It was the Chinese who invented paper “money” around the beginning of the ninth century A.D. Because it was so light it would blow out of their hands, they called it “flying money”.
The ancient Chinese were right about the lack of substance of paper currency. The greenback seems to have less substance every day. But we do not wonder why the greenback seems to be dying. We wonder why it isn’t dead already.
In search of an answer, we look back, to a case brought by the First National Bank of Montgomery, Minnesota, against one Jerome Daly in 1969.
The bank had lent Mr. Daly US$14,000 in a mortgage loan. Then it tried to get its money back by foreclosing on Daly’s house. Daly took to the courts with a defence so ingenious even a Chinese banker might wish to emulate it.
You can’t enforce a mortgage contract, said he, when there was no contractual obligation. And there was no valid obligation because no “consideration” had been given by the bank. Having gotten nothing from the bank, he had nothing give back.
In support of his testimony, Mr. Daly, a lawyer, called the bank president to the stand and demanded to know if the bank had actually handed him a wad of US$20 bills.
“Isn’t it true,” he began, or words to that effect, “that the bank did not actually give me a stack of US$20 bills? In fact, the bank didn’t give me any bills of any sort, right?”
“Well, yes…but…” the bank president must have replied.
“Nor did the bank convey any property to me…or give me gold coins…or any other valuable, tangible thing…right?”
“Well, yes…but…” came the next reply, also cut off by Mr. Daly’s next question.
“And isn’t it true that the bank did not go out and borrow extra money so it could lend it to me…nor did it draw down its depositors’ accounts in order to give me money?”
“Yes, that is correct.”
“In fact, the so-called mortgage loan was, from your point of view, just a bookkeeping entry. Is that not right? And is it not true that the ‘money’ never existed at all…at least not in the sense that most people think of money…and that this ‘money’ was actually ‘created out of thin air’ as the economist John Maynard Keynes once described it?”
By this time, both judge and jury were nodding their heads, sure that they had a combination of Charles Ponzi, John Law and Kenneth Lay on the witness stand.
“Fraud!” concluded Justice Mahoney and went on to rule that the bank had given Daly no lawful consideration, had created US$14,000 out of nothing, and had done so without the backing of any US law or statute.
Therefore, it followed, the bank was obliged to let Mr. Daly keep his house. And, thus it was that Mr. Daly kept his house.
Whether the reasoning behind this case was right or wrong is not at issue here. Our questions are more numerous but much simpler.
We want to know why there are not more Dalys demanding to keep their houses today. And why there are not more Mahoneys around to let them.
Why did one small court adopt this argument while it left no mark otherwise on American jurisprudence? Despite Justice Mahoney, US courts have rejected every other attempt to argue that the US dollar is not the lawful, valuable money everyone thinks it is. But just how valuable the US dollar is, is a question not for the courts, but for the markets.
The euro, the pound, the Canadian dollar, oil and gold have been pronouncing a judgment of their own this week – all soared against the dollar. And yet not a whimper is to be heard from the great American masses. The dollar may be in trouble abroad, but at home its reputation is still spotless. Gas may cost more, heating bills may be higher, but so far milk, eggs, and beer have not soared beyond the budget of the masses. The people may have mortgaged their futures for the roof over their heads and sold their souls for a mess of credit, but with home prices still holding up and stocks pushing at all time highs, the devil has not come around for repayment yet.
Helping to postpone the day he does, the government also quietly stopped reporting M3 money in March 2006. M3 is the broadest measure of the “money supply” in the US economy. As the supply of money increases, typically, consumer prices go up. Independent analysts who keep an eye on these things tell us that the green stuff is being pumped in at one of the highest rates ever – 12% per year, or four times the rate of GDP growth.
“Then why has it not gone to swell the prices of groceries yet?” you might ask.
The answer is that the people with the most money are spreading it around in places far distant from the local Superfresh. The ersatz money is circulating these days in art houses and auctions, in exotic vacation houses and rental properties, in retirement funds and pensions. Securitised and derivatised, packaged and repackaged, it is lent from one end of the globe to the other, forcing central bankers all over the world to work their own printing presses night and day to keep up with it. The resulting global “liquidity” is the bilge upon which asset prices float and make this boom so great for asset owners.
But this liquidity is no different from the non-existent “consideration” that Mr. Daly received from the First National Bank of Montgomery. It was this shaky credit that was packaged into new debt instruments like CDOs that are so intricate that teams of mathematicians cannot fathom all the ramifications and complications thereof. In a miracle rivaling any by the Galilean, these same oily pretzels of debt were twisted into Triple A rated bonds and sold to pension funds and institutional investors. Now the buyers are finding that the grease has turned rancid: Last week, the three leading rating agencies downgraded debt linked to the shakiest part of the housing market – the subprime loans. And following swiftly, one hedge fund at Bear Stearns took ill and passed away altogether while a third gave up 91% of its returns.
Ben Bernanke would like to boost rates to support the dollar and help American tourists, but faced with a liquidity crisis in the US$500 trillion derivatives market, he’ll have to think thrice before doing so. But rates are going up with or without him. Lenders are finally growing wary.
Afraid of the poisonous debt packages, buyers are passing up another helping. “All but one of the 15 ABX indexes fell to a record low,” says Bloomberg news. Offers for CDOs are said to be going “no bid”. And several major debt offerings had to be withdrawn or rescheduled as promoters were afraid that they, too, would go “no bid”.
We don’t know if the First National Bank of Montgomery still exists. But if it does, we wouldn’t be surprised to learn that it is growing more cautious about lending. And dollar holders all over the world are tightening their grip, fearing that their flying money might fly away.
Bill Bonner and Lila Rajiva
for Markets and Money