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Changing of the Guard! ( 0) Printer friendly page Print This
By Michael C Feltham
Axis of Logic
Sunday, Oct 12, 2008

The currently roiling global capital markets and US focus on the dismal bail out plan, perhaps conceals a critical reality, which will rapidly affect each and every United States citizen. 

Since the end of hostilities in 1945, its industrial might have neatly positioned the U.S. to have become the single global super-power: alone, unchallenged and of all developed industrialised nations, totally intact, with no structural damage to its physical self and infrastructure. 

Perhaps most critically of all, the USA had amassed huge gold bullion reserves, making the US Dollar the hardest and most desirable post-war currency. 

Aware of this, and the need to promote political and economic stability in the nations now devastated by global war, the Bretton Woods Conference in New Jersey, 1944 was a meeting of accord: one of the critical delegates being John Maynard Keynes, the eminent British economist and philosopher. 

Keynes had early on realised just how the post-war World might be and had developed plans to replace earlier systems of value exchange in international trade. With the singular exception of America, previously stable countries and currencies were destroyed. 

The conference agreed on the founding of a new global monetary body; the IMF. Additionally the World Bank was created to assist struggling states to re-build their infrastructure, industries and societies. 

(The “World Bank Group” is actually a collection of five different agencies: the first the IBRD –International Bank for Reconstruction and Development – was the first, established in 1945.) 

The agreement created a new basis for currency valuation and exchange: it was called Managed Flexibility. Under this regime, the value of bullion gold was fixed at $35 per ounce (Bearing in mind bullion is weighed under the Troy weight system with 12 ounces equalling one pound), and all participating currencies “pegged” at an exchange rate to the US Dollar, with only a small tolerance of divergence permitted. 

The Dollar was then fixed to all member currencies: in March 1947, when the system became operational this was set at $ 4.03 to the Pound Sterling, for example (December 1945) and had dropped through $2.8 by September 1949 and by November 1967 to $2.4, which is wholly indicative of the dominance of the US currency throughout that period.

The net result of this accord was to place the US Dollar firmly at the pinnacle of global finance: further, since the USA were very much the largest and wealthiest member of IMF and IBRD, policy could be bent to suit both US economic and foreign policy requirements, and this reality was to establish American banks and investment banks and trans-national trading corporations very much in the driving seat of World trade.

Another quirky reality was that post WW II, most international transactions were priced in US dollars, including the oil and gas industry, aviation, shipping, insurance and commodities. Mainly since exporters and sellers felt secure in their pricing, with other global currencies at risk of sudden devaluations and thus capital loss. 

As Asia expanded, all exports tended to be priced in dollars too, particularly so in Japan and Hong Kong and then Taiwan.  

Additionally, starting with George Marshall’s aid programme (Marshall Aid) and subsequent initiatives, aimed at creating economic and political stability amongst war-torn nations, a massive outpouring of US dollars commenced. 

And this has continued, perhaps peaking during Nixon’s flawed presidency, as the dollar printing press was worked 24/7, to fund the external cost of the Vietnam War. 

Indeed, this vast wash of money set the US dollar as the major reserve currency. Another facet was inevitably, the use of these “External” dollars for financing in the private sector. The start and stratospheric growth of the Eurobond Market in the 1970s, can be attributed to the wash of external US currency surging around the World’s currency systems and much of it, in Europe, as the result of the Marshall Aid Plan. 

Always ready to oblige, successive presidencies continued to operate deficit financing budgets and fiscal approaches and in the 1970s, two realities occurred. Firstly, having risen like the Phoenix from the radioactive dust of Hiroshima and Nagasaki, the Japanese industrial machine had increasingly shifted to high gear. By the 1980s Japan had amassed vast foreign exchange reserves, most of it US dollars and was regularly successfully bidding on circa 30% of US Treasury Bills (T Bills) at each monthly auction. 

(Treasury Bills are used to raise short-term government financing and enjoy a tenor – life – of just 90 days to maturity. Most investors simply roll over their cash each month keeping their level of funds static or increasing: as did Japan The Fed, of course with so many willing takers simple upped the ante and kept on increasing the total!) 

All of this allowed the US banking and finance system to dominate the World, ably assisted by the reality that the Chairman of the World Bank Group was always American, which diktat was enshrined in its charter. 

Emerging and rapidly industrialising states adopted the US system and fell into line behind the then global leaders, such as Morgans, Bank of America etc.  If you are the new boy, then you tend to follow what already exists: for the time being, that is. 

US banks led the market

"Globalisation", as it is now called, was first created by trans-national trading multinational corporations, “Hoovering up” local companies and markets; rocket scientists worked out ever more complex and arcane bets; derivatives created a fabric of intertwined obligation and counter-obligations: greed, venality total lack of probity and amorality of conscience prevailed. 

As one risky position seemed to be accepted, then another was quickly dreamed up.

What has recently happened is not an isolated event, as G7 politicians would have one believe: rather, it’s the culmination of nearly thirty years of double dealing and insane risk taking: using some other fool’s cash!

The writing was already on the wall, for those with clarity of vision and sense of impending doom, by late 1998 when Long Term Capital Management crashed, after contracting vast capital exposures on mathematically engineered rocket science financial instruments. 

It is very well worth recalling the cause of this fiasco and its downside. An excellent analysis may be found in Lessons From The Collapse Of Hedge Fund, Long-Term Capital Management  

Particular attention should be paid to the final treatise and explanation and the role and risk exposure of UBS bank:  

An additional driver of huge funds accessed by US banks and Investment banks was the early 1970s action by OPEC states, who took control over their core assets: crude oil and natural gas. They also hiked prices by up to four times! And, coincidentally, tripped a global mini-recession. 

Suddenly, as a direct result of this action, they were awash with cash 

Thus a new player on the block emerged: the phenomenon of what came to be called Petro-Dollars rapidly exploded and vast amounts of currency needed a home. US banks quickly obliged. They tended, in conjunction with major European banks to willingly take petro-dollar deposits and then “Wholesale” this cash down through the financial structure and eventually, into the retail banking and financing sector. 

It became a neat quid pro quo! America would continue to overspend vast sums on defence, and public expenditures: and Arab states and Japan etc would finance it. 

Concurrently, it would progress with the imbalance in its current account and import far more than it exported thus creating and sustaining a massive Balance of Trade Deficit.  

At this juncture, it is perhaps an aid to clarity to consider the present position on which states hold how much foreign currency reserves.


Country/Monetary Authority

Foreign exchange reserves
(millions of USD)

Figures as of the following dates

 World (sum of all countries)

$ 7,565,706



 People's Republic of China
(does not include Hong Kong
SAR Macau SAR)

$ 1,808,828

June 2008



$ 995,800

Sep 2008



$ 546,100

Oct 2008

(EU member states which have adopted the euro, incl. ECB)

$ 563,426

March 2008



$ 283,900

Oct 2008


 Republic of China (Taiwan)

$ 281,130

Sep 2008


 South Korea

$ 239,200

Sep 2008



$ 206,510

Sep 2008



$ 172,600

Aug 2008


Hong Kong

$ 153,200

Aug 2008



$ 149,806

September 2008



$ 143,942

April 2008



$ 119,588

May 2008



$ 109,700

September 2008



$ 101,500

Sep 2008



$ 102,173

May 2008


 United Kingdom

$ 99,956

March 2008



$ 84,000

Oct 2008



$ 81,000

May 2008



$ 80,669

March 2008



$ 79,000

September 2007



$ 78,187

August 2008



$ 76,966

March 2008


 United States

$ 75,850

March 2008

European Central Bank
(ECB, not owned by any
EU member)

$ 65,543

February 2008



$ 62,000

May 2008

Source: Wikipedia

Of particular criticality, perhaps are the reserves now built up by China: and most perverse and worrying of all, those of tiny Taiwan, a state with a population of circa 24 million only! 

Next, consider Balance of Trade: and in the case of the USA, deficit.


Now despite various financial and fiscal problems, Japan has not once, returned a Balance of Trade Deficit since its re-emergence. Not once. 

Table 1: Current Account Balance of Selected States, 2005 Estimate



Current account balance in US$ 



165.6 billion



160.8 billion



115.5 billion


Saudi Arabia

90.73 billion



84.25 billion



58.24 billion



49.49 billion



39.95 billion



32.74 billion



26.92 billion



-38.78 billion



-42.09 billion


United Kingdom

-57.61 billion



-83.14 billion


United States

-829.1 billion

Source: Economic and Social Research Council 


George W Bush’s illegal invasion of Iraq is an excellent example of unfettered, reckless and irresponsible deficit profligacy.


According to Joseph Stiglitz (Three Trillion Dollar War): this misadventure has already cost the US taxpayer in excess of $3 Trillion and rising.


Politicians and public servants could continue their prodigal ways and the American consumer could load up on imported toys and gimcrack and some dummy would always be around to pick up the tab!


Now a hidden aspect of external dollars is “seigniorage”: this, in one sense, is the Free Lunch a state receives when other states hold their currency as reserve. No interest is paid. At present, probably 30+% of external US dollars are held as non-interest charging deposits. This is about to change!


The US dollar is what is called a “Fiat” currency: in other words it has no particular bullion backing and is valued only on its credibility and the underlying stability of the economy of the issuing state.


Well, with recent events in Wall Street, one is compelled to say the dollar, internationally, is now less than triple A!


Significantly and seriously less.


And the belated, frenetic and wholly hollow gestures from the Fed and other Central Banks as a Knee Jerk reaction, throwing hundreds of billions of taxpayer’s cash into the already flawed system in the cause of promoting liquidity, simply exacerbate the reality: devaluing the core currency and driving down its international exchange value still further.


However, this Dollar-Centric global regime is finishing; mainly thanks to the now unsustainable nature of US deficits and the sheer risk exposure experienced by those holding large amounts of the currency.


Other disruptive tensions are at work in the fabric of globalised trade.


As we all know, the hitherto slumbering dragon, China has woken up in a rush. The dominance of China’s manufacturing and exporting industries have taken the World by storm! From a fairly lo-tech start, they have moved, increasingly into more demanding technological areas.


Perhaps this was demonstrated most by the successful launch into space of a Chinese astronaut, just after the brilliantly staged Beijing Olympics. One triumph following hard on the heels of another.


It is typically comforting for United States to say, well, they need us: we are their market!


This is self delusion.


Most interestingly, as this article was in preparation, I listened with great attention to a BBC radio interview with Chinese consumers and government ministers.


Following on from the South Korean example, the Chinese domestic consumer market is growing


Arrogant Western analysts like to believe that the average Chinese citizen still works for a bowl of rice a day.


Look at Korea (South) as a yardstick


Koreans, just 25 years back, worked on average six and one half days per week: annual leave was perhaps two or three days per annum in total. And for not much more than that bowl of rice a day!


Today, Korea is one of the most advanced technology countries in the World with the largest saturation of really high speed broadband, for example.


I well remember back in 1978 when I was involved in preparing financial analysis for a major development in Qatar and assisting with the search for suitable contractors.


Koreans were working in the Gulf States: the singular difference between Western ex pat construction workers and their Korean counterparts was local accommodation. Western guys demanded air-conditioned site buildings, refectories and the rest. The Koreans simply lived in the shipping containers. The ones they used to bring in equipment and materials from Seoul!


Things have moved on from there


Rapidly, Korean industry and determination have allowed their major corporations and conglomerates such as Hyundai to dominate the World.


Korea has the fastest, widest saturation broadband rollout in the World.


Its GSM cellular telephone networks lead the World: paying for random items, e.g. car parking is commonly with use of a mobile phone, as is banking on the move.


The Korean consumer market has expanded to the point where it is an equal with most of the West.


And, China is following; rapidly.


It is sobering to realise that the giant Korean electronics corporation, Samsung, is now in the global top three.


Chinese companies are catching up: fast. Their domestic market is expanding exponentially.


The United States isn't the only consumer of Chinese goods either: as India expands it is consuming rapidly.


And so is Europe: and the Euro is much more worthy and stable than the US dollar.


Plus with less exposure to Sub Prime investments, Europe will pull itself out of recession faster than the USA.


Eventually, at the right time, large holders of external US dollars as reserves will dump them increasingly more rapidly on the global forex markets: it's already happening.


As the US dollar value self-depreciates, ably aided and assisted by Paulson and Bernanke in their desperate yet doomed attempts to stave off reality, then large US dollar holder’s risk exposure diminishes.


The Euro is set to become the World's preferred reserve currency. For the moment: since internal economic and fiscal pressures inside the mechanism and the ECB’s lack of intelligent and rapid response to disparate state’s internal crises has caused tensions and lack of harmony.


Traditionally, countries built up their wealth and stability by prudence and saving. Indeed, Japan amassed its working capital from the diligent savings of millions of workers. Not a dangerous, fickle and out-of-control global market, which is short-term in view.


It is a fact that in the early 1970s when Japanese industrial effort was really moving into gear, and despite their size and asset bases, no one in London’s then new Interbank market wanted to lend to Japanese banks! Their “Names” were not accepted.


I know since I was working in London’s capital markets at the time; and did eventually manage to raise unsecured borrowing for one of the major Nippon banks: it was the hell of a struggle, though!


How times change


Most Western societies had followed the prudent model of personal savings being deposited and then lent out to worthy borrowers.


Previously, cash flowed into the institutions in the City of London and Wall Street et al (circa 85% of all new fresh funds inflow is to institutional investors), and then to the stock market, bonds, treasuries and banks.


This capital would then be “Re-Cycled”, through Institutional Investors, such as Insurance companies, investment operators, mutuals and pension providers. These would, in turn, invest wisely in stable and growing companies with real growth prospects. From this reality came the term “Bell Weather” stock: a reliable and long-term activity, which would weather ups and downs in the financial climate and still come through smiling.


However, the new breed of Gunslinger traders wanted overnight fame and fortune! Don’t we all. Not for them the slow, steady and stable ride into success. New technologies opened up the global financial village to the amoral and opportunistic. 


A new phenomenon of the 1970s was the Interbank market. It all started with money brokers liasing between major banks on a local basis: as globalised trade took off, then brokers became international. This was particularly boosted as countries like the UK removed post war exchange controls[1].


[1] Exchange Controls were invoked mainly post WW II, to conserve hard currency for essential imports. Those wishing to either export funds or buy external assets had firstly to gain permission from their central bank. In the UK, for example, the Exchange Control Act of 1948, was not finally repealed until 1979. The USA has never suffered Exchange Control.  


The beginnings of a Paradigm Shift in banking practice were sown: instead of relying mainly on depositors to fund lending, and restricting expansion to the slow growth in savings rates, now banks could access money via this new interbank facility.


Additionally and despite the relatively recent experience of insane risk taking and collapses caused by over-exposure to Third World Syndicated Loans in the late 70s and early 80s, which caused banking panics and meltdowns: regulation and oversight was increasingly loosened, with repeal, for example, of the Glass-Steagall Act.    


Fractional Reserve Lending became the norm


Perhaps right at this moment, the total collapse of Iceland through excessive bank borrowing and lending on the concept of Fractional Reserve Banking, stands as a good example.


Icelandic banks and financial services company jumped into the brave new world of the rapidly expanding global credit phenomenon. Entrepreneurs bought overseas companies, boosted by what seemed like endless supplies of easy loans. It all looked rosy.


Iceland, a charming country I visited in October 2001 to co-present a seminar was booming: it had rapidly changed the composition of its GDP from a traditional reliance on fishing and shipping of circa 90% to fishing and shipping just 10% and financial services 90% and enjoyed then the highest standard of living in the World.


Then reality came to pass: Icelandic banks had no fat. As the international credit market tightened and contracted they were broke.


Perhaps worst of all, the practice of lending long and borrowing short – at best a highly dangerous practice and one which breaks the first rule of safe banking! – became increasingly the norm. However the global interbank markets seemed ever ready to lend and roll over existing loans.


Financial markets have short memories! A moment’s study of what caused the demise of Continental Illinois Bank in 1984 would have provided good reason for caution.


However, the young and greedy traders were hungry for ever larger and obscene bonuses. And, of course, happy to take ever larger and more dangerous risks with someone else’s money!


Today’s banking crisis is a sort of turbocharged replay of an almost identical scenario, with the addition of new players in the parts of evermore complex and worryingly valueless credit instruments and derivative products.


Only the names have been changed: and the scale accelerated to the stratosphere.


So, where do we go now?


Back to sanity and a greater reliance on deposits from savers?


Not really. As the US economy has been crippled by takeover kings and Acquisition and Merger mania and well established old reliable businesses have been dismantled, asset stripped and bought and sold like Hershey bars, America has neatly reversed itself into a one-way street. Both blue and white-collar jobs have been shed in the dubious cause of efficiency.


These have been replaced by McJobs: the concept of service and retail activities, yet at wage and salary scales so far beneath before, that tens of millions of Americans cannot now afford decent healthcare insurance, let alone save for their old age. 



Savings Expressed as % of GDP







Korea (South)

















 (source: Nationmaster)


I also invite you to examine some of the other significant metrics!


It is an identical scene in the UK.


Worse, as costs and taxes rise – as they must to repay the hundreds of billions scattered around by Paulson and Bernanke and Brown and Darling in their vain endeavours of holding up reality – Joe Average will be less well placed than before to accumulate capital.


In previous economic downturns, America could rely on its inventiveness and industrial base to pull itself up by its financial socks.


With manufacturing plants all over continental USA shuttered and work transferred to Asia, Mexico and Eastern Europe, one is tempted to ask “What industrial base?”


Detroit? On its knees: both Ford and GM have just has their credit rating downgraded almost to junk by S & P.


In the 1970s, the Japanese Ministry of International Trade and Industry – MITI – developed its Grand Plan. Asia would become the World’s factory; the Americas the World’s farm: and Europe its leisure park.


OK, so some of their planning was off. No one could have foreseen the rapid rise and super-growth of China. However much of the plan remains intact.


Earlier we looked at which global powers hold the largest foreign exchange deposits and present the strongest Balance of Trade Surpluses.


It is pretty obvious where the winners are!


Most worrying of all, perhaps, is the size of the US Current Account Deficit: this is expressed as:


“The Economics Glossary defines the Current Account as the difference between a country's savings and its investment. "[If the current account balance is] positive, it measures the portion of a country's saving invested abroad; if negative, the portion of domestic investment financed by foreigners' savings."


Thus the question which must be asked is simply this: Will foreign nation states and major global investors continue to fund the US deficits and borrowing after this current financial and regulatory debacle?


I would say not.


Will the holders of the lion’s share of World currency reserves continue to allow the US banking system to screw up global financial and economic stability through greed, perfidy and malfeasance? After all, they didn’t create this global meltdown, America did. All the Asian banks and Sovereign Risk Funds did was suffer.


I have to say no once more!


Will the World’s major wealth producers and oil states continue to use a demeaned and wholly discredited fiat currency as a yardstick of exchange of value?


No again.


My forecast is a continuance of the Euro as the new reserve currency and medium of value exchange, until within a few short years a Currency Basket is agreed between emergent Islamic states, Russia and Asian locomotive economies.


The World is in for some serious rethinking and remodelling.


Let’s hope US politicians are wise enough to realise which side the bread is buttered this time around.


But they are politicians: and if I measure their brainpower and astuteness by the way Dems and Goppies alike voted through a complex 480 page Bail Out bill, with little or no analysis or oversight, but well larded by Pork Barrel goodies to get them onside, then I for one am not going to hold my breath!


[1] Exchange Controls were invoked mainly post WW II, to conserve hard currency for essential imports. Those wishing to either export funds or buy external assets had firstly to gain permission from their central bank. In the UK, for example, the Exchange Control Act of 1948, was not finally repealed until 1979. The USA has never suffered Exchange Control.


Author’s Comment

The central plank of this work, is to propose and support the core premise of America losing its favoured status of both owning the World’s major reserve currency and controlling the globe’s financial and banking systems. Additionally, I posit the inescapable reality that a continuum of other nation states funding profligate US deficits cannot and will not pertain.

Solid and empirical evidence is presented herewith as well as valuable anecdotal commentary and conclusion.

When presenting any work such as this, it is tempting to pursue the academic route and also produce rafts of supportive evidence and source references. Such a course would, I fear, add further difficulties to the reader’s cause and sanity!

One critical topic I have discussed at length with my Editor, Les Blough, is the separation of values for straight foreign currency reserve and investments in US Treasury paper.

Unfortunately, this is neither an easy nor transparent task, as reporting regimes vary significantly. The IMF is the most credible, since statistical lag is low and their regime demands clear division of values into component items. Unfortunately, however, China does not seem to report adequately!

However, a core aspect of my argument is the obvious dominance by China in possession of other state’s financial and treasury assets: and the paucity of same, sitting in the USA!

I thus adopt a middle course and included herewith a number of useful references from which most combinations of asset type and value may be culled.


© Copyright 2008 by

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Read Bio and Additional Articles by Michael Feltham in FELTHAM ON THE ECONOMY.

He can be reached at:


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