 「Dollar Diplomacy.」 The significance of Roosevelt』s change was that our intervention now could be justified by the mere 「appearance」 that a country of interest to us was politically or fiscally vulnerable to European control. Not only did we claim a right, but even an official U.S. government 「obligation」 to protect our commercial interests from Europeans.

This new policy came on the heels of the 「gunboat」 diplomacy of the late 19th century, and it meant we could buy influence before resorting to the threat of force. By the time the 「dollar diplomacy」 of William Howard Taft was clearly articulated, the seeds of American empire were planted. And they were destined to grow in the fertile political soil of a country that lost its love and respect for the republic bequeathed to us by the authors of the Constitution. And indeed they did. It wasn』t too long before dollar 「diplomacy」 became dollar 「hegemony」 in the second half of the 20th century.

This transition only could have occurred with a dramatic change in monetary policy and the nature of the dollar itself.

Congress created the Federal Reserve System in 1913. Between then and 1971 the principle of sound money was systematically undermined. Between 1913 and 1971, the Federal Reserve found it much easier to expand the money supply at will for financing war or manipulating the economy with little resistance from Congress-- while benefiting the special interests that influence government.

Dollar dominance got a huge boost after World War II. We were spared the destruction that so many other nations suffered, and our coffers were filled with the world』s gold. But the world chose not to return to the discipline of the gold standard, and the politicians applauded. Printing money to pay the bills was a lot more popular than taxing or restraining unnecessary spending. In spite of the short-term benefits, imbalances were institutionalized for decades to come.

The 1944 Bretton Woods agreement solidified the dollar as the preeminent world reserve currency, replacing the British pound. Due to our political and military muscle, and because we had a huge amount of physical gold, the world readily accepted our dollar (defined as 1/35th of an ounce of gold) as the world』s reserve currency. The dollar was said to be 「as good as gold,」 and convertible to all foreign central banks at that rate. For American citizens, however, it remained illegal to own. This was a gold-exchange standard that from inception was doomed to fail.

The U.S. did exactly what many predicted she would do. She printed more dollars for which there was no gold backing. But the world was content to accept those dollars for more than 25 years with little question-- until the French and others in the late 1960s demanded we fulfill our promise to pay one ounce of gold for each $35 they delivered to the U.S. Treasury. This resulted in a huge gold drain that brought an end to a very poorly devised pseudo-gold standard.

It all ended on August 15, 1971, when Nixon closed the gold window and refused to pay out any of our remaining 280 million ounces of gold. In essence, we declared our insolvency and everyone recognized some other monetary system had to be devised in order to bring stability to the markets.

Amazingly, a new system was devised which allowed the U.S. to operate the printing presses for the world reserve currency with no restraints placed on it-- not even a pretense of gold convertibility, none whatsoever! Though the new policy was even more deeply flawed, it nevertheless opened the door for dollar hegemony to spread.

Realizing the world was embarking on something new and mind boggling, elite money managers, with especially strong support from U.S. authorities, struck an agreement with OPEC to price oil in U.S. dollars exclusively for all worldwide transactions. This gave the dollar a special place among world currencies and in essence 「backed」 the dollar with oil. In return, the U.S. promised to protect the various oil-rich kingdoms in the Persian Gulf against threat of invasion or domestic coup. This arrangement helped ignite the radical Islamic movement among those who resented our influence in the region. The arrangement gave the dollar artificial strength, with tremendous financial benefits for the United States. It allowed us to export our monetary inflation by buying oil and other goods at a great discount as dollar influence flourished.

This post-Bretton Woods system was much more fragile than the system that existed between 1945 and 1971. Though the dollar/oil arrangement was helpful, it was not nearly as stable as the pseudo gold standard under Bretton Woods. It certainly was less stable than the gold standard of the late 19th century.

During the 1970s the dollar nearly collapsed, as oil prices surged and gold skyrocketed to $800 an ounce. By 1979 interest rates of 21% were required to rescue the system. The pressure on the dollar in the 1970s, in spite of the benefits accrued to it, reflected reckless budget deficits and monetary inflation during the 1960s. The markets were not fooled by LBJ』s claim that we could afford both 「guns and butter.」

Once again the dollar was rescued, and this ushered in the age of true dollar hegemony lasting from the early 1980s to the present. With tremendous cooperation coming from the central banks and international commercial banks, the dollar was accepted as if it were gold.

Fed Chair Alan Greenspan, on several occasions before the House Banking Committee, answered my challenges to him about his previously held favorable views on gold by claiming that he and other central bankers had gotten paper money-- i.e. the dollar system-- to respond as if it were gold. Each time I strongly disagreed, and pointed out that if they had achieved such a feat they would have defied centuries of economic history regarding the need for money to be something of real value. He smugly and confidently concurred with this.

In recent years central banks and various financial institutions, all with vested interests in maintaining a workable fiat dollar standard, were not secretive about selling and loaning large amounts of gold to the market even while decreasing gold prices raised serious questions about the wisdom of such a policy. They never admitted to gold price fixing, but the evidence is abundant that they believed if the gold price fell it would convey a sense of confidence to the market, confidence that they indeed had achieved amazing success in turning paper into gold.

Increasing gold prices historically are viewed as an indicator of distrust in paper currency. This recent effort was not a whole lot different than the U.S. Treasury selling gold at $35 an ounce in the 1960s, in an attempt to convince the world the dollar was sound and as good as gold. Even during the Depression, one of Roosevelt』s first acts was to remove free market gold pricing as an indication of a flawed monetary system by making it illegal for American citizens to own gold. Economic law eventually limited that effort, as it did in the early 1970s when our Treasury and the IMF tried to fix the price of gold by dumping tons into the market to dampen the enthusiasm of those seeking a safe haven for a falling dollar after gold ownership was re-legalized.

Once again the effort between 1980 and 2000 to fool the market as to the true value of the dollar proved unsuccessful. In the past 5 years the dollar has been devalued in terms of gold by more than 50%. You just can』t fool all the people all the time, even with the power of the mighty printing press and money creating system of the Federal Reserve.

Even with all the shortcomings of the fiat monetary system, dollar influence thrived. The results seemed beneficial, but gross distortions built into the system remained. And true to form, Washington politicians are only too anxious to solve the problems cropping up with window dressing, while failing to understand and deal with the underlying flawed policy. Protectionism, fixing exchange rates, punitive tariffs, politically motivated sanctions, corporate subsidies, international trade management, price controls, interest rate and wage controls, super-nationalist sentiments, threats of force, and even war are resorted to—all to solve the problems artificially created by deeply flawed monetary and economic systems.

In the short run, the issuer of a fiat reserve currency can accrue great economic benefits. In the long run, it poses a threat to the country issuing the world currency. In this case that』s the United States. As long as foreign countries take our dollars in return for real goods, we come out ahead. This is a benefit many in Congress fail to recognize, as they bash China for maintaining a positive trade balance with us. But this leads to a loss of manufacturing jobs to overseas markets, as we become more dependent on others and less self-sufficient. Foreign countries accumulate our dollars due to their high savings rates, and graciously loan them back to us at low interest rates to finance our excessive consumption.

It sounds like a great deal for everyone, except the time will come when our dollars-- due to their depreciation-- will be received less enthusiastically or even be rejected by foreign countries. That could create a whole new ballgame and force us to pay a price for living beyond our means and our production. The shift in sentiment regarding the dollar has already started, but the worst is yet to come.

The agreement with OPEC in the 1970s to price oil in dollars has provided tremendous artificial strength to the dollar as the preeminent reserve currency. This has created a universal demand for the dollar, and soaks up the huge number of new dollars generated each year. Last year alone M3 increased over $700 billion.

The artificial demand for our dollar, along with our military might, places us in the unique position to 「rule」 the world without productive work or savings, and without limits on consumer spending or deficits. The problem is, it can』t last.

Price inflation is raising its ugly head, and the NASDAQ bubble-- generated by easy money-- has burst. The housing bubble likewise created is deflating. Gold prices have doubled, and federal spending is out of sight with zero political will to rein it in. The trade deficit last year was over $728 billion. A $2 trillion war is raging, and plans are being laid to expand the war into Iran and possibly Syria. The only restraining force will be the world』s rejection of the dollar. It』s bound to come and create conditions worse than 1979-1980, which required 21% interest rates to correct. But everything possible will be done to protect the dollar in the meantime. We have a shared interest with those who hold our dollars to keep the whole charade going.

Greenspan, in his first speech after leaving the Fed, said that gold prices were up because of concern about terrorism, and not because of monetary concerns or because he created too many dollars during his tenure. Gold has to be discredited and the dollar propped up. Even when the dollar comes under serious attack by market forces, the central banks and the IMF surely will do everything conceivable to soak up the dollars in hope of restoring stability. Eventually they will fail.

Most importantly, the dollar/oil relationship has to be maintained to keep the dollar as a preeminent currency. Any attack on this relationship will be forcefully challenged—as it already has been.

In November 2000 Saddam Hussein demanded Euros for his oil. His arrogance was a threat to the dollar; his lack of any military might was never a threat. At the first cabinet meeting with the new administration in 2001, as reported by Treasury Secretary Paul O』Neill, the major topic was how we would get rid of Saddam Hussein-- though there was no evidence whatsoever he posed a threat to us. This deep concern for Saddam Hussein surprised and shocked O』Neill.

It now is common knowledge that the immediate reaction of the administration after 9/11 revolved around how they could connect Saddam Hussein to the attacks, to justify an invasion and overthrow of his government. Even with no evidence of any connection to 9/11, or evidence of weapons of mass destruction, public and congressional support was generated through distortions and flat out misrepresentation of the facts to justify overthrowing Saddam Hussein.

There was no public talk of removing Saddam Hussein because of his attack on the integrity of the dollar as a reserve currency by selling oil in Euros. Many believe this was the real reason for our obsession with Iraq. I doubt it was the only reason, but it may well have played a significant role in our motivation to wage war. Within a very short period after the military victory, all Iraqi oil sales were carried out in dollars. The Euro was abandoned.

In 2001, Venezuela』s ambassador to Russia spoke of Venezuela switching to the Euro for all their oil sales. Within a year there was a coup attempt against Chavez, reportedly with assistance from our CIA.

After these attempts to nudge the Euro toward replacing the dollar as the world』s reserve currency were met with resistance, the sharp fall of the dollar against the Euro was reversed. These events may well have played a significant role in maintaining dollar dominance.

It』s become clear the U.S. administration was sympathetic to those who plotted the overthrow of Chavez, and was embarrassed by its failure. The fact that Chavez was democratically elected had little influence on which side we supported.

Now, a new attempt is being made against the petrodollar system. Iran, another member of the 「axis of evil,」 has announced her plans to initiate an oil bourse in March of this year. Guess what, the oil sales will be priced Euros, not dollars.

Most Americans forget how our policies have systematically and needlessly antagonized the Iranians over the years. In 1953 the CIA helped overthrow a democratically elected president, Mohammed Mossadeqh, and install the authoritarian Shah, who was friendly to the U.S. The Iranians were still fuming over this when the hostages were seized in 1979. Our alliance with Saddam Hussein in his invasion of Iran in the early 1980s did not help matters, and obviously did not do much for our relationship with Saddam Hussein. The administration announcement in 2001 that Iran was part of the axis of evil didn』t do much to improve the diplomatic relationship between our two countries. Recent threats over nuclear power, while ignoring the fact that they are surrounded by countries with nuclear weapons, doesn』t seem to register with those who continue to provoke Iran. With what most Muslims perceive as our war against Islam, and this recent history, there』s little wonder why Iran might choose to harm America by undermining the dollar. Iran, like Iraq, has zero capability to attack us. But that didn』t stop us from turning Saddam Hussein into a modern day Hitler ready to take over the world. Now Iran, especially since she』s made plans for pricing oil in Euros, has been on the receiving end of a propaganda war not unlike that waged against Iraq before our invasion.

It』s not likely that maintaining dollar supremacy was the only motivating factor for the war against Iraq, nor for agitating against Iran. Though the real reasons for going to war are complex, we now know the reasons given before the war started, like the presence of weapons of mass destruction and Saddam Hussein』s connection to 9/11, were false. The dollar』s importance is obvious, but this does not diminish the influence of the distinct plans laid out years ago by the neo-conservatives to remake the Middle East. Israel』s influence, as well as that of the Christian Zionists, likewise played a role in prosecuting this war. Protecting 「our」 oil supplies has influenced our Middle East policy for decades.

But the truth is that paying the bills for this aggressive intervention is impossible the old fashioned way, with more taxes, more savings, and more production by the American people. Much of the expense of the Persian Gulf War in 1991 was shouldered by many of our willing allies. That』s not so today. Now, more than ever, the dollar hegemony-- it』s dominance as the world reserve currency-- is required to finance our huge war expenditures. This $2 trillion never-ending war must be paid for, one way or another. Dollar hegemony provides the vehicle to do just that.

For the most part the true victims aren』t aware of how they pay the bills. The license to create money out of thin air allows the bills to be paid through price inflation. American citizens, as well as average citizens of Japan, China, and other countries suffer from price inflation, which represents the 「tax」 that pays the bills for our military adventures. That is until the fraud is discovered, and the foreign producers decide not to take dollars nor hold them very long in payment for their goods. Everything possible is done to prevent the fraud of the monetary system from being exposed to the masses who suffer from it. If oil markets replace dollars with Euros, it would in time curtail our ability to continue to print, without restraint, the world』s reserve currency.

It is an unbelievable benefit to us to import valuable goods and export depreciating dollars. The exporting countries have become addicted to our purchases for their economic growth. This dependency makes them allies in continuing the fraud, and their participation keeps the dollar』s value artificially high. If this system were workable long term, American citizens would never have to work again. We too could enjoy 「bread and circuses」 just as the Romans did, but their gold finally ran out and the inability of Rome to continue to plunder conquered nations brought an end to her empire.

The same thing will happen to us if we don』t change our ways. Though we don』t occupy foreign countries to directly plunder, we nevertheless have spread our troops across 130 nations of the world. Our intense effort to spread our power in the oil-rich Middle East is not a coincidence. But unlike the old days, we don』t declare direct ownership of the natural resources-- we just insist that we can buy what we want and pay for it with our paper money. Any country that challenges our authority does so at great risk.

Once again Congress has bought into the war propaganda against Iran, just as it did against Iraq. Arguments are now made for attacking Iran economically, and militarily if necessary. These arguments are all based on the same false reasons given for the ill-fated and costly occupation of Iraq.

Our whole economic system depends on continuing the current monetary arrangement, which means recycling the dollar is crucial. Currently, we borrow over $700 billion every year from our gracious benefactors, who work hard and take our paper for their goods. Then we borrow all the money we need to secure the empire (DOD budget $450 billion) plus more. The military might we enjoy becomes the 「backing」 of our currency. There are no other countries that can challenge our military superiority, and therefore they have little choice but to accept the dollars we declare are today』s 「gold.」 This is why countries that challenge the system-- like Iraq, Iran and Venezuela-- become targets of our plans for regime change.

Ironically, dollar superiority depends on our strong military, and our strong military depends on the dollar. As long as foreign recipients take our dollars for real goods and are willing to finance our extravagant consumption and militarism, the status quo will continue regardless of how huge our foreign debt and current account deficit become.

But real threats come from our political adversaries who are incapable of confronting us militarily, yet are not bashful about confronting us economically. That』s why we see the new challenge from Iran being taken so seriously. The urgent arguments about Iran posing a military threat to the security of the United States are no more plausible than the false charges levied against Iraq. Yet there is no effort to resist this march to confrontation by those who grandstand for political reasons against the Iraq war.

It seems that the people and Congress are easily persuaded by the jingoism of the preemptive war promoters. It』s only after the cost in human life and dollars are tallied up that the people object to unwise militarism.

The strange thing is that the failure in Iraq is now apparent to a large majority of American people, yet they and Congress are acquiescing to the call for a needless and dangerous confrontation with Iran.

But then again, our failure to find Osama bin Laden and destroy his network did not dissuade us from taking on the Iraqis in a war totally unrelated to 9/11.

Concern for pricing oil only in dollars helps explain our willingness to drop everything and teach Saddam Hussein a lesson for his defiance in demanding Euros for oil.

And once again there』s this urgent call for sanctions and threats of force against Iran at the precise time Iran is opening a new oil exchange with all transactions in Euros.

Using force to compel people to accept money without real value can only work in the short run. It ultimately leads to economic dislocation, both domestic and international, and always ends with a price to be paid.

The economic law that honest exchange demands only things of real value as currency cannot be repealed. The chaos that one day will ensue from our 35-year experiment with worldwide fiat money will require a return to money of real value. We will know that day is approaching when oil-producing countries demand gold, or its equivalent, for their oil rather than dollars or Euros. The sooner the better.