Monthly Archives: November 2009

Dubai is not systemically significant.  If its troubles open our eyes to the likely imminence of the start of the final leg of the journey from household default through bank default to sovereign default, it may do some systemic good, by alerting fiscal policy makers to the vulnerability of their nations’ fiscal-financial positions, and by educating citizens and voters to the urgency of deep fiscal burden sharing.

The markets today were in a bit of a tizzy because the Dubai World Group, a holding company owned 100 percent by Dubai’s government, and Nakheel, a wholly owned subsidiary of Dubai World, imposed a debt restructuring and debt service standstill - failed to perform on their debt or, in ordinary if not legal language, defaulted on their debt.  The combination of the Islamic holiday of Eid and the Thanksgiving holiday in the US boosted the magnitude of the financial market kerfuffle.

I don’t see what the big deal is.  Dubai has experienced for most of this decade the craziest construction boom seen in the Middle East since the construction of the Great Pyramids.  That boom turned to bust – as booms invariably do.  Property developers tend to be highly geared and very procyclical in their revenue flows and access to the capital markets.  During construction slumps they drop like flies.  Because the property sector is risky (ask Donald Trump), its creditors tend to get better interest rates than the sovereign rate.  Dubai is no exception to this rule.  If you earn a risk premium during good times, you should not moan when the borrower defaults from time to time when the going gets tough.

What is so important about H.R. 1207: the Federal Reserve Transparency Act of 2009 aka the ‘Audit the Fed’ bill? This bill “To amend title 31, United States Code, to reform the manner in which the Board of Governors of the Federal Reserve System is audited by the Comptroller General of the United States and the manner in which such audits are reported, and for other purposes.” may not sound terribly exciting, but in addition to making the Fed accountable for its quasi-fiscal activities, it could well set an important precedent for the enhanced accountability of operationally independent central banks everywhere.

Mr Eliot Whitehead sent me the following e-mail message in response to my blog post ‘Gold – a six thousand year old bubble’:

“Regarding your FT article, Gold – a six thousand year old bubble, it would interest you to learn that Rai, somewhat since the end of WWII in the Pacific, no longer has value in Yap: to Yapese, it is, essentially, worthless and disregarded. Ironically, it has fairly great value to foreign collectors, but its export is strictly prohibited by law. In reality, more could be “minted”: a clever entrepreneur with the support of the Yapese government should be able to make Rai in Palau and Guam, transport it to Yap, and sell for a tidy profit to these collectors…but this will never happen.

With the advent of American administration (under UN guise), traditional Yapese cultural practice was undermined to be replaced by contemporary, American style consumer values: building materials, automobiles, roads (a pathetic fate for much, unmovable, Rai lining the original pathways), tin foods, clothing, et al. Of course, Rai had and has no value in obtaining these now necessary items.

I date the seeds of this reversal to the late 1960s and was in full swing by the mid-70s.

I can not imagine the circumstances under which Yapese would ever value Rai again. On a grander scale, could gold follow the same path?

Probably not. In any case, I only put my money in real estate.”

Far be it from me to assert that a fate similar to that suffered by the Yapese Rai will befall gold – another intrinsically worthless fiat commodity.  But the demise of the Rai as a store of value and means of payment, when taken together with the historical experience of pre-columbian native American tribes and nations that attached very little value to the shiny metal, should give the gold bugs some sleepless nights.  More importantly, it ought to discourage investors who are not rich enough to survive a speculative disaster from putting too much of their savings into this frivolous store of value.

Gold is unlike any other commodity.  It is costly to extract from the earth and to refine to a reasonable degree of purity.  It is costly to store.  It has no remaining uses as a producer good – equivalent or superior alternatives exist for all its industrial uses.  It may have some value as a consumer good – somewhat surprisingly people like to attach it to their earlobes or nostrils or to hang it around their necks.  I have always considered it a rather vulgar metal, made for the Saturday Night Fever crowd, all shiny and in-your-face, as opposed to the much classier silver, but de gustibus… .

The total stock of ‘above-ground’ gold is about 160,000 metric tonnes (a metric ton is 2,204 lbs. or 35,264 oz, for those of a non-decimal mind-set).  About 50 percent of this existing stock of above-ground gold is kept as a pure store of value (for investment purposes), most likely somewhere below-ground, for security reasons. The other 50 percent exists as jewellery.  I would argue that most of this jewellery demand is simply small-scale store of value (investment) demand by households, rather than demand driven by aesthetic considerations or other intrinsic sources of joy associated with having gold hanging from your extremities.

There are two reasons why the Fed, or any other central bank, should not act as a quasi-fiscal branch of the government, other than paying to the Treasury in taxes the profits it makes in the pursuit of its mandated macroeconomic stability objectives (maximum employment, stable prices and moderate long-term interest rates in the case of the Fed) and its appropriate financial stability objectives.  The appropriate financial stability objectives of the central bank are those that involve providing liquidity, at a cost covering the central bank’s opportunity cost of non-monetary financing, to illiquid but solvent financial institutions.

Any action going beyond that, such as the recapitalisation of insolvent banks through quasi-fiscal subsidies, ought to be funded by the Treasury.  The central bank should be involved only as an agent of the Treasury – an expert assistant.  It should not put its own conventional or comprehensive balance sheet at risk.

Maverecon: Willem Buiter

Willem Buiter's blog ran until December 2009. This blog is no longer active but it remains open as an archive.

Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.

Willem Buiter's website

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