Is the U.S. Dollar Headed for a Mighty Crash? Part I

Each month, the US Treasury publishes its International Capital account (TIC) which foreign currency traders and bond dealers use to gauge the flows of money from around the world, into and out of the US capital markets. The demand for a nation’s bonds and stocks, combined with international trade flows for goods and services, plus behind the scenes intervention by central banks, all act in concert to influence the foreign exchange market which handles $4 trillion per day.

The release of the TIC report often sparks a flurry of trading activity in the foreign exchange market, due to speculators seeking to earn a fast profit. However, the initial knee-jerk reaction to the news headlines, can be very misleading, and often isn’t long-lasting. For instance, the US Dollar Index, measured against a basket of six currencies, defied conventional logic in February, by climbing +2.7% higher, even in the face of a net outflow of $91 billion in the TIC account.

Instead, large off shore traders are influencing exchange rates, and their betting patterns are difficult to discern on the G-20’s radar screens. The finance ministers of the "Group-of-20" (G-20) recognize the growing threat to their control over the currency markets, and are calling for increased regulation of hedge funds and shadow bankers, insisting on full disclosure of their locations and other information to assess the risks they pose to the manipulations of the major central banks.

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The United States has become dangerously dependent upon the whims of foreign investors, to help finance its massive budget deficits, and prevent a surge in long-term interest rates, which would have a devastating impact on the US economy. If bond or currency traders detect that big investors in US government bonds, such as China, Japan, OPEC, Russia, and Brazil, have ceased to buy US Treasury debt, or worse yet, are becoming net sellers, it could spark a sharp slide in US Treasury notes, sending yields sharply higher, and ignite a free-fall in the US dollar.

Last week, the US Treasury tried to reassure bond and currency traders, that foreign investors haven’t abandoned the American debt markets, despite the avalanche of new debt that is swamping the market. The US Treasury claims that China and Japan were net buyers of a combined $48.5-billion of Treasuries in March, and that Moscow was a net buyer of $8.3-billion. Yet the reliability and accuracy of the TIC report should be viewed with a grain of salt, and a healthy dose of suspicion - perhaps the figures were conjured-up under the guise of "mark-to-make-believe" accounting.

President Barack Obama’s stimulus program could boomerang and destabilize on US-economy. No one is asking who will purchase the remaining $1 trillion of US Treasuries to be auctioned by September. Once that colossal amount of paper is bought, who will purchase another $5-trillion of Treasury paper over the next four years, as the US-government plunges deeper into insolvency? The Federal Reserve would be forced to print (monetize) vast quantities of US dollars to pay the principal and interest on the national debt that is not covered by tax revenue.

The US dollar’s surprising strength since last July was largely attributed to "de-leveraging" and "risk-aversion," which are references to the unwinding of "carry trades," in the foreign exchange market. On April 6th, famed hedge-fund trader George Soros remarked, "The US-dollar is not strong because people want to hold the dollar, but it’s strong because people have debt in dollars."

The enormous fortunes of Wall Street’s aristocracy were built-up on the leveraging of debt, including "carry-trades," in order to buy exotic securities built around sub-prime mortgages, and other instruments of financial speculation. But when the global commodity and stock markets began to meltdown following the collapse of Lehman Brothers, carry-traders began massive de-leveraging - the selling risky assets and buying US dollars and Japanese yen, to pay down margin loans.

There was also a stunning contraction in the US trade deficit, narrowing from $62.5-billion in August to $26-billion in February, its lowest level in nine-years, bolstering the greenback. The US current account deficit, which had increased for five straight years, fell to $673 billion in 2008 from $731 billion in 2007. The deficit equaled 4.7% of the overall US economy last year, down from 5.3% in 2007.

But the US dollar’s "risk-aversion" rally came to an abrupt end on March 18th, when the Federal Reserve shocked the markets by announcing that it would unleash its nuclear weapon, "Quantitative Easing" (QE), by printing $1.1-trillion US dollars off its electronic printing press, to monetize US T-Notes and mortgage backed securities, in an all-out effort to prevent a deflationary spiral in the US economy, which in turn, could lead to widespread defaults on debt and bankruptcies.

By pumping vast quantities of US dollars into the global money markets, easily outstripping the money printing operations in England, the Euro-zone, Japan, and Switzerland, the Fed has headed off the prospect of deflation. Instead, the Fed has reawakened the "Commodity Super Cycle," led by the kingpin crude-oil market, which is feeding off a weaker dollar and ultra-low interest rates worldwide. Crude oil rose above $62 per barrel today, from as low as $35 in January.

The Fed has pumped $1-trillion into the banking system since July, increasing the monetary base to a record $1.87 trillion, while pegging the fed funds rate near zero-percent. Super-easy money, beloved by Fed chief Ben "Bubbles" Bernanke, US Treasury chief Tim "Turbo-tax" Geithner, corrupt Washington politicians and Wall Street Oligarchs, is a traditional recipe for an asset bubble. While the rapid expansion of the US-monetary base is buoying the gold market above $900 /oz, other G-20 central banks are also letting the inflation-genie out of its bottle, providing the yellow metal with a huge advantage over government toilet paper.

"Our actions have succeeded in pulling the financial markets and the economy from the edge of the abyss, beating back deflationary pressures, and set the stage for a recovery," declared Dallas Fed chief Richard Fisher on April 15th. Fisher argues the US economy’s low capacity utilization rate, near 69%, would keep inflationary pressures under wraps. "It is doubtful that inflation will raise its ugly head until employment picks-up and capacity utilization tightens," he said.

Higher inflation down the road means the Fed must at some point, break its addiction to easy money, and dismantle the QE framework, which has flooded the money markets with hundreds of billions of dollars. "Nobody I know on the FOMC wants to maintain our current posture for any longer and to any greater degree than is minimally necessary to restore the efficacy of the credit markets and buttress economic recovery without inflationary consequences," Fisher said.

The FOMC "can ill afford to be perceived as monetizing that debt, lest we come to be viewed as an agent of inflation, rather than an independent guardian against future inflation," the Fed’s propaganda artist said. Typically however, Fed officials continue to keep the printing presses rolling at full-speed, long after inflation has already reared its ugly head, and hyper-inflationary psychology becomes deeply embedded within the minds of commodity traders and the public at large.

Continue to Part II >>

Comments

[worldwise:]

You don't even have to ask the Chinese who are one of the largest US bond holders. Everyone I talk to are asking how is the US paying for all the money they are spending. In fact the chinese do not want the dollar to fall as they will be one of the largest looser. Did you not read the speech from the chinese premier about a month ago and Obama had to reassure that the dollar is sound.

May 22 05:59 PM

[User 418062:]

You wrote "Let us hope the Chinese, et. al lack the analytical sophistication and execution capacity to successfully engineer the strategic switch" why should we hope for that. They are probably using US Treasuries as security for loans to buy commodities and will then default on the loans giving up the bonds which may by then be worth less.


On May 21 11:32 AM User 353732 wrote:

> It is an article of faith amongst currency and govt. debt analysts
> that China , Russia , others, will not risk the loss of prinicipal
> by refusing to buy further US govt debt much less selling some existing
> holdings.
> However, suppose in a couple of years China, Russia ,some others
> after accumulating hundreds of billions of dollars in commodities(ores,
> industrial and precious metals, uranium, coal, oil , even soy beans
> and grain depending on the country involved) decide to start selling
> US debt, creating a a formidable bear market in Treasuries and agency
> debt. Would they not make the calculation that a bear market in US
> /Agencydebt would mean spiking yields and inflation, leading to a
> huge and almost frantic global flight to commodities. The resulting
> surge in commodity prices would result in spectacular inventory gains
> for these countries which would mitigate even if not completly offset
> the capital loss on their US govt debt. The relatively small net
> loss may be a price worth paying.
> The truly dangerous time for the US, i think, is not 2009, but a
> couple of years out when China et. al have put in place the coomodity
> reserve basis for a strategic exit from US govt debt. This is just
> a scenario but one that should not be dismissed without some reflection.
>
> Sadly ,even if we in the USA knew with high assurance that this "strategic
> switch" was being contemplated by China et. al there is nothing we
> would do to prevent it. Such is the tragedy of debt addiction and
> loss of national will. Instant gratification and denial have now
> become the walls and bars of self made prison.
>
> Let us hope the Chinese, et. al lack the analytical sophistication
> and execution capacity to successfully engineer the strategic switch.
>

May 22 06:12 PM

[rick j.:]

it's a stealth bomber...you're not SUPPOSED to see it!


On May 21 08:02 PM nmelendez wrote:

> BTW since the world has evolved to the same level as the US, where's
> other countries stealth technology? i mean China's stealth bomber/fighter.

May 22 11:02 PM

[psig:]

Ditto! We are heading for banana republic status. Watch out for the mirrored sunglasses becoming popular in D.C. and the politicians soon to start calling themselves generalissimo. The Chi Coms will have us bent over the table and may be building up for a trade. We give them Alaska, Alabama, Texax, California, and Georgia and they will give us back our treasuries.


On May 21 12:51 PM User 357705 wrote:

> Oops! Too late!
>

May 23 12:01 AM

[Dean M:]

A weak dollar is the first step to reclaiming our manufacturing base. The only loss will be in our ability to import foreign goods, which I see as more of a benefit. Does that make us a banana republic? It means our currency is more reflective of our trade balance which has been sick for decades, that is called facing reality. Our trade 'partners' have been playing games with their currencies to gain competitive advantage for years. Just like we won the cold war outspending the Russians, now we will win the trade war the same way. That said, I don't believe in bailing out zombie companies, we should just let them die to keep our economy healthy.

May 23 12:46 AM

[realold:]

The US thinks short term. So we by what is cheap from whomever sells it to us. We give them technology to manufacture for us because they sell the end product to us for less. We (corporations and consumers) do not think about the long term effect of not making anything yourself, buying from a natural enemy of democracy and the west, etc. Our common sense died with the men and women who won WW II - also the ones that made products for us. Now, you have a big debt, no one who knows how to make anything, rules and laws up the ying yang that prevent you from mining, building or even thinking about making things in NIMBY land. It is over.


On May 21 03:37 PM nun wrote:

> Explain to me again why the US ever got into protected trade agreements
> with a totalitarian government like China. The US escorted them into
> the WTO with absolutely no conditions whatsoever. China has no qualms
> about stealing patented products, processes, intellectual property,
> pharmaceutical products, blocking US competition within China. What
> would the trade balance be like without this theft and fixed FX?
> Maybe "slightly" better?
>
> Check out the latest consequence of their antics. Chinese counterfeit
> malaria drugs killing people and creating a "superbug" parasite.
>
> www.bloomberg.com/apps...;sid=a8mn5QnniG9Y&...
>
>
> Tell me where are the lawsuits? If a US company produced lead painted
> toys, they would be destroyed. Heck the EU grabbed serious money
> from MSFT and Intel for much less of an offense.

May 23 12:47 AM

[PeteK:]

goldtheory;
Interent is universal, a martian can surf if it wants to.
Don't be silly.
That someone you are thinking could be a 90 year old Yankee.

May 23 08:47 AM

[PeteK:]

Skjellifetti;
A group did a survey months ago asking people 60-years old or older
concerning the fall of the automakers. The result was that over 80% blamed the unions ( sorry for uions, old age, you know) and the rest
blamed the management/gov. etc etc. The reason to ask older folks because young people may not heard of all the "STRIKES" carried out by the workers against the employers all the time until they got what they wanted. In fact, the workers are the BOSS .
A business can only give so much.
Try to ask some older folks yourself, and see how they response.

May 23 11:15 AM

[5142152-337:]

SUPERB article! Thanks for writing.

May 23 02:22 PM

[Skjellifetti:]

Hey Pete:

Surveys only reveal the prejudices of the surveyed.

My family is from Detroit and includes both UAW workers (my parents gen, long ago retired) and engineers (my gen, now being forced into retirement). I've heard the horror stories from both points of view my whole life. GM and Chrysler are two incredibly mismanaged companies. And having heard both sides for years, I know that there is plenty of blame to be shared by all of the parties involved.

Oh, BTW, while we are talking about old folks, maybe you should ask people who are in their 80s and 90s why there are unions in the first place.


On May 23 11:15 AM PeteK wrote:

> Skjellifetti;
> A group did a survey months ago asking people 60-years old or older
>
> concerning the fall of the automakers. The result was that over
> 80% blamed the unions ( sorry for uions, old age, you know) and the
> rest
> blamed the management/gov. etc etc. The reason to ask older folks
> because young people may not heard of all the "STRIKES" carried out
> by the workers against the employers all the time until they got
> what they wanted. In fact, the workers are the BOSS .
> A business can only give so much.
> Try to ask some older folks yourself, and see how they response.
>

May 23 06:25 PM

[Kunst:]

Anybody else think that spending a trillion (current) dollars a year for the last six decades might have something to do with our debt problem?


On May 21 08:02 PM nmelendez wrote:

> BTW since the world has evolved to the same level as the US, where's
> other countries stealth technology? i mean China's stealth bomber/fighter.

May 23 07:37 PM

[odin:]

The news of the demise of the dollar is greatly exaggerated.

The cause and consequence of the trade deficit (and need for its external funding) are interrelated. If China/nations with a net surplus did not fund the US, they would not run a surplus in the first place (at least until the US share of global trade drops dramatically and cross-trade between these nations and/or their domestic consumption increases) and secondly, the US will have to fund its fiscal deficits domestically. The question is: is there an alternative to the dollar for these nations?

It is likely that all fiat currencies may become weaker as nations race to the bottom to protect their share of global trade. In other words, a global inflationary environment. However, to look for the signs in rising commodities prices would be dangerous. Yes, China is stockpiling commodities. But unless it changes the export-oriented nature of its economy drastically, to whom will it sell its products (for which it is stockpiling the raw materials)? To the possesors of a devalued $, who will suddenly find themselves living a more frugal life and decide they can buying a lot fewer Chinese-made appliances and clothes funneled through the Walmart sales outlets?

The fiscal deficit run by the US is indeed concerning -- not so much for the impact on the value of the dollar, but for its potential to crowd out private investment. Public borrowing is taking up an increasing share of savings (domestic or foreign). It might be a band-aid to the current crisis but it is going to slow growth (or worse, if the financial lubricants to the economy get zombified) over the long run. Furthermore, these are promises that need to be paid back out of future consumption (which is constrained by this slower growth trajectory to begin with). That to me is the real danger.

May 23 09:47 PM

[PeteK:]

Skjellifetti;
Your response is well taken.
For the past many many years, GM almost could represent America.
GM was well known world-wide and was the "Pride" of USA.
It is sad to see it comes to this.
There are enough to blame all around.
But right now we all wish GM can stay and be famous again for the next 100 years or more. Thank You.

May 23 10:51 PM

[Mr. Ed, Jr.:]

Since our so-called government is already propping up every worthless business/asset/market they can find, no reason they can't find some idiotic scheme to temporarily keep the USD from crashing.

On the other hand, if the dollar crashes, there really won't be any need to prop up all that other crap.

May 24 12:22 AM

[Masud:]

There is a misprint in Chart 3 , it should read July 2008 i/o 2009

May 24 02:43 AM

[Peter Cooper:]

Have a look at this Bloomberg report on what the US dollar decline meant for commodities and stocks last week:arabianmoney.net/2009/.../
More of the same coming this week ahead - looks inevitable.

May 24 02:56 AM

[rick12345:]

A weak dollar is good for export as well as foreign investors. What we are experiencing at the moment is what the US has been trying to do to the rest of the world for the last 100 years; screw them up the proverbial with its strong USD. With a strong euro, the US will no longer hold the title of being the worlds number one consumer of unwanted goods. Rather Europe, having a larger population, will inevitably become the new super power of the world economy. Suprisingly, this will be good for the country in the long term, but unfortunately the short term picture is bleak. Expect higher taxes and more lax foreign investment laws over the next 3 years as the government endeavours to reduce debt. One thing I don't understand is why the gov't would want to takle deflation head on when a falling dollar would in itself cause inflation?

May 24 07:39 AM

[highlarche:]

Just remember one thing " The chinese invented gunpowder"

May 24 02:32 PM

[James Quinn:]

America is headed for a mighty crash.

theburningplatform.com...

May 27 08:20 AM

[Practical:]

At some point they become their own customers, they have a savings rate of about 20% and are growing more wealthy with time. Their auto industry is projected to pass ours in 10 years. Oil prices to make the gas for those new, additional cars will cost more. Our Congress is making sure the Chinese will have jobs by putting our steel, aluminum and concrete industries out of business with the new carbon taxes on electricity. Those jobs wil be exported along with the products made with steel and aluminum like appliances, autos, motors, (gas, electric and diesel), office furniture, etc. Oh, by the way the income taxes from those workers and companies will be exported with the jobs leaving an even greater deficit.
Bert


On May 21 08:01 PM nmelendez wrote:

> So now the US dollar is at .3. Do you think we will be buying from
> China? Or do you think we will be selling to China? And here i thought
> China wanted their people to have jobs. What am i missing?

May 27 08:54 PM