Mathematical Realities Will Trump the Dollar

I have been on a potential dollar dislocation - or collapse - for more than two years. Indeed, back in the fall of 2007, it was one of the themes of petitions to Congress and letters I sent under personal cover to all 535 members.

The debt liquidation cycle of 2008/early-09 appeared to stop the deterioration. Unfortunately that cycle was interrupted - intentionally - by enabling a continuing pattern of lies and fraud within our government.

This has reversed all of the gains that the dollar had made last fall and winter, despite the stock market and other asset prices being materially lower - by a lot - than when those warnings were issued.

Treasury is always "for a strong dollar" in word, but their view when it comes to deeds is another matter. This is most unfortunate, as this, like Treasury's and The Fed's view when it comes to sweeping trouble under the rug and lying about asset quality has been proved wrong through time not only here in America but worldwide.

Japan is a prime example. They adopted the same sort of "programs" we did when they ran into debt-based trouble in their economy two decades ago. Instead of forcing those who had made bad loans and by doing so blown asset bubbles to eat them - even if it blew them up - they instead played extend and pretend - that the loans were good, that the asset quality was fine, that the banks had plenty of reserves.

The Japanese economy never recovered. Instead it scraped along a deflationary bottom for a literal two decades, sustained only by the Yen Carry Trade.

But carry trades don't deploy the borrowed funds in the "host", or "funding" nation. Indeed, the entire point is to borrow there cheaply and then "invest" (or trade) somewhere that has a higher return. This drains the host just as does any parasite, and drain it did - for more than a decade, Japan's capital flows were turned inside-out.

Now it's our turn; the dollar has turned into the funding currency of choice, cutting off the last bit of Japan's bond appetite. The government is now threatening to issue as much as $50 trillion Yen of bonds in the next year of "new issue" in an attempt to keep the game going, flooding the market. This could in turn provoke a currency dislocation and drive the Yen/Dollar swap to 200, according to some observers.

There is a lesson there that is not lost on others; out of Australia we now have this:

In unusually pessimistic comments for a senior political figure, Senator Joyce said the US Government was running such large deficits and building up so much debt that it was in a similar position to Iceland or Germany before World War II.

In a Senate estimates hearing on Wednesday night, he asked Treasury secretary Ken Henry what would be the implications of an American debt default for the Australian economy.

....

''Far from turning around the [George] Bush legacy of deficits and debt, [US president Barack] Obama has made it worse. It has got all the hallmarks of a financial collapse about to happen in America.''

Senator Joyce said investor concerns about the American Government's ability to fund its deficits were already undermining the role of the US dollar in the international trading and financial system.

''The US dollar is almost becoming like junk bonds,'' he said.

Uhhhhhhh.... yeah.

Unfortunately.

America had a justified hubris for decades coming out of WWII in terms of our manufacturing base and intellectual capital, both of which led to the dollar's strength and a fully-reasonable view that the dollar was indeed the global currency - whether others liked it or not.

But today this has changed. The view that "deficits don't matter" and that The Dollar can be debased by outrageously ridiculous spending patterns in the Congress has undermined the foundation on which the dollar relies for that reserve status. Political promises have put into place a budgetary structure in our government that defines more than half of all the money spent every year as "mandatory", going to either Social Security and Medicare or debt interest, and another 1/4 being spent on defense. Of those four categories only two - interest and the military - are defined as enumerated and proper powers in The Constitution, yet the demographic and political realities turn the other two into "mandatory" categories that are impossible to challenge or modify. Those who have tried to do anything other than enlarge either have been swiftly booted from office.

Mathematics, however, trump politics. The mathematical reality is that you can only sustain deficit spending policies (whether by government or private debt acquisition) if GDP grows faster than debt and that growth has to come from the private sector, not government transfer payments, or the deficit percentage and impact will grow faster than GDP. This is, again, mathematics and cannot be avoided, since the government is only a fraction of the entire economy (and even in a command economy can't be more than 100% of it!)

Again I present the graph that I have shown before on what happens if you don't obey the realities of mathematics:

This isn't conjecture. It isn't politics. It is mathematical reality.

There has been NO - underline that - NO - recognition of the mathematical realities that underlie debt and GDP growth within our government, including Congress and regulators.

None.

This is precisely the same road that Japan went down after the Nikkei topped and then crashed when their debt bubble blew up.

A raw refusal to recognize the mathematical realities has led The Fed and Treasury to instead make legitimate outright fraudulent accounting, enabling banks and others to arbitrarily defer recognition of losses based on nothing more than a hope that through currency debasement popped bubbles can be re-inflated.

History tells us that such strategies never succeed, especially in an import-based economy, which we are, as input costs are tied directly to currency debasement and worse, those foreign interests that hold necessary imports also tend to hold significant currency reserves. As those reserves are debased the holders of these resources will raise prices and/or constrain supply so as to recover not only the current debasement but also the debasement of their reserves.

Congress may not like the facts, but that doesn't change them. Fraud never pays in the end, and despite all of the crooning and intentional diversion by people such as Bernanke, Summers and Geithner the above chart is a simple reflection of mathematical realities of compound growth - a reality that cannot be changed with "magic wand" waving or burying bad assets under a mountain of fraudulent accounting manipulation.

Comments

[Dave Wrixon:]

Yes, but that is a bit like saying that in 100 years we will all be dead.


On Oct 23 08:02 PM Mark Anthony wrote:

> Karl:
> You just seems can't make up your mind one way or another, do you?
> You keep swing the pendulum between a dollar bull and then a dollar
> collapse, and back to dollar buul again. Today you published two
> articles, one claims you have a dollar long position, one claims
> sudden collapse of the dollar. Exactly what is it?
>
> You get all the facts rights but all the analysis wrong. You absolutely
> have no understanding of fiat currency system. Each and every fiat
> currency that has ever experimented throughout human history has,
> without one single exception, all failed at the end. That is a historical
> FACT. Read some history.
>
> Today, it is the turn of the US dollar to fail, and to become the
> statistics.

Oct 24 04:45 AM

[Chris Cook:]

@Dave Wrixon

In fact it's known as Triffin's dilemma.

In a global financial system where money is created as debt, then the provider of the global reserve currency necessarily becomes a debtor to the world, and in the long run, that is not sustainable.

...and yes, as Keynes put it, in the long run, we're all dead.

Oct 24 09:18 AM

[perceptions...:]

Bartlet & Martenson are right, you can not operate exponential Financial/Economic systems, in a world of finite resources and exploding Populations.

Something has to give eventually and we are now facing major tipping points.

I suggest you hold onto you hat, batten down the hatches and await the storm!

Oct 24 09:55 AM

[JPDewy:]

>To sort this mess out, it likely that the Constitution would need to be entirely rewritten and even then electorate would need to have the intellect...>

In case you missed it the Constitution was abolished a long time ago! We don't have a Constitution now. There are no rules might makes right.


On Oct 23 02:08 PM Dave Wrixon wrote:

> The problem is you don't have an economic cycle, all you have is
> an almost inevitable slide into the abyss.
>
> Theoretically, I guess the economy could be saved. Politically, it
> is just not doable. There is not the political will or appropriate
> political structures in place to have any hope of control. To sort
> this mess out, it likely that the Constitution would need to be entirely
> rewritten and even then electorate would need to have the intellect
> and integrity to vote in a government that is not only morally sound,
> but actually understands what needs to be done. We are at least a
> decade from that point, so frankly there is no realistic hope of
> turning this around.

Oct 24 11:25 AM

[TeresaE:]

He did this by accounting fraud and pushing his mandates onto the next administration.

A deaf, blind monkey could have "led" us through the late 90s. Two separate once-in-a-lifetime events set us up for prosperity.

And even Pres Clinton didn't see reality (or didn't care, after all he went from not having a down payment on his house to filthy rich this decade).

I hate that Clinton is lauded as some kind of economic genius, he isn't. And he is the one that signed into law the things that 100% gutted the American ability to produce things and fix this current mess.


On Oct 23 01:16 PM user396040 wrote:

> It is very important to separate two issues here - 1. should we be
> running a deficit at this point in the economic cycle where the economy
> is operating with enormous excess capacity; and 2. should we be running
> net deficits throughout the economic cycle (the policy of George
> W. Bush) even in years of growth and prosperity. I think the first
> question depends on whether one accepts Keynesian economics - it
> would be dangerous to "balance the budget" now because it would likely
> tank the economy, tax receipts would decline precipitously, and the
> deficit would actually get worse. Of course, we could do things
> like refusing to send out tax refunds and social security, slow pay
> military contractors and simply refuse to pay the Army, Air Force,
> Navy, and Marines and see how that worked out but I really don't
> see that strategy as strengthening the country.
> The second question is a very different one. Over the course of
> an economic cycle we should seek to balance the budget. This means
> running surpluses in boom years so that we can run deficits in bust
> years. The only President to follow this policy since WW2 was Bill
> Clinton who, I suspect, was not a favorite of some of the Tea Party
> deficit hawks speaking up on this issue now.

Oct 24 11:33 AM

[TeresaE:]

Tax cuts to whom? Those making less than $20k a year?

Wow, look at the money they can spend.

My business's expenses are skyrocketing as my sales hit 25 year lows.

Higher taxes ALWAYS equates to lower tax collections and fewer jobs. Always.

Come study Michigan. We had the largest tax increase EVER, just two short years ago. Result? Now we are using $2 BILLION of your money (from Jen's friend in the WH) and getting ready to raise taxes AGAIN, higher than the last time.

I'm sure this time it will work. Just ignore the fact that high taxes have NEVER worked, unless your goal is total government control of every aspect of our shared poverty.


On Oct 23 10:33 PM PlutoToo wrote:

> Oh boy, tax cuts. Half the stimulus was tax cuts. How'd that work
> out?
>
>
> <img src="i173.photobucket.com/a...">

Oct 24 11:37 AM

[TeresaE:]

BS. Utility inflation is here
Gasoline inflation is here
Food stuffs - anything processed, especially foreign made. Yep, here.
Pharmaceuticals, sorry again, here.
OTC drugs, band-aids, shampoo, toothpaste and razors? Here.

Great, I can now buy a tv for less money, but yet my monthly outflows are skyrocketing.

Inflation, due to the fact that nearly everything we eat, consume or need is foreign made, is here.

Quit looking to falsified reporting from WDC & their media minions and go and talk to a few moms that pay attention to cash flow.

While deflation is stealing things we already bought and paid for, inflation is killing what is left of our paychecks. If lucky enough to still have one of those.


On Oct 23 08:05 PM Thomas J. Gordon wrote:

> Agree with what Karl says. But so far no one has paid the piper.
> Obama and Geithner spend like drunken sailors and u.s. treasuries
> rates are very low, inflation is no where to be found, and the stock
> market is going up. I suppose you could argue that high unemployment
> was caused by deficits but that's a causal chain that few people
> understand. I think the most important thing we people of good will
> have to push for is a mathematical insistence that the federal budget
> is only equal to tax take.

Oct 24 11:41 AM

[Graham and ...:]

The article and charts puts the lie to the 2000s proposition that we can borrow our way to higher growth. If the law of diminishing returns says that the has to grow faster than GDP growth, sooner or later, it will become an unsustainable proportion of the U.S. economy.

"It's all relative."

Oct 24 12:48 PM

[yellowhoard:]

I see Clinton as more of a Caligula type.


On Oct 23 11:36 PM untrusting investor wrote:

> Any suggestions for the Roman=US comparison :
> For example:
> Clinton=Augustus
> Bush=Nero
> Obama=Claudius
>
> Let us know how they stack up with their historical counterparts.
>

Oct 24 12:54 PM

[doubleguns:]

I did not think Caligula smoked cigars;-{


On Oct 24 12:54 PM yellowhoard wrote:

> I see Clinton as more of a Caligula type.

Oct 24 01:06 PM

[Formyx:]

FX is a relative game. Your US-centric analysis ignores the other players. Well, I have news for you. Japan is going bust first.
1. In 2009 govt borrowing will be higher than tax revenue for the first time since 1946.
2. Govt debt to GDP will be 200% in 2010.
3. Japanese savings rate is forecast to be negative in a year's time while in the US is going up.
4. Japanese population older than the USs.

Inferences from the dismal US public finances to statements about the US$ are disappointing indeed.

Oct 24 01:14 PM

[Karl Denninger:]

I will simply comment that a significant number of comment-posters in this thread **invented** statements in their mind that were not made.

It's rather amusing, really..... but not surprising.

Now I get to see, having made this comment, how many people who have commented can go back and figure out what the above paragraph means.

Oct 24 03:37 PM

[bob adamson:]

Well said user396040.

Too many otherwise intelligent, perceptive and knowledgeable observers of the economy allow their political or ideological preferences to blinker their capacity to consider policy options. This happens on both the left and the right (extreme Marxists and Extreme Libertarians alike, for example) and seems to intensify during challenging economic times. It’s right and proper to have goals and strong aspirations for society and the economy based on a political philosophy (we all do and should) but we have to deal with the world as we find it from time to time and not pretend that economic history can be ended in ecstasy by some wild embrace of some economic truth.

At its most obvious and extreme, this leads many to see disaster around the corner and only one possible albeit dramatic and painful solution; a solution if we will only take the great leap of faith and embrace will resolve all difficulties and bring the world back into balance. Interestingly, many with this mindset will see the same disaster and promise of miraculous salvation at any stage of current economic health or lack thereof; disaster and the millennium always just around the corner.

Most of us continue to live in a world where circumstances change and history unfolds; where, metaphorically, Ecclesiastics and not Revelations sets the pattern.

In short, I fully agree that there will be much time and many stages to the economic recovery and that stabilization after the meltdown of last fall is the first stage. That first stage is not yet completed and requires internationally coordinated stimulus which happily is occurring. Disaster is not at hand provided we all remain rational and not theological (by which I mean ideological) in our willingness to consider options.


On Oct 23 01:16 PM user396040 wrote:

> It is very important to separate two issues here - 1. should we be
> running a deficit at this point in the economic cycle where the economy
> is operating with enormous excess capacity; and 2. should we be running
> net deficits throughout the economic cycle (the policy of George
> W. Bush) even in years of growth and prosperity. I think the first
> question depends on whether one accepts Keynesian economics - it
> would be dangerous to "balance the budget" now because it would likely
> tank the economy, tax receipts would decline precipitously, and the
> deficit would actually get worse. Of course, we could do things like
> refusing to send out tax refunds and social security, slow pay military
> contractors and simply refuse to pay the Army, Air Force, Navy, and
> Marines and see how that worked out but I really don't see that strategy
> as strengthening the country.
> The second question is a very different one. Over the course of an
> economic cycle we should seek to balance the budget. This means running
> surpluses in boom years so that we can run deficits in bust years.
> The only President to follow this policy since WW2 was Bill Clinton
> who, I suspect, was not a favorite of some of the Tea Party deficit
> hawks speaking up on this issue now.

Oct 24 04:39 PM

[yellowhoard:]

I'm not a fan of Obama, but Claudius was considered by many of his time to be somewhat of a retard. Even those of us who disagree with the man don't think he's an idiot.


On Oct 23 11:36 PM untrusting investor wrote:

> Any suggestions for the Roman=US comparison :
> For example:
> Clinton=Augustus
> Bush=Nero
> Obama=Claudius
>
> Let us know how they stack up with their historical counterparts.
>

Oct 24 05:51 PM

[optionsgirl:]

Interesting observation. You are not alone in your opinion. Time to short the yen?


On Oct 24 01:14 PM Formyx wrote:

> FX is a relative game. Your US-centric analysis ignores the other
> players. Well, I have news for you. Japan is going bust first.<br/>1.
> In 2009 govt borrowing will be higher than tax revenue for the first
> time since 1946.
> 2. Govt debt to GDP will be 200% in 2010.
> 3. Japanese savings rate is forecast to be negative in a year's time
> while in the US is going up.
> 4. Japanese population older than the USs.
>
> Inferences from the dismal US public finances to statements about
> the US$ are disappointing indeed.

Oct 24 07:18 PM

[Swashbuckler:]

Steve Wynn is a visionary and practically built Las Vegas into what it is today. He is also hated intensely by much of the Vegas establishment and has an ego bigger than Donald Trump's.


On Oct 23 02:45 PM ebworthen wrote:

> Yup - but Steve Wynn has to live in the real world, Congress and
> the rest of the federal government does not.
>
> Steve Wynn runs a great hotel; best places in Vegas, value, service,
> cleanliness, have been his hotels and they have gone downhill as
> soon as he left (poor Treasure Island!).
>
> Congress runs a plantation, and you and I are picking the cotton.
>

Oct 24 07:34 PM

[Dialectical...:]

That is probably the most interesting thing I have read this week (the idea that since women's options were limited, more great minds went into teaching than today). I think there is now more wrong with our public education than just having bright minds will fix (rampant violence, kids too hungry or sleepy to learn, etc.) but getting great minds back into teaching should definitely be a priority. Now if we could also get great minds into government, that would be a plus...

On Oct 23 06:26 PM optionsgirl wrote:

> Wynn also suggested that the way to improve public education and
> attract math and science teachers is to make a portion of their pay
> a tax credit, to induce the best and brightest to teach rather than
> go into industry, which pays better. He also said that years ago,
> we had better math and science teachers because women were restricted
> to teaching or nursing generally, so brighter minds taught in the
> public schools.
>
> On Oct 23 02:45 PM ebworthen wrote:

Oct 25 03:44 AM

[Thomas J. G...:]

TeresaE: Agree about Clinton, one of the luckier guys you're ever going to meet. Perot guaranteed his first election as president. Reagan did all the heavy lifting on the international front and he had 8 years of our enemies in retreat. The Internet Bubble (unsustainable) made the economy excellent (people would kill for that economy now) and he looked good on the economic front and left his successor to deal with the bursting.
Yellowhoard: I don't think Obama is too bright. They said Reagan was stupid, they said Bush was stupid. They say all conservatives are stupid. Well now I'll say it. What Obama knows about economics you could put in a thimble.

Oct 25 11:05 AM

[obewon:]

@ebworthen:

Yeah, generally true, but only in the short term!

Of great importance to the current administration (and our corrupt politicians in general) is to "keep the hope alive." Their mistaken belief is that a heavily manipulated stock market will continue to make many Americans happy this holiday season, and so that is is their fundamental short term objective.

But with deficits spiralling out of control, continuing high unemployment, and virtually guaranteed $2 trillion deficits each year over the next 5 years, this "house of cards" will eventually collapse on our politicians and their agents, GS and JPM. A government can't continually manipulate EVERYTHING, and continually increase national debt, while expecting any kind of solid economic growth.


On Oct 23 02:06 PM ebworthen wrote:

> Political realities (e.g. - get re-elected) are trumping mathematical
> realities.

Oct 25 04:48 PM

[Mark Anthony:]

If any one is still in the illusion that the US dollar will not collapse, and that one should long the dollar and short the general equity's market ("short the phone book"). You need to read the reasons behind why the dollar is doomed:

seekingalpha.com/insta...

Key theme: Hot money escaping from America, like spill over of a melting cook pot. And you guys think the dinner can still be saved?

Look at AMZN making new record high. What does that tell you?

Oct 26 09:56 AM