Nomi’s Note: I’m doing something a little different in Inside Wall Street this week. I’m giving you a behind-the-scenes look at my new book, Permanent Distortion.
It’s hitting shelves on October 11. But as a “thank you” for being a loyal reader, I wanted you to be among the first to see it. So this week, I’m sharing some of my favorite sections from the book.
If you missed my previous excerpts this week, catch up here, here, and here. Then read on for our fourth and final sneak preview this week. As you’ll see, the permanent distortion in the markets is global. And that has implications for the current world order – and the role of the U.S. dollar.
The financial crisis began in the West. Yet the destruction it incited was global.
Rising economies from China to Brazil to India were positioning themselves as nascent political powers.
China, besieged by the negative elements of the Western-born crisis, was no longer willing to sit back and remain a neutral actor on the matter of monetary policy.
On March 23, 2009, the People’s Bank of China (PBOC) released a critical document titled “Reform the International Monetary System,” by PBOC governor Zhou Xiaochuan.
For the first time, Zhou publicly called for a supranational reserve currency related to the IMF’s Special Drawing Rights (SDR) basket. He claimed:
The crisis again calls for creative reform of the existing international monetary system towards an international reserve currency with a stable value, rule-based issuance and manageable supply, so as to achieve the objective of safe- guarding global economic and financial stability.
The SDR is an international reserve asset. It was created by the IMF in 1969 to supplement its member countries’ official reserves.
Until October 2016, this basket had included the US dollar, the euro (before the euro, it had been the German deutsche mark and the French franc), the Japanese yen, and the British pound sterling. After that point, it added the Chinese renminbi.
In reaction to Zhou’s claims, President Barack Obama, Fed chairman Ben Bernanke, and Treasury Secretary Tim Geithner opposed the idea of a global currency or the SDR’s ascent.
At a press conference on March 24, 2009, Obama declared, “I don’t believe that there’s a need for a global currency.”
A week later in London, at the G20’s second meeting (convened to discuss solutions to the international crisis), that organization’s Leaders’ Statement overrode this US objection.
More cracks in the Bretton Woods wall lay ahead.
The markets, on the other hand, had been coddled by the unprecedented money-fabricating actions of the Fed and other central banks.
For instance, on March 5, 2009, the Bank of England (BOE) created £75 billion of new money, ostensibly to be pumped into the UK economy.
The reason for that maneuver, as the BOE admitted, was that it had run out of ammunition, having already cut rates to close to zero, and so other “additional unorthodox measures” such as quantitative easing (QE) were required “to prevent a slide into deflation.”
Prices of UK government bonds, called Gilts, leapt from investors’ joy over the central bank’s plan to buy about a third of the 5- to 25-year Gilts outstanding.
Shortly thereafter, the European Central Bank cut interest rates to 1.5%, which was, at the time, the lowest rate since the 1999 establishment of the eurozone.
On March 18, 2009, the Fed announced that it would pump $1 trillion into the financial system by purchasing Treasury bonds and mortgage securities.
That was all it could do with its key interest rate already hovering around zero.
Buying securities (such as long-term government and mortgage bonds) with money conjured out of thin air was another way for the Fed to inject more dollars into the economy – or into the markets, which was where much of it went.
Those actions were the Fed’s biggest yet. They nearly doubled the amount of all its 2008 artificial money-creating measures.
The idea was to spur economic activity by somehow getting the banks out of their bad investments. The markets responded with requisite glee: the S&P 500 index leapt by 2% on the announcement.
But a large rift was forming on the back of this central bank intervention.
The world was dividing between nations that depended on Fed policies, those harmed by them, and those caught in the middle.
Foreign capital slithered around the world like a python. Speculation and central bank stimulus lifted financial markets even as the underlying economies lagged.
Central bank policies in the developed world stimulated an increase of public and corporate debt in the developing world.
That’s because once the QE policies and purchases of commercial banks by governments of developed countries took effect, the debt would be transferred to developing countries, which did not have the same mechanisms to safeguard their banks or contain inflationary pressures.
Developed economies forced austerity on developing ones by virtue of this debt accumulation. The austerity measures throttled existing economic and social projects. This drag in productive economic activity spread through emerging markets and hit Mexico, Brazil, Argentina, Venezuela, and Turkey particularly hard.
The financial crisis further disrupted emerging-market economies because capital flight, on top of liquidations of domestic assets at bargain prices, drained liquidity. This sharply pushed up domestic yields, and with them borrowing costs.
Emerging nations’ central banks exacerbated the problem by selling or devaluing their currency to buy dollars.
This was their own artificial way of injecting more dollars into their economies, which were already facing dollar flight due to their currency devaluation. Brazil, for example, adopts this mechanism in times of currency crisis and high inflation.
It was a vicious circle.
Fear of liquidity shortages and general instability caused foreign and domestic investors to extract money from less stable regions such as Latin America, where central banks in Argentina and Uruguay in 2002 and in the Dominican Republic in 2003 injected money into the financial system in response to banking crises and fears of systemic collapse.
In contrast to their counterparts in the developed world, central banks in emerging nations didn’t have the same power to control global markets or influence other countries’ central bank policy.
As a result, countries such as Brazil, Turkey, India, and Nigeria were forced to find other ways to deal with domestic monetary and economic policy problems that resulted from the actions of the major central banks.
The fallout from monetary overreach and financial system problems on the lives of normal people was evident everywhere.
Throughout Europe, workers and students were casting their votes and voicing their anger against governments set on stealing their benefits because of the actions of big global banks.
Around the world, various groups combined their voices and movements to combat economic injustice. The Occupy Wall Street movement began in September 2011 and was replicated around the world. Arab Spring protests sprouted in Turkey, Lebanon, Iran, and Saudi Arabia.
These uprisings weren’t isolated instances so much as signs of global exasperation from citizens who were repeatedly taking the economic hit for the failures of the financial system, even as stock markets rallied in their faces.
As citizens protested, political winds shifted. Realignments and fresh alliances among international superpowers and regional powers were activated in a manner not seen since the end of World War II.
The 21st-century upsurge of the People’s Republic of China as an economic, monetary, and political superpower was accelerated by the US financial crisis and the PBOC’s criticisms of Fed policy, which resonated throughout the developing world.
China sought to extend the presence of its currency, the renminbi, to defuse the power of the US dollar. As China became more powerful, it saw the dollar as an obstructive element in foreign markets, investment, and development.
However, true swings in dominant currencies are not frequent, and though pundits routinely announce the looming end of the US dollar, it is not that close at hand.
What history shows is that many factors must come into play over a period of decades or even centuries to evoke a seismic change in the currency order.
However, that does not mean that smaller shifts aren’t in the cards. As Sir Isaac Newton’s First Law of Motion put it:
A body at rest will remain at rest unless an outside force acts on it, and a body in motion at a constant velocity will remain in motion in a straight line unless acted upon by an outside force.
In the case of global currencies, that force must be massive and prolonged.
Adapted from Permanent Distortion: How the Financial Markets Abandoned the Real Economy Forever. Copyright © 2022 by Nomi Prins with permission from PublicAffairs, an imprint of Perseus Books.