The Swansong for the Greenback
by Mike Whitney
The great dollar sell-off has begun in
earnest, although to a large extent, it's being concealed from
Wary currency traders have been expecting
a dollar-slide for months but were nervous about the possibility
of widespread panic. Everyone from Bill Gates to Paul Volcker
has predicted that the current trade deficit of $800 billion (7%
of GDP) would inevitably produce a weaker dollar, so it is only
natural that China, Japan and other foreign lenders would begin
to cut back on their purchases. The danger to the United States,
however, remains extreme. If the transition doesn't go smoothly,
it could precipitate a run on the dollar and trigger economic
pandemonium. No one wants to see the world's economic powerhouse
pirouetting through the ether in flames. By the same token, no
one wants to be the last man holding onto stockpiles of scrip
that are diminishing in value.
The delicacy of the situation explains
the sudden appointment of Henry Paulson as Treasury Secretary.
Paulson is a brainy insider who has the bona fides to manage a
very tricky "retreat" from the dollar. America's economic
future will depend heavily on his ability to steer the ship of
state through troubled waters.
As we said, there was no doubt that China,
Japan and others would eventually reduce their dollar holdings
as America's debt continued to mount. What is surprising though
is that a sell-off did not occur earlier when Bush enshrined his
reckless tax cuts and profligate spending as "permanent".
The administration's fondness for living beyond its means has
never been in doubt, now the greenback will pay the price for
Of course, Bush is not the main scoundrel
in this morality play. The Federal Reserve has weakened the dollar
enormously by engineering one monetary coup after another. Greenspan's
"cheap money" policy has created massive equity bubbles
that appear whenever interest rates are absurdly low. When the
stock market crashed in the late '90s, millions of working class
people lost their retirement and life savings overnight, while
wealthy insiders walked away unscathed. Undaunted by the economic
carnage he produced, Greenspan again lowered interest rates to
a ridiculous 1% in 2001 which created a $9 trillion housing bubble,
"the largest equity bubble of all time" (says The Economist).
Now, as interest rates inch higher, the housing industry is lumbering
towards the power-lines and certain death. The effects on the
world economy will be catastrophic.
Under Greenspan, the money supply expanded
at an unbelievable rate. "From 1982 to 1992, it went from
a "modest" 8% year-on-year expansion. However, from
1992 to 2002 it moved into overdrive with the deregulation of
global markets with a year-on-year expansion of more than 12%.
Since the 2002 post-9/11 crash, the money supply has been expanding
at greater than 15%", more than doubling in less than a decade.
(Nigel Maund, "Fiat and Credit")
Now there are signs that foreign lenders
are tired of the weakening dollar and are reducing their stockpiles
of greenbacks and dollar-denominated securities. The Gold Forecaster
reports in its recent article "The US Dollar and its Prospects":
Last month saw the U.K. and Caribbean
Banks buy a disproportionately large amount of U.S. Treasury assets.
It appears that this is part of an international dollar liquidity
management program. If this is correct the two centers will buy
even more from now on, as other foreigners reduce their purchases
of the U.S. dollar.
This means that China and Japan have begun
to reduce their purchases of US Treasuries but, surprisingly,
some mysterious third party has begun to pick up the slack.
Who is crazy enough to increase their
dollar holdings when most analysts are predicting a loss in value?
Apparently, the Bush administration (along
with the Federal Reserve) is purchasing its own debt (Treasuries)
to control the rate at which the dollar declines. It's a good
strategy, but it can't last forever.
If the dollar began a sudden nosedive,
central banks around the world would quickly ditch their stockpiles
and ignite a global economic firestorm. By purchasing its own
debt, the US hopes to engineer a "soft landing" while
maintaining its status as the world's "reserve currency."
As the world's reserve currency, the Fed
can simply print money that the rest of the world accepts as payment
for its manufactured goods and resources. It's the slickest deal
on earth. As one admiring currency trader said, "It's like
having a mint in your own backyard."
The system was put in place after the
vast devastation of World War II and has made the Federal Reserve
the de facto steward of the global economic system. Nearly 70%
of the reserves in foreign central banks are either dollars or
dollar-denominated securities. This is as close to a monopoly
as it gets.
The expansion of the dollar is the greatest
fiat-money experiment in history. The awesome power of the greenback
extends to all markets, and yet, is completely disconnected from
the traditional means of measuring value, like the gold standard.
It's clear that Bush believes that the
dollar can survive "devaluation" if the US is able to
control the vast oil resources in the Middle East. Foreign countries
will be forced to use the dollar in their oil purchases regardless
of the staggering trade deficits. The dollar's value will continue
to be pegged to oil while its future will increasingly depend
on the military's success in Iraq and, potentially, Iran. Needless
to say, the results are far from certain.
Even if the administration's plans in
the Middle East succeed, there are stormy times ahead for the
greenback. The United States has reached an unsustainable level
of debt in government, business and personal finances. Personal
savings are down, mortgage payments are up, and credit card debt
is higher than ever. The entire country is mired in swamp of red
ink for which there is no easy remedy.
James Shepherd, President of JAS MTS Inc.
puts it this way:
"A perfect storm is developing and
much of this danger has to do with debt. . . . When a saturation
point of debt and leverage is reached, even a minor dislocation
can cause a dramatic collapse. . . . Debtors are always punished
more severely in a declining economy because, as activity subsides,
they are less able to service their debt and the value of the
assets that have collateralized are also falling. Once those that
own real estate realize that their neighbors cannot service their
mortgages and are forced to sell at almost any price, thereby
driving down the perceived value of their own property, the conditions
necessary for a full-fledged debt-driven meltdown will be in place
. . . a severe recession -- is about to sweep over the landscape
and blow away those who are not prepared."
The predictions of Warren Buffett, Chairman
of Berkshire Hathaway, are equally sobering:
"There are deep-rooted structural
problems that will cause America to continue to run a huge current-account
deficit unless trade policies either change materially or the
dollar declines by a degree that could prove unsettling to financial
markets. Indeed, without policy changes, currency markets could
become disorderly and generate spill-over effects, both political
Could the falling dollar lead to "political
turmoil," as Buffett suggests?
The Organization for Economic Cooperation
(O.E.C.D.) has joined skeptics at the IMF in predicting that the
dollar will fall by 35% to 50% in order to balance current account
deficits. These are modest predictions given the enormous amount
of debt the US has accumulated in just the last six years ($3
trillion). Consider how life for the average American will change
when gas is $6 per gallon rather than $3; when groceries skyrocket
to twice their normal price, and when life savings are cut in
The greenback is now facing its greatest
challenge due to its massive account imbalances, reckless mismanagement,
and erosion in confidence. The only way the dollar can slow its
downward slide is by maintaining its stranglehold on the oil trade.
Currently, oil is sold exclusively in dollars, which allows the
US to float trillions of greenbacks through the system without
fear of them being cashed in. Unfortunately, there's rebellion
among the vassals. Iran (5.4% daily world oil output) Venezuela
(5.2% daily world oil output) and Russia (15.3% daily world oil
output) are all threatening to abandon the dollar in their oil
transactions which would send hundreds of billions of dollars
back to the US and plunge the country into a deep recession. If
this mutiny succeeds, the dollar will vanish in a poof of black
Abolishing the M-3
In late March 2006 the Federal Reserve
ceased publishing the M-3, the indicator of how many dollars are
currently in circulation. This removes all the reliable data on
the dollar's value. Now, the public has no way of knowing what
is going on with its own currency. This lack of transparency will
be disastrous for the dollar as the use of money is predicated
on confidence. By making their activities as opaque as possible,
the Fed has undermined the public's trust and added to the anxiety
in the markets.
America's biggest lenders in Europe and
Asia are now expected to calculate the value of the dollar without
the statistical tools they need to make a reasoned judgment.
That does not inspire confidence.
How long will countries continue to loan
money to a nation that takes a "trust me" attitude,
especially when the government is as widely distrusted as the
Bush administration. The removal of the M-3 may seem like a short-term
fix to obscure the machinations of the Fed, but over time it will
be seen as a costly mistake.
Paulson to the Rescue
Newly appointed Treasury Secretary Henry
Paulson has been given the daunting task of closing ranks with
the Federal Reserve and supervising an "orderly devaluation"
of the dollar. There's great concern that a "sudden disorderly
adjustment" will precipitate a run on the dollar, traumatizing
the markets and sending the economy into a tailspin. Regrettably,
there are no easy choices; the dollar is losing air, and fast.
The accumulated weight of unfunded tax cuts, extravagant military
expenses, personal debt, and global trade imbalances have taken
a wrecking-ball to the greenback and left little room for hope.
Paulson's job is to turn the dollar's downfall into a "controlled
demolition" rather than a full system meltdown.
Mike Whitney lives in Washington state,
and can be reached at: firstname.lastname@example.org.