Government Panic Could Herald Dollar Panic

One of the few things more troubling for an economy than government intervention is government intervention driven by panic. Time and again, history has shown that when governments rush to engineer solutions to pressing problems, unintended difficulties arise.

In the current crisis, there is growing evidence that Washington is in a state of increasing panic. Despite its massive cash injections, market manipulations and 'rescue' plans, the recession is clearly deepening and spreading. With little to show thus far, politicians don't know if they should redouble past efforts, break ground on new initiatives, or both. However all agree, unfortunately, that the consequences of doing too little far outweigh the consequences of doing too much.

Although there are many parallels between the current crisis and the Crash of 1929, one key difference is the global profile of the U.S. dollar. In 1929, the dollar was on the rise, and would soon eclipse the British Pound Sterling as the world's 'reserve' currency. Furthermore, the American economy was fundamentally so strong that in 1934 America was the only major nation able to maintain a currency tied to gold.

Ever since, the U.S. dollar's privileged 'reserve' status has been a principal factor in America's continued prosperity. The dollar's unassailable position has enabled successive American governments to disguise the vast depletion of America's wealth and to successfully increase U.S. Treasury debt to where the published debt now accounts for some 100 percent of GDP. The total of U.S. government debt, including IOU's and unfunded programs, now stands at a staggering $50 trillion, or five times GDP! If the dollar were just another currency, this never would have been possible.

In today's crisis however, the dollar is likely making its last star turn as the leading man in the global financial drama. Other stronger, less burdened currencies are waiting in the wings for the old gent to take his final bows.

The dollar's demise is being catalyzed by the neglect of the Federal government. Instead of enacting policies that would restructure the U.S. economy, and restore productive, non-inflationary wealth creation, Congress is simply financing the old crumbling edifice.

Faced with the growing realization that America is not doing the work necessary to right its economic ship, it will not be long before America's primary creditors begin to seriously question the nation's ability to service, let alone repay, its debts.

There is now the prospect (inconceivable until recently), that America could lose its prestigious 'triple-A' credit rating. In today's risk adverse market, this could cost the Treasury one percent in interest on long bonds. Each additional percentage point of interest would cost America some $10 billion a year on each trillion dollars of new debt, or some $300 billion over the life of a 30-year bond.

Many of the foreign governments who hold huge amounts of U.S. dollar Treasury debt, such as China and Japan, have announced plans to spend money on their own ailing economies. Should these foreign central banks divert to domestic initiatives some of the funds used to buy U.S. Treasuries, serious upward pressure on U.S. interest rates will result. Should they actually sell parts or all of their holdings they will likely put serious downward pressure on the U.S. dollar. Last week, a Chinese official claimed the U.S. dollar should be phased out as the world's 'reserve' currency.

In the short term, as dollar 'carry-trades' continue to be unwound and questions of political will and falling interest rates haunt the Euro and some other currencies, the U.S. dollar may be the recipient of some upward appreciation. But with the American government appearing increasingly to be in panic mode, a run on the U.S. dollar could develop rapidly into cascading devaluation. Even if no such panic run materializes the long-term outlook for the U.S. dollar is one of high risk and low return. This beckons major upward pressure on precious metals.

Comments

[Greg Pinelli:]

There's little to argue about concerning the dollars trashing...All that potential money/credit will hit the streets at some point..The REAL question though is just what the dollar is going to devalue against...I haven't seen any candidates presented by Mr. Browne...he either doesn't know or he isn't sharing his insight with us. So let's do a little heavy lifting for him....
The Euro would be the next big dude on the monetary block..except that it is a currency in search of a plan. Just holding the Euro together will require some very deft diplomacy..it's a currency by committeee..and many of the members don't like each other.
The Yen? Hardly..its major international function is as a whipping post in carry trade play...
The A$? The Yuan? One too small..the other..too secretive..That leaves the ONLY other default currency ...Gold. No one really has to MAKE a case for it..I think 2000 years of exposing monetary progligacy speaks for itself....

Jan 08 10:57 AM

[secmaven:]

The Fed's mere announcement of the possibility of the purchase of long term Treasuries drove 10 year and 30 year bond rates down by 100 basis points very quickly. If this plan is implemented why would interest rates rise? The Fed can buy all the bonds of all sellers and dictate the rate. The resulting dramatic increase in the dollar money supply by definition is inflationary but not in a world starved for liquidity due to the destruction of so many dollars, Euros, etc. loaned to bad debtors. For inflation to get rolling again it will take a shortage in the physical supply of oil.

Jan 08 12:00 PM

[Adam O.:]

I think the problem could lie with a potential oversupply of Treasuries. If the US can't raise cash from third parties, then the Fed effectively becomes the Treasury buyer of last resort.

That could be a destabilizing dynamic.


On Jan 08 12:00 PM secmaven wrote:

> The Fed's mere announcement of the possibility of the purchase of
> long term Treasuries drove 10 year and 30 year bond rates down by
> 100 basis points very quickly. If this plan is implemented why would
> interest rates rise? The Fed can buy all the bonds of all sellers
> and dictate the rate. The resulting dramatic increase in the dollar
> money supply by definition is inflationary but not in a world starved
> for liquidity due to the destruction of so many dollars, Euros, etc.
> loaned to bad debtors. For inflation to get rolling again it will
> take a shortage in the physical supply of oil.

Jan 08 12:24 PM

[fran:]

did you mean profligacy? yes, he did refer to upward pressure on precious metals. i believe he refers to "things" vs fiat paper["things" which hurt when dopped on foot].

On Jan 08 10:57 AM Greg Pinelli wrote:

> There's little to argue about concerning the dollars trashing...All
> that potential money/credit will hit the streets at some point..The
> REAL question though is just what the dollar is going to devalue
> against...I haven't seen any candidates presented by Mr. Browne...he
> either doesn't know or he isn't sharing his insight with us. So let's
> do a little heavy lifting for him....
> The Euro would be the next big dude on the monetary block..except
> that it is a currency in search of a plan. Just holding the Euro
> together will require some very deft diplomacy..it's a currency by
> committeee..and many of the members don't like each other.
> The Yen? Hardly..its major international function is as a whipping
> post in carry trade play...
> The A$? The Yuan? One too small..the other..too secretive..That leaves
> the ONLY other default currency ...Gold. No one really has to MAKE
> a case for it..I think 2000 years of exposing monetary progligacy
> speaks for itself....
>

Jan 08 01:14 PM

[Rob Viglione:]

Problem is persistent deficits financed by borrowing. The Fed can buy all the Treasury bonds/notes it wants, but if the government wants to raise revenue at some point they need to sell to outside parties. Selling and buying their own bonds means no net revenue...not a feasible position for a banana republic.


On Jan 08 12:00 PM secmaven wrote:

> The Fed's mere announcement of the possibility of the purchase of
> long term Treasuries drove 10 year and 30 year bond rates down by
> 100 basis points very quickly. If this plan is implemented why would
> interest rates rise? The Fed can buy all the bonds of all sellers
> and dictate the rate. The resulting dramatic increase in the dollar
> money supply by definition is inflationary but not in a world starved
> for liquidity due to the destruction of so many dollars, Euros, etc.
> loaned to bad debtors. For inflation to get rolling again it will
> take a shortage in the physical supply of oil.

Jan 08 05:11 PM

[austrian63:]

Unfortunately but not unexpected, the Obama team will continue the same profligate policies that have gotten us here. More stimulus any one? Beware the "fixes" the new brain trust send us. If over spending spending and over leveraging by individuals and businesses got us here how can the same behaviour by gorernment cure the malady?

Jan 08 06:11 PM