USD: Toxic Monetary Cocktail

Last week, the Fed extended its emergency economic powers, which include lending to the money center banks at zero interest. A few days later, the Fed's plan was reinforced by similar announcements from the rest of the G-20. The road map the authorities are providing for the near-term global economy can't be much clearer. There will be no cessation of the seemingly endless supply of cheap dollars being pumped into the financial system.

With the world apparently in complete accord on the need for ever more liquidity, stock markets are staging an easy-money rally. The main line media is almost euphoric. But what should investors make of this seemingly good news?

This time last year, the world faced a meltdown of its financial systems and a potential depression. Fed Chairman Ben Bernanke, a renowned expert on the Great Depression, coordinated an international rescue of the toxic financial system. Although the bill for these operations has yet to come due, almost all agree it will prove costly to present and future generations. For now at least, the most significant impact of these policies has been the creation of a liquidity bubble in stocks and a surge in commodities.

However, any efforts to reduce these stimuli will result in an immediate correction toward our previous depressionary trajectory. Acceptance of this uncomfortable truth is a political third rail. Therefore, it is highly unlikely that any major government will change course. Rather, the change will be thrust upon them.

It could have been argued that some of the actions taken last year were worth the cost if they had corrected the dangerous deficiencies in the financial system. But after a year, what has changed? The same behemoth banks remain, but even larger and yet more demanding of federal salvation. That particular risk has been increased rather than reduced.

Indeed, the four largest banks have been given well over $1 trillion of TARP funds to trade. In addition, with a zero-cost of Fed funds and a positive yield-curve, the banks have been able to generate massive profits without having to incur the risks of lending to the private sector.

With such a license to steal, their stock prices have risen dramatically, sending false signals to other market participants of a broader economic recovery. Soon, these burdens to the taxpayer will pay some $140 billion in year-end bonuses. Far from a disaster, it seems as global financial crisis has been a godsend to Wall Street.

The banks also have been allowed to continue manipulating accounting rules to hide their toxic assets, including their multi-trillion-dollar exposures to the murky derivatives market. In addition, the banks continue to face escalating loan, mortgage, and credit card defaults, and an impending crunch in the commercial real estate market.

Despite popular impressions, it is clear that the bailed-out banks still face trouble. Indeed, they face enough trouble to potentially threaten the whole system again.

Could this be the reason that, despite its cautious optimism on the economy, the Fed is intent on maintaining an open source of free money for the banks? If the Fed's public optimism were to be believed, then why is there a need to continue the "emergency" TARP, bank subsidies, and economic stimulus? Could it be that the Fed is still fearful of a second financial panic? More importantly, will this fear lead to limitless liquidity – even at the cost of the value of the dollar?

The Fed's laxity would be contained somewhat if the Washington had its fiscal house in order. Unfortunately, with an official projected national debt of $20 trillion by 2015, the Administration is in no position to push for a strong dollar. Nor has Mr. Obama shown any interest in reining in the debt, instead occupying himself with a generous new healthcare entitlement. If the debt cannot be brought under control, a higher interest rate will push the U.S. government toward outright default.

This toxic cocktail of fiscal and monetary constraints on the U.S. dollar may be what prompted India to buy some 200 metric tons of gold from the IMF, China to hoard a large part of its own massive gold production, and other government parties to the shady Central Bank Gold Agreement to lose enthusiasm for selling their gold.

In a recession, gold should be falling in price. But with a Fed Chairman who seems unwilling to hit the brakes even as we head for a cliff, and an Administration that doesn't seem to care, creditor nations are jumping off the dollar train for a terra firma made of money metals. Wise investors should follow their lead.

Comments

[chris coonan:]

Are we aboard the Silverstreak Train?

Nov 12 04:53 AM

[User 353732:]

The dollar is a symbol of what the world believes the America to be.
When the world viewed America as strong, true and a force for global innovation and freedom the dollar was indeed a great store of value and impeccable medium of exchange. The world fled TO the dollar.

Now the world views the Regime that occupies America as vain, selfish, corrupt and cowardly. It views the fiat dollar as a fraud and the US regime as a major source of investment risk and cause of wealth destruction. The world is beginning to flee FROM the dollar.

In its diseased and ignorant conceit, the US Regime imagines that there is no substitute for its fake dollar and the world is held hostage. Much of the world, however, reacts very poorly to hostage taking. Most of the world, most of the time, accepts casualties in a shoot out with hostage takers. The latter, almost always are killed or taken captive.

Nov 12 07:48 AM

[Leftfield:]

ZIRP or bust. The US is in a box; it's policies are killing the diminished value-adding sectors of the economy while trying to reflate the fundamentally busted, parasitic financial, government and crony sectors. Rising interest rates will cause another financial meltdown to which there will be no remedy as all the furniture is already being thrown into the fire to keep the old party going.
Pretend and extend until "the change will be thrust upon them."

Nov 12 08:43 AM

[The Geoffster:]

"This toxic cocktail of fiscal and monetary constraints on the U.S. dollar may be what prompted India to buy some 200 metric tons of gold from the IMF..."

I can't speak for India, but that's why I bought gold.

Nov 12 09:09 AM

[Moon Kil Woong:]

I agree that QE, zirp, stimulus etc. proves that all is not roses in the US economy even though the Treasury and Fed proclaim it so. We are not such big fools after all. The dollar dump exchange for GDP and stock gains can't continue without breaking the machine. Thus, as of today I sold most of my positions.

Let the Federal Reserve and Congress go to war. I'll stand by and watch. I'd hold metals but at this price that also scares me should the Fed cover its ass by closing it's QE positions so it can hide as much of its losses as it can before an audit.

Nov 12 11:45 AM

[Dave5577:]

It seems the FED would always embrace Q.E. and could become the lender of last resort if the interest rate environment turned hostile and threatened to crash the economy. This again would artifically provide us with low interest rates. The question in my mind is: is this the final reflation or is there another one lurking in the future somewhere.

Nov 12 12:33 PM

[Bruce Vande...:]

Very good summary of the corner the US has painted itself into.

Nov 12 01:20 PM