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Doom and Gloom, Get it Straight!
01/08/09 by Nicholas Jones
Filed under Bourbon & Bayonets
“There will, before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury bills and bonds are still viewed as a safe haven by many. But learning takes place.” -Telegraph 1/6/09
That quote comes courtesy of Professor Willem Buiter of the London School of Economics. As you know, little comes from the world of academic economics that I agree with. We have an exception here although Professor Buiter and I disagree on how we’ll get there.
The “dollar demise” story is one that has been beaten to death up until now. It’s been covered, denounced, called un-American, and with the recent dollar strength, it’s been all but dismissed. The problem with all the coverage is that the overwhelming majority of analysts, just like Professor Buiter, have the means wrong. They don’t understand how this process will shake out.
The fundamentals of the dollar’s weakness are apparent and discussed everyday. The problem is that they’re discussed in some other context. Let’s start by taking at an issue I’ve covered extensively in prior issues of B&B.
Balancing the Budget Deficit
The bearish fundamentals surrounding the treasury market are blatant. Let’s take a look at this keeping the dollar in mind.
Our budget deficit, like Clifford the dog, is big and red. We are already looking at a $1.2 trillion budget deficit, and that doesn’t include Obama’s stimulus package that will probably increase our deficit by another 2/3. I promise you it won’t stop there. Our new left of center fiscal policies are set to only loosen further as this fiscal irresponsibility grows in mass.
As our nation’s liabilities grow, it becomes ever more constraining and difficult to make payments. Look at it this way. If you were racking up the credit card debt, it is more expensive in the long run to make the minimum payment, than it is to simply pay off the debts. That is what we’re currently experiencing.
One way to ease the burden of our massive debt is to decrease its real value. In other words, regulators can inflate the money supply. In theory, the Federal Reserve could inflate the value of our deficit to zero if they wanted. It obviously worked well for the likes of Zimbabwe and Weimar Germany.
Contrary to the past several months, inflation hasn’t been the notable “flation” discussed. Obviously it’s the deflation that regulators have been worried about, or at least want you to worry about. Just as inflation reduces the value of our nation’s debt, deflation does the exact opposite.
This is one of the main reasons deflation will not be tolerated. The end game here would simply be default on an unpayable deficit. Then there’s the other scenario: reflation.
With deflation scaring the pants off our nation’s leaders, regulators are doing everything in their power to combat it.
Inflation Avalanche
In prior issues of B&B, we looked at the alarming numbers regarding the recent monetary inflation. Let’s revisit some of those statistics.
The Federal Reserve has already lent over $2 trillion through its different lending facilities. The recipients of this money have not been released. Bloomberg has recently filed a suit under the U.S. Freedom of Information Act to find out who this money was going to. The Fed has denied access to the information. This does not pertain to the topic of inflation, but is another example of outright criminal behavior undertaken by the authorities.
Anyways, since the middle of Sept. to the beginning of November, the Fed has increased facilities lending by $1.23 trillion marking an increase of some 138%…in just 12 weeks!
After Lehman Brothers went bankrupt, regulators entered panic mode. For those who don’t know, when regulators panic, they hop in their expensive Mercedes, or Lincoln, or whatever fancy car they drive, and head straight to the printing presses. They flip the switch from “Jesus was printing a lot of money” to “Holy warp speed,” and that’s exactly what they did.
By the end of Oct., year over year money supply growth was 38%. For those of you who don’t know, when everything is shaken out, money supply growth exactly equals price inflation. Anyways, the last time the money supply was growing at something remotely close to the 38% figure was in 1939 when money supply growth was 28%.
Little did we know that we were just getting started. Once the first week of Dec. rolled around the Federal Reserve really kicked it into gear. In Dec. 2007, the monetary base was $836 billion. In Dec. 2008, the monetary base is $1,479 billion. That’s a growth of 76% year over year.
There’s an interesting little twist here. Leading up to the Lehman Brothers collapse, the Federal Reserve held the monetary base relatively steady. This means that the majority of the staggering 76% money supply growth has taken place in the last three months. That’s an annual rate of approximately 300%.
(Some figures and statistics provided by William Engdahl)
If that isn’t enough, I guess pictures speak louder than words.
Conclusion
So here’s the deal. The U.S. is growing both its budget deficit and money supply on exponential levels. Once all of this money starts to show up in the prices of goods look out. When inflation takes grip it is going to move fast.
The problem is that this massive growth in the monetary base will make it more difficult and more expensive to finance our nation’s debt at a time when we need more financing then ever.
When we begin to struggle financing our debt, the next step is to monetize. This step is one that the Fed and Treasury have already embarked on. Monetizing the debt is simply when the Treasury write the notes and the Federal Reserve prints the money to buy them. Obviously, pending the size of the unfinanced debts, this is very destructive on the domestic currency.
Here’s the deal. The U.S. needs to finance a lot of debt. Their monetary looseness is beginning to limit their ability to do so. This will only worsen significantly. The more debt we can’t pawn off to foreigners, the more we must monetize. When we monetize, we finance our debt at a great cost to our currency. This will only make it more difficult to sell debt, therefore we will monetize. It’s starting to snowball now. It’s very simple. The longer the treasury market bubble goes, the more immediate destruction is done to the U.S. dollar.
There is only one end game here. Analysts love to discuss whether or not the financial system or Detroit is solvent. Let me tell you, we got bigger problems. The next big question will be: is the U.S. solvent?
Nicholas Jones
Analyst, Bourbon & Bayonets
Tony W. on Fri, 13th Feb 2009 5:38 PM
…some observations/questions.
I had read Buiter’s comments with interest, but figured it was just more of the usual economic BS because he never even got around to identifying what the US dollar was going to lose value in relation to.
Next I read your comments. While they’re “better than Buiter’s” and I agree with everything you have written, it’s what’s missing that is most interesting. I believe that you [and Buiter] have not addressed the difficult (relevant) part of making predictions along these lines.
Print money; debase currency – we all agree it’s happening. Let’s consider a few other factors.
The US dollar is the world currency. A US$1.00 can be presented anywhere in the world and everyone [literally] knows what it is and what it will buy. No other currency comes close – or ever will. I hear it’s even recognized by aliens in outer space.
The US dollar currently holds a powerful position as a medium of exchange for global trade. Much of that global trade involves the US. If the US dollar blows up, eventually everyone else will have to blow up their currency as well. Call it the fate of all paper.
So what really happens when the world’s most ubiquitous and most massive currency hits the wall?
Will the world come to an end? No. (I’m assuming you’d say no, or are you that guy on the corner holding that sign?)
Will paper be trusted? No more than it ever should have been.
How will commodities be valued? Higher in paper terms, but how will priorities change?
And what’s the action plan?? How about accumulating massive debt at locked-in rates, buying “real” things, waiting a few years, then working for a day to pay it all off? or?
Robert M. on Fri, 13th Feb 2009 5:39 PM
The dollar can be fixed…fast…and here is how!
A number of the following suggestions provide for funding the bailouts, helping average Americans eliminate their debt loads, and reaching nearly full employment.
Why do the politicians not see how easily they could achieve greatness by noticing the elephants in the room like Lender Side Usuary Rate taxation and hydro electric power generation?
I am just an average, unemployed American, with a mortgage fast becoming unpayable, no hope of buying a car, and a slave to credit that, in my opinion, loan shark banks are ever raising interest rates on. Perhaps you would be able to understand that Americans would be able to meet their financial obligations, pay their mortgages, and buy new cars if a few non regulatory changes are made. In the process, the federal government would benefit from a cash flow that only consumer lenders, who admit they are making obscenely huge profits on, would object to.
These things would help fix America, its economy and give financial relief to American families:
1) Lender Usuary Tax: One hundred percent of consumer interest and fees above eight percent effective annual percentage rate should be taxed away from lenders for the federal government to use as it sees fit (to pay back the bail outs for example). Eventually, lenders will bring their rates down to eight percent (or less to be competitive) just to escape the red tape. It is enough, for example, that consumers pay another month’s interest on a missed payment amount without an additional late fee adding windfall upon windfall to lender incomes.
2) Individual Interest Rate Deduction Restoration: All consumer interest and associated fees (annual, late, etc) paid by individual taxpayers must be made tax deductable from their taxable income, not just mortgage interest.
3) Gasoline Tax Deduction: All local, state, and federal fuel and fuel sales taxes must be deductable from individual taxable income.
4) Minimum Savings Account Interest: Financial Institutions, including banks, credit unions, brokerages, Discover Card, etc, that offer cash accounts like savings, IRAs, 401Ks, etc, must offer no minimum balance savings accounts that must pay a minimum of four percent annual effective interest rate. No fees of any kind may impact the principal or the minimum interest rate. Not applicable to securities held in those accounts.
5) Lock COBRA Health Insurance Premiums: Ex employees must have health (including dental and vision) insurance at the same premium for them as when they were employees with the identical employer participation. This premium rate must be available for ten years.
6) Captains of Industry Incentive Plan: All levels of government and industry management must pay a three percent individual income tax surcharge on their total compensation package for each one percent or portion thereof of national unemployment max percent for the tax year. For example, for over six percent unemployment, there would be an additional twenty one percent tax to pay. Individuals can subtract one percent from the national unemployment rate for each added direct report within the relevant tax year or three percent tax for the Incentive Plan tax down to a limit of zero plan tax. Individuals can also add to their tax formula by loosing a direct report, with no upper limit for the tax. Americans would then gladly reopen their boarders to the world’s best and brightest when full employment returns as a result of this plan.
7) Return to Hydroelectric: If you google “Hydroelectric Prospector”, you will find a web site that details sufficient hydroelectric potential to meet the needs of the nation without coal, nuclear, wind, or solar…and for much less investment and in a shorter amount of time. Ample cheap electricity will make life easy for everyone enabling cheap mass transit powered by electricity. Gasoline prices will plummet. Heating oil will be unneeded in all electric homes. Diesel fuel prices will plummet. With lower fosil fuel consumption, global polution and warming problems will abate. It is insanity not to develop our hydroelectric potential. Charging vehicles on-the-fly with overhead or guard rail mounted supplies would make electric vehicles much more feasible and make electric freight trucks possible.
The rest of our economy will take care of itself once these changes are implemented.
Liza M. on Fri, 13th Feb 2009 5:41 PM
Well considered!!
Hank P. on Fri, 13th Feb 2009 5:43 PM
Thank you, and please keep sending such astute commentaries.
Gunner on Fri, 13th Feb 2009 5:45 PM
…If you were racking up the credit card debt, it is more expensive
in the long run to make the minimum payment, than it is to simply pay off the debts…>>>
..but we heard something like that in the 80′s as well and nothing happened…that has been the strangest thing for me licing in this country since 1980 – “nothing ever happens” – budget deficits in the eighties…bank crisis…lowering taxes and raising expenditures….a trillion per year for war and destruction…lying about this, lying about that…printing money at will….start new wars…oil goes up ….oil goes down…oil goes up….
So – the breathtaking criminality of the Bush regime has been handled brilliantly – they have gotten away with precisely everything – and in the process demonstrated how utterly useless the “american system” really is. (If accountability is something to be desired).
..well…there is one more card to play..and that is to turn the war machine on the people that nurtured it. The American “people”…
It was a great read…