Lou Thomas

Sell the U.S. Dollar into Strength

In its fundamentals, this article is an excellent dose of reality. Sometimes the obvious needs to be stated, especially on a site whose other writers have often taken exactly the positions debunked by this author.

I would disagree, however, that the dollar intervention was primarily intended to placate a (U.S.) public that is tired of inflation. That would not explain the participation of other central banks in the intervention, and the Fed could not have done this without a lot of help, or at least the tolerance of China and other major holders of dollars.

The reality is more complex. The U.S. owes more money than it can pay. Creditor nations have allowed the U.S. to run up a huge tab in order to build their own export industries, and possibly, if we can imagine them as being a bit diabolical, to put the U.S. into a weaker position. But in the process they have accumulated our moldy green scrip, which they've invested into our mortgage and equity bubbles, inflating them in the process, and thereby furthering a cycle of unsustainable consumption.

Now, it has become clear that the U.S. can never pay its debts. Even more importantly, the bubbles are popping, and the U.S. consumer is dying, and that is reducing the incentive that China and others have to keep propping up the U.S. economy and dollar in order to support exports to our (formerly) profligate consuming class. But if they pull the plug, then all of that green paper falls to its true value, and they have quite a lot of it. So, it is kind of a dilemma for everyone. And that is why so much energy is going into the various mechanisms of denial (e.g., bailouts, special lending windows, and so on) that postpone, and make worse, the final cataclysm.

The GSE bailout is the most recent and trenchant example. Here, the Federal government is "guaranteeing" the debts of foreign investors. But, the Federal government already borrows a large percentage of its budget each day from those same foreign investors. So, who will be asked to invest even more money to pay for this Federal guarantee? Those same foreigners, of course! You could say that it is a Ponzi scheme, except for the fact that there are no new suckers to be added - it is borrowing from Peter to pay...Peter! So, Peter had better be a schizophrenic if you want that scheme to work out for very long.

Somebody asked where they should put their money if they take it out of the dollar. This is a good question, as there is no safe place in a world that is falling apart. But there are many things that will probably be better than the dollar! So, look around and see what you can find. I'm leaning toward German sovereign debt, myself, but the analysis on which that is based is complicated and tenuous, and I am just an amateur, not someone who does this for a living. But anyway:

It's clear that the main U.S. trade imbalance is with Asia and the oil producing nations. However, Asia in particular is very export-oriented, and so its economy will suffer a serious blow when the U.S. consumption machine finally succumbs. It will probably not be able to grow its middle classes quickly enough to take up the slack. Therefore, it will need to look for ways to expand in areas of the world that do have significant consuming classes. I see Europe as one of the main such areas other than the U.S. So, my thought is that China will sell U.S. Treasuries and GSE bonds and buy European bonds to push the Euro in particular up relative to the yuan so that they can sell some of the exports that used to go to the U.S. (that they can't absorb internally) there.

Also, I'm a bit more afraid of currency controls and other forms of intervention affecting foreign investors in China in particular than in Europe, although that's not based on a good understanding of China, but rather, just a lack of information and general uneasiness. But China has tended toward insularity in the past.

As for gold, once again, probably better than the dollar, but gold is a commodity, and we're headed into a worldwide recession - possibly a depression. Commodities tend to lose value as demand drops. How much agreement will there be that gold is a reasonable store of value, when what people really need is food. Ask King Midas about gold - you can't eat it. A fiat currency such as the Euro that is tied to a real economy that makes stuff that people really want might actually do better - but then again, maybe not!

Good luck, if you deserve it! If you don't, you know who you are - focus on human relationships to get you through the coming difficulties.