An article in The Independent newspaper caught a lot of attention a few days ago, whether it deserved it or not is a hard question to answer:

All the participants were certainly wearing their tinfoil hats. RGE Monitor points out:

Intermittently, oil exporters, especially Russia, Iran and Venezuela discuss moving away from pricing oil in dollars. OPEC members have tended to be divided on this issue. A October 2009 report, in the Independent, a British paper suggested that GCC countries had discussed moving away from dollar pricing with China and Russia. although the report was denied by Saudi Arabia, the largest OPEC producer which has a very large stock of US assets, it added to concerns that key creditors might move away from the U.S. dollar

Here, economics is nothing more than politics in drag. There is little in the way of fundamentals to support Russia’s or any other country’s refusal to accept dollars, save for Iran. Assets are frozen at the urging of the US and Iranian oil cannot be directly traded to the US; Europe and China are its best customer and accepting euros is reasonable under the circumstances.

Luis de Sousa wrote a commentary on The Oil Drum, using the world oil but never getting around the the heart of the matter:

If gold goes to 1500$ […] it has to do with the fact that the dollar is imploding […]

The Fed needs the dollar to get down by about half in the next 14 years. We have 60 trillion dollars of liabilities […] there’s no feasible combination of growth and taxes than can fund those liabilities. […] They need to do that, but that’s a dynamically unstable process. They would like to do it gradually, and that’s the plan, but if the market gets ahead of it, if the market sees this playing (which probably they will), you could have a very rapid collapse of the dollar […]

Rickards is another gold bug, which means he can be safely ignored. At the same time, this argument is part of the wider one that has been taking place economy- wide; whether the world is experiencing inflation or deflation.

Rickards links an oped article at the Wall Street Journal penned by Federal Reserve governor Kevin Warsh to the G-20 meeting in an interesting way: it is a camouflaged warning against a fast drop of the dollar against other currencies, especially gold.

Doesn’t something jump out at you? “Federal Reserve Governor”, “Federal Reserve”, “IMF”, “Global Central Bank”, “G20”, “Finance ministers and central bank governors”, the “UN” … all centralized authorities.

Here’s what Milton Friedman sez about inflation: “Inflation is always and everywhere a monetary phenomenon.”

Here’s another def from Mike ‘Mish’ Shedlock: “Inflation is best described as a net expansion of money supply and credit.” He defines deflation similarly: “Deflation is logically the opposite, a net contraction of money supply and credit.” The implication is some authority, acting on its own without any public interest expands money and credit.

There are many other similar takes on inflation as a money supply issue. Bernanke is accused of massively increasing the money supply by printing limitless amounts of dollars. This is an attempt to inflate the US currency to devalue out of existence that hopeless amount of USA debt. To counter this, central bankers/ finance ministers/Wall Street/the IMF cabal meets secretly to create a new currency that cannot be inflated into irrelevance. Maybe, there will be a gold- backed currency, like in the ‘good ol’ days’. I guess that will show those undisciplined Americans a thing or two about financial prudence!

To understand what ‘money supply’ refers to, take some time and watch this video primer, “Money As Debt”:

In fiat money systems – which include all money systems in all countries on planet Earth – the dollars and other currencies are lent into existence by banks and other finance houses. The principle behind this is simple, double- entry bookkeeping. A deposit to a bank account – a loan from another bank, often – is recycled as loans to others, that are in turn deposited by sellers in other banks to be lend again and again. Every loan is an asset to the lender, balanced by deposits which are loans to the bank. normal daily business results in the creation of money; central banks, the G20, finance ministers, the UN or other authorities don’t create money. In the process of borrowing money, you and I create it.

The Fed is simply another bank, it does business the same way as do other banks, it lends to the Treasury as do other banks, it lends to other banks as well. Unlike other banks it can monetize interest payments; consequently there is no abstract limits to the breadth of the Fed’s balance sheet. Even so, it cannot create inflation. Only people buying/selling can do so. This is the ‘public participation’ factor. People are currently not buying/selling. We are in deflation as a consequence, even though the Fed spews money into the banking system, unless people start buying/selling, the new- money output of the Fed is as a bucket of water to the ocean.

Perhaps the ‘dollar doom’ stories are an attempt to scare customers into spending money before it ‘becomes worthless’. If so, the attempt is irresponsible. It also isn’t working. People don’t need to spend; they already have everything they need! My brother owns four cars. He’s not going to buy another one, regardless of how much credit is available!

Here’s the Steve From Virginia definition of inflation; in a fiat system, aggregate buying and selling results in inflation. The more buying and selling, the higher the rate of inflation. (Buying is coupled with selling as for every buyer there is always a seller.) This rate on its own without lending/borrowing represents ‘velocity’; the turnover of the same money in different buying/selling transactions. In the real world, the turnover of transactions and money amplifies money creation and that of credit as each bankable transaction allows more credit … and more money … to be created. Deposits to the bank are lent against; it can be considered there are are two components to inflation: buying/selling and lending/borrowing. Both are interconnected; creating money by borrowing generally is part of any given transaction; money is borrowed to be spent, money is spent creating the demand for more lending.

All of this confirms the quantity theory of money. What that leaves out is the trade origin of money, the ordinary supposition being that a central authority first creates money and then it is used.

If buying/selling is inflation, then less buying/selling is deflation. No buying/selling at all is depression. The establishment can print as much money as it pleases, it can expand the supply of available money as much as possible and it will not generate inflation. There is no way authorities can conjure inflation, regardless of intent – or scare mongering.

At the same time, authorities can remove money from circulation, they can make it out of pancake batter or radium foil, if few people buy/sell, there is deflation. That this is taking place right now is obvious and should be observable to central bankers and other bureaucrats, but they may not go out very much.

Inflation is self- generating and by doing so it is a virtuous cycle. The increase of lent money reduces the real value – as opposed to the nominal amount – of the principal due to the lender; at the same time the lender receives interest payments on the money that otherwise earns nothing. Since the returns are immediate, the potential loss of principal value in the future can and is discounted.

The public, not authorities creates inflation or does not; de Souza’a argument is built on a false premise.

The dollar became the world’s premier reserve currency as a matter of convenience. There are large amounts of dollars; the ‘base money’ is around $1 trillion. About 3/4ths of this is in circulation overseas. The dollar is the official currency of Ecuador and Panama; it is the unofficial currency of dozens of other countries. That there is so many dollars in circulation makes them available when currency is in demand as was the case last year. That there are many dollars in circulation is the result of the hundreds of thousands of American tourists who travel abroad every year and the billions of dollars sent as remittances to families of workers legally and illegally in the US, also every year. It represents the cash accounts of organized crime syndicates that sell drugs, arms, whores, pirated goods worldwide; also the receipts of US businesses that contract with workers overseas; China is the 51st state of the US, whether they like it or not at any particular second.

The dollar is the world’s premier reserve currency because of what it is proxy for, what it can buy. Currencies of nations or regions are ‘grounded’. They originate in a place and generally can only be redeemed for a good or service in the place where they are born as debt into money. The dollar can be – and is – used to buy any good made in the USA. Since goods in the USA are also made in China, India, Saudi Arabia, Japan, Germany, Ireland, Russia, etc; the dollar is proxy for all of these other countries’ goods and services as well. What can anyone buy in the US with yen? Very little, yet any good found in Japan can be had for dollars. Same with all other countries that trade with the US; Pounds- Sterling, Euros, Roubles; all these currencies are limited to what can be had in their originating countries, which can also be had with dollars. Everything that can be bought for yuan in China is available for dollars in the USA. This is what ‘reserve currency’ really means. It has nothing to do with prestige. The dollar is proxy for all the world’s goods. This is the result of the market speaking; the actions of both American and others buying/selling.

What about gold? What can be bought for gold? How many people have or possess gold? Imagine gold as the currency – it was USA money up to 1934 – who would have all the money if gold was the currency?

Right, only the rich people. If gold is the money, the rich can sit back and wait for it to come; trading food for gold. A person without gold would be destitute. For those with some gold, becoming destitute would be a matter of time. All the gold bugs ever talk about is buying gold, nothing is ever mentioned about selling. What does one buy with the gold? Paper money? A can of beans? Gold, like any other currency has no value unless it is spent, a person spending gold does not have it any more. If gold is the money, that person has nothing. The shift from gold to paper signified an historic shift, from possessing wealth to transacting business. In a fiat system, if there is a shortage of money, the people themselves can lend/borrow some more into existence.

It’s not just the amounts of money in circulation that matter, its what the money buys. Not one finance article or money trade or commodity money article I have seen has mentioned this major characteristic of money! The Chinese yuan is a paper representation of poisoned dog food and hammers that break in your bare hand. The dollar buys Hollywood! … ’57 Chevies, the Dallas Cowboys, New York City, desktop supercomputers, Babe Ruth, crack cocaine, Jack Daniels, Yellowstone Park, and freedom … even if it’s tarnished, constrained, corroded version of the real thing.

China; you buy a hyper- corrupt, hard- line dictatorship, a command economy that is in worse shape than America’s veneered over with lies, a bubble ready to pop. All this punctuated with polluted ‘Blade Runner’ cities and the ugliest buildings imaginable.

Since so many people out there in the world are going to use dollars because of convenience and what it can buy, it is hard to see an alternative being circulated in quantity enough to be equally convenient. Since buyer/sellers create currencies, it is hard to see how the required volume of circulation can ever take place, despite the fervent desires of China and the IMF bureaucrats.

Dollar alternatives are proposed as reserve currencies because of these currencies’ relative exchange value. These currencies are scarce and this is reflected in a scarcity premium. This isn’t transactional value, but a commodity – supply/demand – value. It is useful to currency traders but nobody else. This is also never seen in articles about money and reserve currencies. It is nevertheless observable in the real, outdoorsy world.

Here’s another take from the estimable Chris Martenson, who had done the world a service by authoring the Crash Course.

Martenson made an astute observation regarding the way the establishment has been managing the supply of debt.

Martenson’s argument is that a deflationary collapse hasn’t taken place despite a massive and growing overhang of (bad) debt. The nationalization of debt by the Fed and its proxies is a reasonable supposition. Martenson doesn’t go so far as to observe there are no limits to the Fed’s ability to expand its balance sheet; it could indeed monetize all current Federal liabilities both active and presumed … and still expand some more.

At the same time, inflation is not to be seen anywhere. Gas prices are falling, food price wars are taking place in grocery stores, while wages are not falling, the number of employed is falling – the quantitative result is the same.

Looking at the economy as superimposed twins, the productive supporting the financial – there is deflation in the productive economy, while the machinations of the establishment have created a short- term form of ‘Potemkin Inflation’. In reality only the public’s buying/selling can create inflation, even in the finance economy.

MONEY AND OIL

One thing to keep in mind at all times is that modern economic activity requires petroleum fuel to power commerce. Price levels matter. Oil and credit are both embedded in all goods and services. Constrained inputs of either – as reflected by price – have serious consequences.

At today’s oil price level of $70, it is hard to see how inflation could take root. At lower price levels, businesses can afford to make oil/energy purchases and additional purchases as well; real estate, plant, equipment, technology and research. At the higher level, a choice must be made between energy and some goods and services, leaving out others. For the past ten years, the choice not taken was US skilled labor, which was exported to low- wage China and Mexico. Credit was substituted for earnings; cutting workers and workers’ wages also cut business receipts. Credit aimed to inflate asset and collateral values to hedge against the increases in energy price.

If your house doubles in value because of access to mortgage products, the cost of heating fuel doesn’t matter as much.

The outcome of this allocation process is the aggregated buy/sell transactions are reduced. The higher the price level for crude, the fewer ‘other’ purchases can be made. Eventually the allocation choice is ‘either- or’; oil or everything else. Right now, the threat to the economy is the steady onrush of business failures in the productive economy. With credit nationalized, and labor costs declining, what remains as the root cause for these failures is the price of oil.

Unlike in 2004 – 05, high crude prices will not be treated as inflationary by the Federal Reserve; the current or higher price will not trigger increasing money cost. The price of oil alone – not the aggregate of credit- plus- fuel costs – is determinate; the Fed recognizes the deflating force of high energy prices.

As for the dollar’s continued use as the major crude purchasing currency; it doesn’t matter in the long run which currency is accepted by producers. All are proxies for each other and all are markers for buying/selling (not production!). It would be ironic that a customer for a product (oil) would be penalized for being a customer, whicb is often suggested by Ambrose Evans – Pritchard.

A Freudian slip of the keyboard? I doubt it … dollar/oil relationship is what matters … and the way currency/swap markets work is that ALL currencies/oil are proxies of the dollar. It’s value/oil, whether in dollars or guinea pigs … or Venitian ducats. Since the dollar’s proxy relationship with what it buys, this value is the relationship to oil. No authority makes this decision, it is producers and oil refiners buying and selling, the refiners themselves as stand- ins for their own customers who in turn buy/sell and create the means to support the value relationship. Certainly, the oil producers need the US to buy oil, for their own reasons, they have decided to follow the American example and make waste out of their own product, but this is not the issue of this discussion.

The proxy is the ‘American’ buyer, with the ‘American’ lifestyle … be he Japanese, Chinese, French, Brazilian or whatever. Until destiny and the Earth itself rules otherwise, all the world is America, whether anyone likes it or not.