Bretton Woods II: Will a New Financial-World Order Solve the Economic Crisis?

By J.D. Seagraves, on October 20th, 2008

On October 13, British Prime Minister Gordon Brown called for a new-world financial order. “We must create a new international financial architecture for the global age,” Brown said. “We must have a new Bretton Woods.”

Brown’s statement echoed the sentiments of French and EU president Nicolas Sarkozy, who on September 26 said, “We must rethink the financial system from scratch, as at Bretton Woods.”

So is a new “Bretton Woods” a good idea? Before we can answer that question, we need to take a look at the original Bretton Woods System, which was the world’s first fully negotiated international monetary order. What inspired global leaders to create it, and what ultimately led to its demise?

The Monetary Role of Gold

By 1900, most Western European nations had evolved from centrally planned monarchies to pseudo-capitalist republics. This resulted in the heyday of the International Gold Standard, in which market economies of the West engaged in relatively free trade, facilitated by the ultimate global currency of gold.

Gold, according to Austrian economist Carl Menger, emerged as money millennia ago. In fact, gold’s monetary nature predates the existence of the nation-state. It is “real money” in the sense that no one has to be forced to accept it: they do so willingly. And thus, gold presents a problem for nation-state governments—they can’t manipulate it as easily as paper money.

True, nation-states dating back to the Roman Empire and before have attempted to make money a state institution through the implementation of “monetary policy.” The chief tactics of these ancient states were coin clipping and debasement (mixing cheap alloys in with gold) and forcing people under “legal tender” laws to accept devalued coins at full face value. These monetary tricks ultimately led to the ruination of numerous empires throughout history, with the Romans being neither the first nor the last.

The End of the International Gold Standard

Fast-forwarding 150 decades or so, the nation-states of the early 20th century were in a similar bind: they couldn’t finance the wars they wanted to fight under the strictness of a gold standard. “War,” after all, as Randolph Bourne said, “is the health of the state,” as it lends itself to an intense concentration of government power. But early twentieth-century bureaucrats found it difficult or impossible to fund wars through taxation without inspiring domestic revolts. The other option—printing money—wasn’t feasible under a gold standard, since each paper note had to be backed by real gold. So what were war-makers to do?

What aggressive governments did do, time and time again, was temporarily suspend the convertibility of notes. Typically under a gold standard, individuals could trade in a fixed number of dollars (or pounds or francs, etc.) for an ounce of gold. To make war, governments would simply print up extra notes and all money unconvertible for the duration of the conflict—and then devalue their currencies after the war. European nations did this countless times, and the U.S. suspended convertibility during the Civil War, World War I and World War II. But then the Allied nations of that final conflict had a better idea: why not do away with the International Gold Standard once and for all and inflate without limit?

The Creature from Bretton Woods, NH

Unfortunately for them, nation-states had not yet developed the means of social control necessary to impose fiat currencies on the world. So instead, global leaders did the next best thing—they abandoned the too-restrictive International Gold Standard in favor of a new monetary order: the Bretton Woods System.

For three weeks in July of 1944, 730 delegates from all 44 World War II Allies met in Bretton Woods, New Hampshire, as part of the UN’s Monetary and Financial Conference. By the time they were done, they had created the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD). These entities—created by “democratic nations” with no democratic approval—would be the enforcers of the new world-financial order.

Ostensibly, the IMF and IBRD were supposed to facilitate “free trade.” In truth, just like modern “free trade” agreements, the IMF and IBRD inhibited and indeed prohibited truly free trade and, instead, created rules to promote government-managed and controlled trade.

Regardless, if we can believe the architects of the post-war order, Bretton Woods was intended to end the protectionist currency manipulation that occurred under the International Gold Standard. Under the gold standard, a country with a trade deficit could simply revalue its currency relative to gold, thereby encouraging exports and discouraging imports. But under Bretton Woods, all member nations had to “peg” their currencies to a weight of gold, plus or minus 1 percent.

The Death of Bretton Woods I

The U.S. dollar, however, had a different role under Bretton Woods: it would take the place of gold and serve as the world’s reserve currency. Only the U.S. dollar could be converted to gold (at $35 an ounce), and only foreign central banks could do the converting. Following Frank D. Roosevelt’s draconian Gold Confiscation Act of 1933, private ownership of gold was banned in the U.S. and remained illegal into the 1970s.

When Bretton Woods was set up, the U.S. held about 60% of world gold reserves. However, beginning with the New Deal, the ever-expanding federal government had quite an appetite and, like empires of old, preferred to fund its growth via monetary trickery instead of taxation. Thus, the government’s central bank—the always eager-to-inflate Federal Reserve—created far more dollars than there were ounces of gold backing them.

This led to an old-fashioned bank run. Foreign governments were smart enough to know there wasn’t enough gold to back all of the dollars in circulation, so they raced to redeem their dollars while they still could. By 1970, the U.S. held just 16% of world gold reserves.

Clearly, the system was unsustainable, so on August 15, 1971, President Nixon “closed the gold window” and reneged on America’s promise to redeem paper dollars in gold, severing the U.S. dollar’s 179-year tie to gold and converting the greenback into a full-fledged fiat currency.

The Birth of Bretton Woods II?

It’s said that the nations that came together for Bretton Woods I all shared a belief in “capitalism.” Austrian economists would scoff at this notion. One of the primary architects of the Bretton Woods System and the notorious IMF was John Maynard Keynes, a Fabian socialist and advocate for central planning in a “mixed economy.” Keynes attended Bretton Woods on behalf of the UK and argued for a world central bank issuing fiat notes known as “bancos.” The U.S., then a creditor nation, resisted. Now, of course, the United States—the world’s biggest and most broke debtor—would have no such leverage.

World leaders are meeting next month to talk about the possibility of setting up a new Bretton Woods System. If these leaders share a common belief, you can be sure it isn’t in capitalism, and you can bet all the fiat money in the world that gold will not play a role in Bretton Woods II. A much more likely scenario is that John Maynard Keynes will finally get his wish, 64 years later, and we’ll have a world central bank and the beginnings of true global government. Everything else Keynes advocated has failed so miraculously and led to so much misery, one can only imagine how bad life under the “banco” might be.



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Google-Yahoo Deal Under Investigation by Justice Department

By G.L.C., on October 20th, 2008

The high-profile advertising partnership between Google and Yahoo announced in June after merger talks between Microsoft and Yahoo collapsed could run into a challenge from the U.S. Justice Department. The Association of National Advertisers, the American Association of Advertising Agencies, and the International Advertising Association have expressed concerns about the deal and asked the Justice Department to investigate and block the deal. Many advertisers have warned that the deal will limit competition, raise prices, and reduce choices.

Last month the Justice Department hired veteran antitrust attorney Sanford Litvack to help assess the evidence gathered by its lawyers in what many see as the clearest indication that the Justice Department could be planning to mount a legal challenge to the deal which allows Google to sell ads alongside some Yahoo search results on some of its Web sites. Google dominates the search advertising market. It is feared that the deal will reduce competition in the search advertising market and lead to higher prices. The real concern of antitrust law is to protect consumers–-the advertisers. Investigators trying to build a lawsuit to block the deal worried are that it could give Google too much power.

The two companies have maintained that the deal does not violate antitrust law and recently agreed to delay implementing the deal until at least October 22 to give the investigators–-federal and state–time to scrutinize the deal and complete their investigations. According to them, the deal would serve advertisers and users more effectively.

Both companies are in talks with the Justice Department in an effort to prevent any challenge to the deal. The negotiations are at an early stage and both companies have discussed concessions including capping the volume of Google ads Yahoo would use, assurances that Yahoo would continue to compete in search ads, and a reporting mechanism to ensure compliance. A reporting mechanism could require the companies to disclose details about their closely guarded search advertising technology. The disclosure requirement could require disclosing more than what they really want to disclose. The Justice Department will try to impose measures to ensure that advertisers won’t have to pay prices that are significantly higher.

Any settlement reached would likely be laid out in a consent decree that would be filed in court allowing the deal to go ahead. If the deal does go ahead, many feel it will be a formal recognition of Google’s market powers constraining its future conduct. It could draw private antitrust suits–opponents of the deal including Microsoft have been provided with documents and depositions for use in possible litigation.

Some experts are looking at the appointment of Mr. Litvack as an effort by the Justice Department, which in the past has been criticized by some in Congress for its approach to antitrust enforcement, to deflect any political fallout from its ultimate decision.



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Mortgage and Foreclosure Fraud Mushroom in the Wake of Housing Bubble

By Evelyn Black, on October 20th, 2008

A recent article splashed across the front page of the mid-size mid-western city where I live tells a surprisingly unfamiliar story about how ordinary people have pocketed hundreds of thousands of dollars by investing in subprime real estate. Though the current financial crisis has brought about intense discussion about the moral hazard of borrowing beyond one’s means, as well as the irresponsible underwriting that went hand in hand with the subprime borrowing fever, much less attention has been paid to the phenomenon of mortgage fraud.

We know mortgage fraud mushroomed during the boom times of subprime loans. Yet it continues to hover just off the main radar screen, remaining conveniently just outside of public awareness. What exactly is mortgage fraud anyway?

In the case recounted in my local paper, two men–let’s call them Mr. Smith and Mr. Jones–decided to go into the real estate development business by buying up properties in depressed neighborhoods, ‘flipping’ (that is, renovating) the houses they bought, and then selling the houses or renting them out and thereby making a profit on their investment.

So far, that doesn’t seem like a bad idea, especially when credit is readily available and the houses in question are close to a university or a major manufacturing center, or are part of a boom market like some areas in Florida or California. We’ve all watched TV shows on the Learning Channel and on the Discovery Network that chronicle the adventures and misadventures of these flipping entrepreneurs, and many of us have vicariously enjoyed their journeys while eating Cheetos and keeping our own hands soft and clean.

What we don’t see, however, are the house flippers who never flip, never sell, and then default on the loans.

Here’s how it works:

Mr. Smith buys a home in a slum neighborhood for $20,000. He hires an appraiser to value the home at $80,000. The appraiser is committing a crime at this point–the house is not worth $80,000 in anyone’s imagination–but the appraiser and Mr. Smith know each other and are working together to defraud the mortgage industry. Mr. Jones comes along and offers to buy the house (which is actually worth $20,000 or slightly less but is now appraised at $80,000) for $100,000. Mr. Jones is a ’straw buyer’. He doesn’t really want to own the house; he is working with Mr. Smith and the fraudulent appraiser.

Mr. Jones approaches an out-of-state mortgage broker who, not knowing or caring too much about the value of local real estate, is only too happy to make Jones a loan of $80,000 or even $100,000. When Mr. Jones explains he will be improving and then reselling this hot property, the broker envisions repeat business and repeat commissions when Jones buys and flips his other houses.

Mr. Jones then repeats this same process with a dozen or more other properties, all in league with Mr. Smith and his fake appraiser. They pocket the profit on the homes ($60,000 or $80,000 on just the first one alone) and then Mr. Jones proceeds to default on every single mortgage, sticking the out-of-state company who wrote the first mortgage with a $100,000 debt on a nearly worthless house.

Although FBI tables show that mortgage fraud has increased dramatically in recent years, the cases that are actually investigated are really just the tip of a very large iceberg. The FBI doesn’t have anything close to the staff it needs to launch a thorough and comprehensive investigation into this kind of scam because of the sheer volume of cases since 2006 alone.

In my own town, with our own local Mr. Smith and Mr. Jones, neither man has ever been formally charged with anything and neither have paid anything to the mortgage companies that made them the loans. The FBI will neither confirm nor deny whether the two of them are under investigation for fraud. These two men, under their own initiative, have purchased, sold, and defaulted on over 60 homes in the worst neighborhood in this city over the past two years for a net profit of over $1.5 million for Mr. Smith and over $750,000 for Mr. Jones. Their defaults account for more foreclosures in that specific neighborhood than all the other individual foreclosure cases combined.

Both Mr. Smith and Mr. Jones now claim to be disabled and speak to the press only through their spouses, who both insist no wrongdoing has occurred. None of the homes were ever rented or improved. All of them are currently vacant and in a state of serious disrepair. Mr. Jones never took out a single building permit. He claims that he planned to do the work himself but health issues intervened.

Is it possible that these two men are just a couple of enterprising fellows who fell down a flight of stairs at the same rather convenient time? I guess so. Is it likely?

What do you think?

A new and particularly nasty wrinkle on this scheme is called foreclosure fraud. While many different scenarios can be set up, by far the most common involves a ‘foreclosure rescue’ agency that approaches (or is approached by) a longtime homeowner behind on his or her house payments. You’ve probably seen signs posted around your town that say, “We Buy Houses!” Many of these agencies are set up to defraud people in danger of foreclosure. If you try to track them down or investigate them, all you will find is a list of post office boxes and vague nonspecific names attached to no specific person.

Here’s how it works: The foreclosure rescue agency offers to buy the house from the mortgage company about to foreclose on the property and then rent it to the homeowner for a set period of time, during which the homeowner hopes to improve his or her financial situation. At the end of that mutually agreed-upon period (typically two or three years), the foreclosure rescue agency promises to then resell the property to the homeowner on terms they can actually afford. The rescue agency claims to make their money on fees and appreciation, the people get to stay in their house, and everybody is happy.

Except, what really happens is that the minute the homeowners sign the house over to the ‘foreclosure rescue’ folks, the rescue agency runs right out to the easiest lender on the farthest block, cashes out the equity in the home, then disappears off the face of the earth, leaving the homeowner still about to foreclose and owing more in some cases than the house is even worth.

Foreclosure fraud is off the charts in recent years and is growing so fast no one is quite sure how many people have been hit. If you are in danger of foreclosure, read up on some of the most common schemes before you agree to talk about your situation with anyone except your original lender.

As we listen to the most recent attempts to bail out and/or stabilize the U.S. economy, we have also been hammered by lots of campaign rhetoric meant to push our emotional hot buttons by assigning blame for the current mess to individuals we might already mistrust or dislike: certain ethnic groups, minorities, members of certain financial occupations, Wall Street bankers, mortgage brokers, Democrats or Republicans, and so forth. What we are witnessing is a veritable frenzy of blaming, and it gets to be contagious. For some reason, it feels reassuring in times of crisis to find a scapegoat, to blame somebody, anybody, for what is happening. Blame, when properly or improperly placed, always creates the illusion of control. We think that if we find the right person or persons to blame, we can then proceed to hold them accountable and then fix the problem at hand.

While the need to assign blame is completely understandable, especially in an election year, it unfortunately obscures the sheer volume of criminal activity that took place at every level of commerce during the height of the housing bubble. Even at the most basic level–the level of buying a single house–an underpaid local reporter was able to uncover millions of dollars of what was, for all intents and practical purposes, most likely out and out fraud. And that’s just in one small mid-western city. All the poor people on that entire side of town didn’t cause as much damage as those two guys and their fast thinking. And that’s at the very lowest, most transparent level of the whole mess. Now multiply that scenario by every city in the U.S., and square with every level of finance and speculation, and you’ve got the mother of all criminal messes.

So far, few people are going to jail for any of this. But maybe at some point a few should.

At the very least, it’s food for thought.



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