Currency trading worldwide totals about $1.4 trillion daily.  You will notice that the $1.4 trillion cited is in dollars, not euros or some other currency.  This is because the US dollar is the world’s base currency, not just one nation’s currency.   It is the currency every country and every corporation doing cross border business uses to mark their product’s price to market.   That’s why every 10 days or so there’s more dollars traded worldwide than the entire annual gross domestic product of the United States.

What does this mean in a practical sense?  First it means the value of the dollar is dependent not just on what the US is doing, or not doing, but is dependent on what the world’s doing.   It means there has to be enough of these dollars worldwide to grease the commerce of the globe, not just the 25% of worldwide economic activity represented by the United States.   It means there has to be enough dollars to support the transactions of all economic activity, which is four times what would be necessary if it was not the world’s base currency.

In short the dollar price is dependent more on what the other 75% of the world’s economic needs require than it is dependent upon domestic US needs.   If China needs $300 billion in international business being done on a particular day, then those transactions require that many dollars being available, even if all the parties need their own currency at the end of the transaction.  And of course, in many cases they won’t need their own currency at the end of the transaction because possessing dollars provides more flexibility in global business than any other currency.   A Czech bank can have an account at the Federal Reserve, which is the world’s bank because dollars are the world’s currency, where in our digital age dollars can be transformed instantaneously into the Czech currency, or any other currency for that matter.

Think of it this way.  If we were discussing the world’s energy needs, then the US would be the world’s transmission system, responsible not for all energy production but necessary for getting power from one spot to another, worldwide.  Seamlessly and without endangering commerce.   That’s what being the world’s base currency is like, with the Federal Reserve being control center for the transmission system.

From  the Social Science Research Center a nice speech explaining some history of economic thought by economist Erik Reinert.  Thanks to Mark Thoma at economist’w view for highlighting Reinert’s speech.

What we’re undergoing today has happened before; in 1848, the 1890s, the 1930s, and again today.  In each period economic thought became dominated by classical economics.  Other, often complementary, economic approaches were pushed aside.  In each instance it became apparent that classical economics failed to avoid  or explain, subsequent economic collapses.   In each case other more practical theories came to the rescue.  Call it common sense or applied economics–whatever–classical theories turned out to be just that, theories.  And in each period classical economics were, at minimum, salted with other economic ideas that worked better in reality.

Today we’re back in the soup, again.  And just as occured the last couple centuries those classical theories, resurrected and now formalised in elegant mathematics, have produced mal-investments and extreme economic underperformance.  From the speech:

In the case of financial crisis, long periods of economic stability produce easy credit, which with time creates instability and systemic risk, even with a small economic downturn. In the case of economics, long periods of economic stability create a belief that a Physiocratic (today’s laissez faire) approach of deregulated market – which may work well for a while – will forever solve all problems. Both the French Revolution and the European Revolutions of 1848 were results of an overdose of Physiocratic thinking, and both cases produced a return to Anti-Physiocratic – active – economic policies. The present financial crisis falls in the same category of an overdose of Physiocratic de-regulation, the famous “flaw” that Alan Greenspan discovered was a typical Physiocratic flaw: the market, if left alone, did not produce automatic harmony, but financial collapse. It remains to be seen if – and how fast – Anti-Physiocratic regulatory measures can be put back. Strong vested interests wish to prevent it….

A key problem of mathematized neo-classical economics that came into fashion during the Cold War was that it only came with one very high level of abstraction: the tools used automatically disregarded any and all real-life nuances and differences. By disregarding all differences between economic activities, between human beings, and between cultures, economics became a science depicting markets as producing automatic harmony. Economists proved, not very surprisingly, that a standardized humanity in a world where all economic activities were identical, would produce equality. When communism promised “from each according to ability and to each according needs,” this became an unnecessary complication of things: the market would also produce equality. That the apparent equality of outcome that the models produced was simply a result of the assumptions on which the theory was based – how could a model where everything is identical and equal produce anything but equality as an outcome? – was simply not listened to. The West sorely needed models supporting the perfection of the market system, and we got it…..

When Margaret Thatcher famously said “there is no such thing as society” she was merely stating a fundamental assumption of ruling economic theory. Assuming no difference between economic activities and a frictionless economy, economists modeled a world where a coordinating nation-state was no longer needed. So Ronald Reagan’s statement that “government is not the solution to our problem; government is the problem”[41] was completely in line with ruling economic theory at the time. The society modeled in neo-classical economics did not need governments, only centuries of experience would contrast what had become the mathematically obvious fact expressed by Reagan. Economic theory modeled a world with no voluntary unemployment, and it therefore became legitimate to label all the unemployed of the world as “lazy.” Neo-classical economic modeling produced that blend of wishful thinking, ignorance, and intolerance which we call neoliberalism….

That by abstracting from key agents and key phenomena economics had also abdicated from studying reality only became evident much later. Under a guise that the magic of the market would create factor-prize equalization, the opposite movement – towards a polarization of incomes – is taking place. In the meantime vested interests took over increasingly larger slices of the economy. Under the assumption that the financial sector can be treated as any other sector in the economy, and under the assumption that no regulation of the financial sector was necessary (the abandonment of the Glass-Steagall Act), individuals and nations are increasingly becoming debt slaves to the financial sector. Under the assumption of perfect competition, what used to be called natural monopolies – the opposite of perfect competition – have been privatized, and long-lasting monopolies and quasi-monopolies have been created. All in all, the economics profession became a useful tool (and fool) for the vested interests of a ‘plutocracy’. Under the assumption that markets would create automatic harmony, the West – particularly the United States – is embarking on a process of Darwinian survival of the fittest, a movement that previously had been stopped starting in the 1890s and again in the 1930s. The distribution of wealth and income is moving in the direction of a post-industrial feudalism, but a new type of feudalism, where power is not narrowly based on land ownership but on financial ownership in general…..

What needs to be reconstructed is a science of practice:a theory based on human observations of facts. This contrasts with today’s standard economics, where observations of reality tend to be filtered through a set of arbitrary and – from the point of view of observable reality – mostly totally inappropriate assumptions. This theory produces accuracy, but at the expense of relevance.

Margaret Thatcher famously said “there is no alternative,” and in this tradition capitalism is often presented as one solid block of theory to which there is no alternative. Hyman Minsky, on the other hand, argued that there are fifty-seven varieties of capitalism.[43] To explore and reconstruct the many alternative versions of capitalism, we need to resurrect the methodology of the historical schools: creating new knowledge by connecting previously unconnected facts. Present mainstream theory cannot for ever explain away important phenomena as “market failure” rather than recognize them for what they really are: theory failure.

Beezer here.  We’ve had a series of ‘market failures’ the past 22 years in particular: The Orange County (CA) bankruptcy in 1989, the S&L collapse of 1990-92; the Long Term Capital Management (LTCM) collapse of the late 1990s, the North Atlantic banking collapse of 2007–08 and the European Union banking crisis of today.   Neo-classical economics got blindsided by all of them, yet those theories simply won’t die even though they’re obviously seriously flawed.  These cannot be simply wished away as ‘market failures.’  These are theory failures. We need to get back to a less formalized economics approach, one that’s flexible, facts based and empirical.  That which makes the patient better is what is used.  Today we desperately need jobs.  The private economy is still struggling and cannot profitably hire new employees fast enough.  Tax cuts piled on top of tax cuts plus super low interest rates and dramatic Federal Bank intervention in markets have not turned the trick.  The one tool we haven’t used is the tool that guarantees jobs:  Direct hiring to rebuild America’s infrastructure.    

This post is taken from Barry Ritholtz’s Big Picture blogsite.  Ritholtz is a no nonsense investment advisor who pulls no punches when he thinks someone is playing fast and loose with the facts, or is essentially getting away with financial murder.  The post is about Greece and its kleptocrats, but read it through and substitute the United States for Greece and the Federal Reserve for the European Central Bank (ECB).

Here is a quote from a first-person report (via Zero Hedge) titled The Ugly Truth:

What angers me and most hard working Greeks is that the common workers are bearing the brunt of the austerity measures while the rich get off scot free. In Greece, if you want to strike it rich, become a specialist dealing with critical life and death decisions, tax collector or a high profile minister in the government. The scandalous stories that are coming out now of doctors, tax collectors, and ministers with millions of euros in their bank accounts and villas in Santorini and Mykonos are no surprise to regular hard-working Greeks.

This is a classic description of a kleptocracy: a financial and political Elite which skims and concentrates the wealth of the nation via corruption and embezzlement while being protected by the winking complicity of their fellow plunderers who hold civil and financial authority.

Here’s the real dynamic in Greece: The Kleptocracy–broadly, the political and financial Elites of the nation–saw a stupendous opportunity to embezzle hundreds of billions of euros from greed-blinded European banks at super-low rates of interest.

Being kleptocrats, they sniffed out the basics of the bezzle right away, and have been playing it ever since: we’re not paying any of these loans back, so go get the money from the European Central Bank (ECB) and the German taxpayers, or declare bankruptcy. Your choice.

The Greek kleptocrats knew all along that the German, Dutch, French and Finnish taxpayers were easy marks, just as they knew the European Union Power Elites would fall all over themselves to “save the euro” which was the centerpiece of their “one Europe” strategy of domination.

Only the Greek kleptocrats just beat them at their own game. The entire game plan of the “one Europe” Elites depends on nation-states actually complying with non-enforceable codes of conduct and on European banks making prudent loans.

Neither condition held: Greece’s Elites reckoned they could game the system and string along the Eurocrats, if not forever, then certainly long enough to engorge their Swiss accounts with euros skimmed from the banks, and they’ve played that hand to perfection.

Their performance is truly a thing of beauty, a masterful display of the Big Con. Yes, we will agree to austerity, but of course that is only for “the little people.” Then, we’ll renege on that, and demand another bailout. The Eurocrats will of course comply, lest their own plans for domination crumble along with the euro and the Eurozone edifice.

Meanwhile, the European banks were playing a similiar bezzle. They knew Greece had a history of defaulting on a regular basis, and any employee of the bank who lived in Greece could have briefed them on the kleptocracy’s hold on that nation. But the banks knew they could play the Eurocrats and the ECB, too, as the Eurozone had what amounted to a “German Put”: if any bad bank loans to Greece ever threatened the Eurozone, the German-led European Central Bank would make them whole.

Once again, the Eurocrats responded as expected, quickly massing hundreds of billions of euros to backstop the impaired loans to Greece and promising that bondholders would not suffer any losses.

The banks and the Greek kleptocracy are like the wife and the mistress of a prominent conservative socialite who absolutely needs to preserve a facade of conventional propriety. The kleptocrats, like the mistress, know they can blow down the entire charade, and so when they demand some baubles (bailouts) from their “Sugar Daddy” European Central Bank, the bank whimpers and complains but forks over the cash, lest the whole shaky facade collapses in a heap, along with the ECB’s dominance.

The wife, meanwhile, also gets her demand met. Now that the European banks have leveraged themselves up to pre-implosion Lehman Brothers levels of 30-to-1, they need a bailout, too, and so they tell the ECB, don’t even think about saying “no” because massive bank insolvency would also shatter the Euroland’s thin veneer of permanence.

The euro system is already broken, but the ECB and its Eurocrats are desperate to maintain the facade. The game is untenable, however, because the Greek kleptocrats and the European banks have all the leverage and the ECB is the bleating mark trying to satisfy the dualing demands of its wife and mistress.

“But you promised.” Ah yes, Dearie, but I changed my mind.

It is almost laughable to see the Eurocrats desperately trying to get another “austerity deal” approved, even as everyone involved knows it’s as phony as passing off your mistress as your “private secretary.” The austerity plan will not actually be put in place, none of the line-in-the-sand fiscal targets will be met, and the Greek kleptocrats will be smirking as the frantic ECB marks scrounge up another bailout and another face-saving “austerity program.”

The wild card here is the oppressed Greek citizenry, who might just spoil the fun by overthrowing their corrupt Overlords. They could also spoil the game by simply refusing to play any more, as a General Strike of any length would quash the fantasy of rising taxes and all the rest of the absurd assumptions at the heart of the “austerity program.”

If the Eurocrats and the ECB really want to save the euro, then they should help the Greek citizenry evict their kleptocratic Elites. But that would take genuine courage and insight, and alas, the Eurocrats, like all bureaucrats seeking to protect their fiefdom at any cost, don’t really care about the oppressed Greeks. They just want to play for time, and hope that a miracle will occur. Even as their fat, sweaty fingers hold a jumble of worthless cards–not even a pair of deuces–they persist in a laughably transparent charade of holding four aces.

The game is over for the ECB, the Greek kleptocracy and the european banks. All that needs to happen now is for the players to reveal their miserable cards and fold. The losses will be stupendous, but they will only get more horrendous the longer the game is allowed to go on.

Beezer here.  The con in the United States is exactly the same.   Now, of course, in both the US and Greece the average citizen who had nothing to do with the problem is being forced to shoulder all the austerity responsibility. 

Peter Diamond is an economics professor at MIT and a  Nobel prize winner.  President Obama nominated him for a seat at the Federal Reserve but Republicans, as Republicans now do all the time, successfully blocked his nomination in the Senate.   Here’s Diamond explaining himself in a New York Times article where he also announces his withdrawal as a nominee.  It should give any thinking person some concern about what’s going on with the GOP.

LAST October, I won the Nobel Prize in economics for my work on unemployment and the labor market. But I am unqualified to serve on the board of the Federal Reserve — at least according to the Republican senators who have blocked my nomination. How can this be?

The easy answer is to point to shortcomings in our confirmation process and to partisan polarization in Washington. The more troubling answer, though, points to a fundamental misunderstanding: a failure to recognize that analysis of unemployment is crucial to conducting monetary policy.

In April 2010, President Obama nominated me to be one of the seven governors of the Fed. He renominated me in September, and again in January, after Senate Republicans blocked a floor vote on my confirmation. When the Senate Banking Committee took up my nomination in July and again in November,  three Republican senators voted for me each time. But the third time around, the Republicans on the committee voted in lockstep against my appointment, making it extremely unlikely that the opposition to a full Senate vote can be overcome. It is time for me to withdraw, as I plan to inform the White House.

The leading opponent to my appointment, Richard C. Shelby of Alabama, the ranking Republican on the committee, has questioned the relevance of my expertise. “Does Dr. Diamond have any experience in conducting monetary policy? No,” he said in March. “His academic work has been on pensions and labor market theory.”

But understanding the labor market — and the process by which workers and jobs come together and separate — is critical to devising an effective monetary policy. The financial crisis has led to continuing high unemployment. The Fed has to properly assess the nature of that unemployment to be able to lower it as much as possible while avoiding inflation. If much of the unemployment is related to the business cycle — caused by a lack of adequate demand — the Fed can act to reduce it without touching off inflation. If instead the unemployment is primarily structural — caused by mismatches between the skills that companies need and the skills that workers have — aggressive Fed action to reduce it could be misguided.

In my Nobel acceptance speech in December, I discussed in detail the patterns of hiring in the American economy, and concluded that structural unemployment and issues of mismatch were not important in the slow recovery we have been experiencing, and thus not a reason to stop an accommodative monetary policy — a policy of keeping short-term interest rates exceptionally low and buying Treasury securities to keep long-term rates down. Analysis of the labor market is in fact central to monetary policy.

Senator Shelby also questioned my qualifications, asking: “Does Dr. Diamond have any experience in crisis management? No.” In addition to setting monetary policy in light of a proper understanding of unemployment, the Fed is responsible for avoiding banking crises, not just trying to mop up afterward.

Among the issues being debated now is how much we should increase capital requirements for banks. Selecting the proper size of the increase requires a balance between reducing the risk of a future crisis and ensuring the effective functioning of financial firms in ordinary times. My experience analyzing the properties of capital markets and how economic risks are and should be shared is directly relevant for designing policies to reduce the risk of future banking crises.

Instead of going to the Fed, however, I will go about my congenial professional existence as a professor at M.I.T., where I have taught and researched since 1966, and I will take advantage of some of the many opportunities that come to a Nobel laureate. So don’t worry about me.

But we should all worry about how distorted the confirmation process has become, and how little understanding of monetary policy there is among some of those responsible for its Congressional oversight. We need to preserve the independence of the Fed from efforts to politicize monetary policy and to limit the Fed’s ability to regulate financial firms.

Concern about the (seemingly low) current risk of future inflation should not erase concern about the large costs of continuing high unemployment. Concern about the distant risk of a genuine inability to handle our national debt should not erase concern about the risk to the economy from too much short-run fiscal tightening.

To the public, the Washington debate is often about more versus less — in both spending and regulation. There is too little public awareness of the real consequences of some of these decisions. In reality, we need more spending on some programs and less spending on others, and we need more good regulations and fewer bad ones.

Analytical expertise is needed to accomplish this, to make government more effective and efficient. Skilled analytical thinking should not be drowned out by mistaken, ideologically driven views that more is always better or less is always better. I had hoped to bring some of my own expertise and experience to the Fed. Now I hope someone else can.

Beezer here.  In the good old days the Senate confirmation process, while it could be tough, was at least honest and responsible.   If you failed the process there was usually some sound reasoning involved that explained the failure to gain Senate support.  But this version of the Republican Party is not responsible as was seen by the voucher health care proposal embedded in the budget proposed by House Republicans.    

Technically we’re out of the Great Recession.  It doesn’t feel all that good because we still have too much unemployment and growth is painstakingly slow, stretching everyone’s patience.

So what have we done so far to fight the malaise?:

• Cut taxes.  This was done in hopes the additional money in the hands of the private economy would boost lagging demand for products and services.  It looks as though this had some positive effect.  The negative effect was it increased government deficits.
• Cut interest rates, effectively to zero.  This was done in an effort to force savers out of savings and into productive, riskier investments–and to decrease the costs of new borrowing for productive investment and the cost of government deficit financing.  The negative is that the retired who live on safe bond  portfolios see a reduction in income, and Social Security dependent elderly don’t get cost of living increases. 
• A series of Federal Reserve moves intended to shore up weakened bank balance sheets.   Other than saving the banking system directly, another hope was that this would boost lending for productive investment.
• Stimulus spending for infrastructure projects.  Although a minor part of the overall stimulus spending (tax cuts being the largest component), this was the only money spent on directly hiring people.  (Editor’s note: Advisor points out that tax cuts were not the largest portion of the original stimulus bill, spending accounted for about 65% of the bill.  Infrastructure spending was half of that spending.  Since that bill, however, the lame duck Congress following the 2010 elections added more than $700 billion in additional tax cuts over the next two years.)   

Although lacking detail this list covers the choices we’ve made so far.   So what could we do in addition that might trigger economic growth, but not put undue pressure on deficits?

• Restore progressive tax tables, at minimum to those levels under President Clinton where the top marginal rate was 39.6% on income above $250,000.  This would force large savers to divert some of their inert savings into riskier, potentially more productive assets.    Additionally,  the government could pay more bills and it’s liability to insure huge undifferentiated savings would decrease.
• Establish an infrastructure bond program aimed at specific, large projects.  We have $2.2 trillion in such projects already identified across the nation, but a national goal setting project on the scale used in the 1950s to build an interstate highway system would qualify as a large enough trigger to spur economic growth.   Think  national urban commuter rail modernization and expansion, for one example.  Or a national energy transmission system modernization, for another example.    This would employ many millions in private companies nationally, a good portion of whom would come from those now unemployed.  It would improve the economy’s efficiency, and thus its global competitiveness, for decades.  Another nice positive is the bonds would help satisfy savers’ needs for income while, at the same time, turning those savings to productive use.  To the degree the projects derive revenues once built, the government’s liability to insure AAA savings would be reduced as well. 
• Use tariffs and other methods to reduce the nation’s trade deficits.  Cap and trade would raise revenue and reduce fossil fuel use.  Expanding the production and use of natural gas would decrease oil imports–a serious portion of the current trade deficits.  Subsidizing promising sustainable energy companies would create jobs and reduce our dependence on imported oil too.   

The government has cut taxes serially.  Cutting taxes even more will offer, at best, diminished returns.  To the degree they aggravate government deficits, their effect is likely to be net negative.   The Federal Reserve has pretty much run out of tools to use.

What’s not been used are progressive tax tables and direct spending on large, national infrastructure projects that would directly employ millions of workers.   We should be doing both right now.  And we should be aggressive about it.  The fastest way to end recessions and pay off debt is to grow the economy.

Barry Ritholtz, author of the Big Picture blog, posted an interesting article detailing who actually owns most of our outstanding debt.  Turns out we own most of it.