62. Two decisions and the worth of US economy

Hi friends

Today I would like to continue my non-specialist analysis of the global financial crisis, its origin and consequences. Actually, I  hesitated to name this series “Global crisis for dummies” but realized after some email conversations – there is a good chance that I am the only dummy around

As I have explained last time, there were two key decisions made by FED that lay in the origin of the present financial crisis. The first one was made in 1971 under the rule of the Nixon’s administration, and never after the US dollar was backed up by a gold standard. Development of the crisis of 70s shows from my point of view that the FED print service was not quite under control already earlier (exceeding amount of cash was printed) – both budget deficits and inflation were in place during 60s, the situation being remarkably similar to what happens now.

Although gold standard was left, another kind of the backup appeared at that time: US authorities came into agreement with OPEC to price oil exclusively in US dollars for all transactions worldwide. The price US have paid to OPEC was promise to protect Persian Gulf countries against domestic coups or invasions. In essence, the only backup US dollar had after 1971 was US military power, clearly, very hard to estimate the internal worth of this component of the world’s economy, if possible at all.

US dollar took the place of gold in the world’s trade, in particular, it became the world’s foremost reserve currency, and the FED printing service acquired an additional degree of freedom – eurodollars. Printing eurodollars in excessive amounts allows (well, allowed at least) the internal worth of the US economy nominated in US dollars to grow. In particular, US is (was) able to maintain trade deficits so necessary for US economy without decreasing the value of US dollar.

One can take a look on the following picture as a simple illustration (stolen from uzhas_sovka himself):

A European Guy, I am not sure what is the price or pork in a mall in Madrid, but here in Finland we can hardly buy a piece of not-super-quality pork for less than 6 euros/kg (on sale):

So, as I can say in answer to your comment, indeed, I have an impression that US can easily regulate the internal worth of its economy because the latter is nominated in US dollars. This has a price of course – development of instabilities in the overall financial system. Pumping cash into the system is analogous to pumping the energy into the flow of a fluid by an external force – as a result, turbulence may develop.

The second decision I have mentioned was made by FED around 2006. It looks like at this point the amount of eurodollars so much exceeded any meaningful bound that FED was a kind of scared to deliver information about that amount. The development of the crisis was well on its way as the unprecedent growth of US total public debt (and external debt in particular) shows:

In conclusion, the US economy has of course some intrinsic value (nominated, say, in gigawatts of power or liters of gasoline or ounces of gold), and the latter should be very seriously overestimated while nominated in US dollars. The surplus, amount of US dollars which are backed by the price of paper they are printed on, should clearly go somewhere. Where does it go? I will discuss it in the next post.