Central Banks

Money from nothing

Originally published in the July 2007 issue

The last central banker to get it right was Joseph, in the Bible, seven good years followed by seven bad years, but he had God’s help. The US Federal Reserve Bank was created in 1914: The FED was created by the government. Currency values are the market’s perception for future government policies and central banks’ actions. Government policies are determined by politics. The definition of politics is ‘the advance auction of goods that have not yet been stolen’. The demands of the majority are always greater than taxation alone will provide and that’s where the central bank comes in and fills the demand with new dollars.

Since the FED’s creation, the value of the dollar has declined 97%. Due to that stellar performance, the dollar became the world’s reserve currency. As the world’s reserve currency, the US has had the advantage of exchanging a massive amount of IOU’s (US treasuries) for goods, assets and real wealth. All around the world central banks have learned, from the FED, to print more money. In the 60’s, the US had a trade deficit with Japan. The exchange rate then was approximately 300 yen to the dollar. Now it is 117 yen to the dollar; a 60% plus decline and we have had a trade deficit with Japan every year since 1960. Currently the US wants China to let the Yuan appreciate. It will, but it won’t make any difference. The Yuan would have to increase over 10 fold to bring wage rates in line with G-7.

Japan and China have purchased massive amounts of US treasuries to stem the dollar’s decline. They loan us money to buy their products because they need the US as a customer. When will this end? When the Asian Tigers develop a consumer credit system and their three billion plus citizens become the customer. At that point we will no longer be able to live beyond our means – the dollar decline will accelerate and interest rates will rise.

The dollar has instructions in faith right on it, “In God We Trust.” Placing your faith in the FED could be a dangerous action. Prior to the creation of the FED, the worst bank panic caused 2.8% of the banks to fail in 1873. Following the creation of the FED, almost 50% of the banks failed during the 30’s. The FED made a local problem national – now the problem is global, a brilliantly executed, bad plan. Someday, the dollar could fall to its intrinsic value. Currencies do not float, they sink at varying rates. Currencies are abstractions not redeemable in any specific amount of anything, they are an ‘I owe you nothing certificate’.

The FED’s invisible hand of intervention is trying to keep interest rates as low as the world will allow. But the world is becoming a bit nervous. The US has borrowed over $1 trillion overseas. Some day it will be repatriated. The exchange of paper for wealth will go into reverse. We will get our paper back and have to return real wealth. Our biggest export under Greenspan’s term was the US Dollar.

During Alan Greenspan’s term at the FED the dollar declined 37% so he was nicknamed ‘The Maestro’. The FED is like the post office, giving out money instead of stamps. Faith in the FED is based on elaborate mathematical models relying on the breathtakingly faulty assumption that human beings behave rationally.

We all work for something. Central banks manufacture, with no sweat, no work, no creativity, no risk; they just turn on the computer and create more currency.

Greenspan at the FED continued with the policy that reduced the value of the currency 21/2 % to 3% per year. During Greenspan’s leadership the world accumulated over 2 trillion US dollars. Foreigners currently own over 45% of US treasuries. Now Greenspan has left the FED and helicopter Ben Bernanke has taken his place. The FED is currently attempting a neutral interest rate policy. Neutral for the FED is like pornography to the Supreme Court.

They can’t define it, but they claim they will know it when they see it. Recently, the FED has raised the rent they charge for money but until just the last month or so, if you could fog a mirror with your breath, you could borrow all you wanted.

For years Japan, China, and other countries have sent us Toyotas, Sonys and other consumer goods, we in turn send them ‘IOU’s’. When the next recession starts later this year, Bernanke will lower interest rates and start the helicopter. Foreign dollar holders don’t vote, so the dollar will be sacrificed. One of the first Japanese imports into the United States was little umbrellas to keep our drinks shaded from the sun. Some day the US will send Japan little umbrellas with treasury bills on top to keep their drinks shaded.

Clyde C. Harrison is President and Director of Brookshire, which designs, develops, markets and manages raw material-based financial products for institutional, private and public investors.

Brookshire Raw Materials: strategiesand systems

The returns of the Brookshire Core Group of Funds stem from much more than the simple appreciation of raw materials. The returns on the funds come from (i) the expected price appreciation of raw materials; (ii) monthly rebalancing; (iii) the returns from backwardation; and (iv) the returns from a portfolio of investment grade fixed income securities held as collateral for raw materials futures.

Monthly Rebalancing

Monthly rebalancing forces the funds to buy low and sell high on a monthly basis allowing for small incremental gains in the market to be redistributed across all raw materials.

For example, an increase in the price of crude oil would require selling some crude contracts to adhere to the 23% weight assigned to crude positions. The gains on crude would be distributed across the index as additional contracts of other raw materials would be purchased.

The benefits of monthly rebalancing stretch from bull markets to bear. In an upward market they take the profits from raw materials that have appreciated in price and distribute them across the other constituents of the fund. In bear markets monthly it softens the downward pull of falling prices on the fund. In sideways markets, it redistributes the benefits of transient upswings in the market and takes advantage of downfalls by forcing the fund to open additional positions in relatively cheap raw materials.

In short, rebalancing profits from the volatility of the market and generates a return which far less volatile than investing independently in commodities.