Death of the Dollar » New Jersey CFO

Despite the administration’s aggressive and costly economic policy initiatives, there is trouble all around.

Barely six months in office, President Obama already finds himself in an economic box. For despite his aggressive and costly economic policy initiatives, the jobs market shows no sign of healing. At the same time, the housing market foreclosure crisis continues apace, while renewed questions are again surfacing about the soundness of the U.S. banking system. To complicate matters, financial markets are now starting to fret about the longer-run inflationary consequences of the unusually large budget deficits in prospect for as far as the eye can see.

In January 2009, on presenting its $780 billion fiscal stimulus package, the Obama administration assured the public that because of that stimulus package U.S. unemployment would not exceed 8 percent. Yet already by June 2009, unemployment had risen to 9.5 percent; including part-time workers, who would prefer to be working full time, unemployment rose to a staggering post-war high of over 16 percent. Worse still, the jobs market shows every sign of being far from bottoming out.

The degree to which unemployment has exceeded the administration’s forecasts has to raise basic questions about the appropriateness and coherence of President Obama’s economic policy approach.

The degree to which unemployment has exceeded the administration’s forecasts has to raise basic questions about the appropriateness and coherence of President Obama’s economic policy approach. These questions pertain not simply to the very poor design of the fiscal stimulus package. Rather they pertain to the adequacy of the measures aimed at stabilizing the housing market and at resolving the country’s most wrenching credit crisis in the post-war period.

At the most basic level, one has to question how much sense it made for President Obama to allow the fiscal package to become excessively back-loaded at time when the economy needed immediate large scale support. If a large fiscal stimulus was indeed needed, why has only $60 billion of that package been dribbled out by June? And why is less than a third of the package scheduled to come into effect in 2009, the year when the package is most sorely needed?

Similarly one has to wonder about the heavy price that the Obama administration paid for effectively outsourcing the package’s design to House Speaker Nancy Pelosi and the rest of the Democratic congressional leadership. Should it really have come as a surprise to us that the resulting stimulus package would be laden with pork and with expenditures that are going to be very difficult to roll back? Or should we now be shocked that the package fell sadly short of including fast acting and effective fiscal stimulus measures that might have gotten the most bang for the buck?

Perhaps the most troubling aspect of the Obama fiscal stimulus package is the serious way in which it compromises the country’s long-run public finances and fans long-run inflationary expectations. The nonpartisan Congressional Budget Office estimates that the Obama budget not only implies unusually large budget deficits over the next two years but it implies that, even when the economy eventually fully recovers, the deficit will remain in the region of between 4 and 6 percentage points of GDP. As a result, over the next decade, the public debt will rise in a manner that has never occurred before in peacetime, from around 41 percent of GDP in 2008 to 82 percent of GDP by 2019.

Over the next decade, the public debt will rise in a manner that has never occurred before in peacetime from around 41 percent of GDP in 2008 to 82 percent of GDP by 2019.

The rising tide of unemployment must also raise questions about the Obama administration’s efforts to stabilize the housing market, which the administration correctly views as a necessary condition for producing a meaningful economic recovery. One has to expect that a weaker job market will only exacerbate the country’s present foreclosure crisis, which is adding supply to an already glutted housing market. The Center for Responsible Lending estimates that 2.4 million homes could be in foreclosure in 2009 and as many as 8.1 million homes over the next four years. Yet, the Obama administration’s loan modification program announced earlier this year has to date only resulted in 190,000 offers at mortgage loan modification.

Rising unemployment also has to raise questions about whether the Obama administration is not being overly sanguine about the health of the U.S. banking system. For it would seem that unemployment will now well exceed the worst-case scenario in the bank stress test presented by the administration earlier this year. Yet, despite a weakening unemployment outlook that is sure to boost bank losses, the Obama administration is now cavalierly backing away from its earlier initiatives to reduce the toxic assets that remain on the banks’ balance sheets.

Less than six months into his term, President Obama already faces difficult economic policy choices. He can choose, as he now seems to be doing, to counsel patience and assure us that all is well at considerable cost to his credibility on economic policy management. Or he can own up to the facts that he misread the economy in January and that his economic team now needs to go back to the drawing board. For the sake of the U.S. economy, one has to hope that he has the courage to review the overall coherence of his policy approach before it is too late.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was managing director and chief emerging market economic strategist at Salomon Smith Barney and a deputy director in the International Monetary Fund’s policy and review department.

Our $17 Trillion Chinese Split Won’t Be Pretty

A Growing List Of One Term Presidents, A State of Distress, China and the Treasuries - A Dependency Relationship, Coming Social Unrest, Death of the Dollar, Deflation-Inflation-Stagflation, It Is Nice To Be Part of the Elite!, Let's Call What It Is - DEPRESSION, Market Strategies, Obama's Hypocrisy, Our phony middle class, TARP fruit loops, US Trade Imbalance, Watch The China Market, We Have Become Beggars To The World No Responses »

Jul 142009

Returning from China last month, U.S. Congressman Mark Kirk had a bearish take on a high-level visit by American officials.

Treasury Secretary Timothy Geithner claimed the U.S.’s biggest creditor voiced great confidence in its debt. Kirk, an Illinois Republican, came back with the opposite impression.

“China is beginning to cancel Congress’s credit card,” he told Fox News on June 10. It “doesn’t want to lend much more money to the United States and especially is worried about the Fed’s policy of printing money to buy new debt.”

A month later, there’s no doubt about whose assessment was more accurate. Chinese leaders are clearly very concerned about the dollar. How they will react is a key question hanging over markets, and it’s time to take the discussion to the next level.

Everyone knows China wants to reduce its dollar holdings. Little is known about how that process may unfold and how much work and preparation needs to go into it. Lots, in fact.

Think of China and the U.S. in history’s most expensive divorce. The two economies total $17 trillion of output, and polls in China show little support for adding to almost $800 billion of U.S. Treasuries.

This argument can be broadened to the rest of Asia. The idea that China or Japan — with $686 billion of Treasuries — can just start selling massive blocks of dollars is ridiculous. It would devastate markets the world over and the fallout would boomerang back on Asia. If you think markets are shaky now, just wait until word of a central-bank fire sale gets around.

Copycat Selling

Sure, Singapore (with $40 billion of Treasuries), India ($39 billion) or South Korea ($35 billion) could try to dump dollars on the stealth. Good luck in this highly connected, around-the-clock world. News that a key economy seeks a first- mover advantage over peers would inspire copycat selling. Expect investors and traders to respond with massive sell orders.

Warren Buffett can discreetly trim Berkshire Hathaway Inc.’s interest in a company or a currency. How a central bank divests itself of tens or hundreds of billions of dollars on the sly is another matter.

Governments that may be concerned about getting stuck with their dollars for good have a point. And by curtailing investments in dollars today, Asia is ensuring that the U.S. currency will be worth less a year from now. Bernard Madoff can tell you a thing or two about how this process works.

Dollar Accord

What may be necessary is a global framework or pact to end the dollar’s dominance. A “Plaza Accord” of sorts may be needed to dismantle the so-called Bretton Woods II system of tying currencies to the dollar that emerged after the global crises of 1997 and 1998. A Dollar Accord, anyone?

Just as stocks take a hit when additional shares are issued, Asia faces a debt-dilution dynamic for which it never bargained. The Federal Reserve’s zero-interest-rate policies don’t help. And Asia can’t do a lot on its own here.

This process will require considerable cooperation, be it through the International Monetary Fund, the Group of 20, the Asia-Pacific Economic Cooperation forum, the Association of Southeast Asian Nations or a yet-to-be-created entity. Goals must be set, mechanics discussed and timing negotiated. If ever there were a time for a currency summit, it’s now.

Politics will be a stumbling block. It’s hard to envision the U.S. signing on to scrap the dollar as the reserve currency. Neither the euro nor the yen is ready to replace it. And China’s designs on currency domination are a decade away — or longer.

IMF Solution

The amount of scrutiny the dollar’s successor would face makes you wonder who would want to print the reserve currency. That explains why the most credible argument making the rounds involves the IMF’s so-called Special Drawing Rights, or SDRs.

They are really an account of exchange, rather than legal tender, and are calculated according to a basket of currencies consisting of the dollar, euro, yen and pound. Chinese central bank Governor Zhou Xiaochuan wants the IMF to move toward creating a “super-sovereign reserve currency.”

Or, here’s another suggestion: Brady bonds for less- troubled economies. The idea behind bonds created in the 1980s as part of Latin America’s debt restructuring was to let investors swap their claims on nations in turmoil for tradable instruments. A similar process may work with the dollar.

Rumors of the dollar’s demise are no longer exaggerated. What is being exaggerated, though, is how easy it will be for Asia to get out of the quandary it’s in. Cutting off the U.S. government’s credit card, for example, means American consumers can’t buy your goods. And any sudden divorce between the world’s two main economic powers won’t be pretty. Far from it.

It’s time to figure out what the next step is, and policy makers need to get serious. Complaining about our dollar-based system won’t get us there. Some brainstorming about where to go from here would be far more constructive.

(William Pesek is a Bloomberg News columnist. The opinions expressed are his own.)

Our $17 Trillion Chinese Split Won’t Be Pretty – William Pesek, Bloomberg

Last Call for Monetization?

Death of the Dollar, Deflation-Inflation-Stagflation, Dollar Musings, How do you dampen the inflation dragon?, The excellent adventures of Ben Bernanke No Responses »

Jul 012009

In the past three weeks there have been several indications that the Federal Reserve is reconsidering the extent and perhaps necessity of its extraordinary liquidity provisions to the Treasury market. How far have the chairman and governors pulled back from their quantitative easing policy?

On June 3rd Chairman Bernanke commented in Congressional testimony that federal deficits cannot continue forever. In fact the deficits can continue, but the Fed’s $300 billion Treasury purchase plan will end unless additional funding is authorized by the Fed governors. At this past week’s FOMC meeting the board specifically did not authorize further Treasury purchases. The Fed is also letting one of its emergency liquidity programs expire and curtailing two others. None of these developments is an overt change in policy, but they are assurances that the chairman and the board view these liquidity measures as crisis expedients and not as permanent institutions of monetary and economic policy.

It is easy to forget that the Fed policy of direct support for credit markets was an emergency response to the crisis of confidence that overwhelmed the financial system last fall. Fed purchases of various securities supplied liquidity to non-functioning markets; they were not intended to be permanent. The Fed said as much at the time, though in the ensuing months market focus shifted from the programs themselves to the lack of a clear strategy for absorbing the excess money supply from the economy.

In March the market reaction to the financial crisis was at its peak. Treasury prices had been driven to historical highs by sustained panic buying of US Treasuries. Treasury interest rates and rates on 30-year fixed rate mortgages were at record lows. But even though mortgages rates were extraordinarily low the Fed judged that the reeling economy could not tolerate the surge in interest rates that would occur if Treasury prices began to fall. The governors may have suspected that the Treasury market would begin to drive prices lower and rates higher on its own as credit conditions normalized

In that context the Fed announced its $300 billion Treasury purchase in the FOMC statement of March 18th. The governors may also have been worried about the impact of the federal deficit on the bond market whose reaction was then an unknown quantity. But despite the Fed backstop the Treasury market fell relentlessly after March 18 with the 10-year rate rising more than 1.5%. More dangerously the dollar index fell 10% from March 18th to June 2nd. For the currency markets the Fed Treasury program has had one meaning, monetization of the Federal debt. Judging by the subsequent rise in Treasury rates the Fed governors may have known that the $300 million committed would be insufficient to hold the line on Treasury rates. But that relatively minor amount had a deadly effect on the dollar. The merest suspicion that monetization of US debt was possible sent the dollar into a three month swoon. The inflation that would result from a rapidly falling dollar and the effect of a collapsing dollar on the Treasury market itself could undo much of the economic and rate stabilization that the Fed was striving to achieve.

The Fed concern about the Treasury market was for the economic effect of higher interest rates on the US economy, particularly on the housing market thought by many to be at the heart of the economic collapse. But higher Treasury yields and mortgage rates have not, at least so far, choked whatever positive change in the economy has occurred since March. 30-year fixed mortgages have gained more than a point but the housing market has stabilized; new home and existing home sales in May were both in the center of the range they have exhibited since January.

The Personal Consumption Expenditures Index has revived since last December. It gained 0.9% in January, 0.4% in February, 0.3% in May, was flat in April and lost 0.3% in March. The half year prior to January had six negative months in a row. Non Farm Payrolls were substantially improved in May at -345,000, with the three month moving average (-500,000) having gained almost 200,000 since March (-691,000). Consumer sentiment numbers have moved up steadily since the beginning of the quarter. The economic situation that prompted the Fed quantitative easing has returned to more normal territory.

The Treasury market has also stabilized in the past two weeks. After reaching 4.00% the yield on the 10-year note had declined to 3.54% on the Friday close. The government Treasury auctions, a record $104 billion in the past week alone, have been subscribed at higher rates than normal. The bond markets are not demanding substantially higher rates on American debt, despite the vast continuing supply of US issuance.

The key to the extension of the Fed Treasury program is the attitude of the credit markets. It is relatively simple. If bond purchasers do not demand higher yields for US debt, then whatever the long term effect of the ballooning US debt and inflation the government will not be forced to pay higher rates. If Treasury prices are not falling the Fed will not have to support the market with further Treasury purchases and the currency markets will not be stampeded away from the dollar by monetization.

Foreign central banks have been unusually critical of the US government’s fiscal and debt policy. The Chinese were so again this week. But what matters are not the banker’s words or their musings about a world reserve currency. What matters is action. As long as the Chinese, Russians, Japanese and private investors continue to buy US Treasuries, the Fed will not have to choose between supporting the US economy and supporting the dollar.

It is a delicate balance but so far the Fed has, with the cooperation of the Treasury markets, kept the pointer right in the middle of the scale. The Fed has managed to mitigate the scare it threw into the currency markets in March with its recent statements and actions.

There are still a huge amount of Treasuries to be sold over the next three months and the economic situation is still dangerous. But the Fed view as reflected in the FOMC statement, no more quantitative easing and a slight though significant withdrawal from the credit markets may be the right and artful balance between keeping down US interest rates and avoiding a dollar panic in the currency markets

Last Call for Monetization? – Joseph Trevisani, FX Solutions

Is inflation our next big worry?

Coming Social Unrest, Coup d'etat in America, Death of the Dollar, Deflation-Inflation-Stagflation, History of Finance, How do you dampen the inflation dragon?, Patience is a virtue...Delusion is a vice, The Importance of Strategic Planning, Wage Deflation No Responses »

Jun 262009

Why inflation is around the corner

The government wants inflation to some degree. Congress and the White House have spent nearly $3 trillion recapitalizing U.S. banks, revamping the domestic manufacturing industry and replacing a portion of the consumption spending Americans have not been able to afford. The economy is recovering as a result, but U.S. debts are also ballooning. The nonpartisan Congressional Budget Office projects that the U.S. deficit will exceed $1.8 trillion this year.

The government doesn’t plan on paying off that debt or the interest on it without some help from the Fed. Earlier this year, the central bank announced it would directly purchase $1.75 trillion worth of U.S. debt in the form of mortgage-backed securities, U.S. Treasurys and agency debt. In essence, the Fed’s action “prints” more money and injects it into the economy.

Is Inflation Our Next Big Worry? – Catherine Holahan, MSN Money

Optimism Is Contagious

Death of the Dollar, History of Finance, The End of American Capitalism As We Know It? - Discuss, The New American Socialism No Responses »

Jun 242009

Diane Francis, Financial Post Published: Monday, June 22, 2009

American opponents to President Barack Obama’s announced reregulation of the financial sector are billing the issue as capitalism versus socialism or even communism.

It is not the case. This is not the economic version of the Cold War, and the search for a new architecture does not mark the death of capitalism.

In fact, free enterprise was nearly murdered by Wall Street, AIG and other reckless financial institutions. They did not meet their defined responsibilities. They bent the law to bypass rules governing their behaviour. Many of them abandoned traditional banking and got into the gaming business. And they brought the world to the brink in the fall.

The role of government is appropriate in the financial sector because of its importance to sustaining a healthy capitalist system. Banks, brokers, insurers and others are licensed by the government to benefit society by being astute gatekeepers to success. They deploy their own capital and savings from the public honestly by investing in worthy individuals and entities that will create wealth, then repay their loans.

Government’s role is necessary because these institutions, in turn, exist as a result of deposits from the public and shareholders’ money. They have a fiduciary obligation to responsibly use other people’s money for the benefit of all. The rules dictate who, what and how they lend or insure, as well as how they leverage.

But what Wall Street and the others did was lend, or insure, obscene amounts of money to inappropriate entities for inappropriate reasons without any market discipline. There were no clearing houses for the trillions in derivatives they created, no markets for them, no pricing mechanisms, no leverage restrictions, no capital allocation and no transparency or proper accounting.

They were not players in a free-enterprise system, but were gamblers rigging the system for their own benefit.

America’s financial punters sank the legitimate and regulated credit system. They collected upfront fees and played fast and loose with credit instruments; witness estimates that the notional value of credit default swaps and other risky “derivatives” could total up to US$600-trillion, or 10 times the world’s GDP.

Last fall, Washington was told by AIG and Lehman Brothers that the world had gone bust. Thanks to trillions in bank bailouts, and shotgun marriages, total collapse was averted.

Months later, there are positive signs. Consumer confidence has a pulse, at long last, though this has yet to translate into spending. Some 53 million people have lost their jobs worldwide and governments are in hock to the tune of trillions. Innocent victims include the world’s poorest nations and their citizens, including those who ran their fiscal and monetary houses in a responsible way.

Wall Street’s recklessness, and in some instances criminality, has destroyed credit, which continues to afflict third-party, real-economy businesses from Detroit (which already had problems) to retailers and most others.

The fix will take years, require international co-operation and wasn’t the fault of government or the rest of us. So the next time some Wall Streeter or financial-sector apologist is blabbing about how reregulation will kill capitalism, just remember it was capitalists, so-called “champions” in pinstripes, who nearly destroyed free enterprise by driving it into a wall.

An Error In Judgment

Death of the Dollar, Dismal Science-Ignorant Scientists?, History of Finance, The End of American Capitalism As We Know It? - Discuss, The excellent adventures of Ben Bernanke, The Financial Elite, The Geithner Resignation Watch, The Importance of Strategic Planning No Responses »

Jun 192009

The blunt fact is that the economic recoveries that have been rapid and seen fast growth in employment are those that ended when a central bank, following strongly restrictionary policies to fight inflation, eased off and significantly lowered interest rates. No such lowering of interest rates is possible this time—interest rates are already as low as they can possibly go. So I can see no reason to anticipate a rapid recovery and rising employment when the cliff-diving stops. And I do not understand why the Obama administration is following policies that presume such a rapid recovery—a V rather than an L for the shape of the recession—is not just possible but probable.

How Far We’ve Come from Last December – Brad DeLong, Free Exchange

ILLITERACY IN HIGH PLACES

by Paul Craig Roberts

If a person lives long enough, he can watch everyone forget everything they learned.

Everyone includes Federal Reserve Chairmen, economists, Bank of America “strategists,” and even Bloomberg.com.

Federal Reserve Chairman Ben Bernanke thinks he can hold down US long-term interest rates by purchasing mortgage bonds and US Treasuries. Sixty years ago the Federal Reserve understood that this was an impossible feat. After an acrimonious public dispute with the US Treasury, in 1951 the Federal Reserve forced an “Accord” on the government that eliminated the Fed’s obligation to monetize Treasury debt in order to hold down long term interest rates.

President Truman and Treasury Secretary John Snyder wanted to protect World War II bond purchasers by preventing any rise in interest rates, which would mean a decline in the price of the bonds.

The Fed understood that monetizing the debt to hold down interest rates meant loss of control over the money supply. The policy of suppressing interest rates could only work until the financial markets anticipated rising inflation and bid down the bond prices. If the Fed responded by buying more Treasuries, the money supply and inflation would rise faster.

Since Fed Chairman Bernanke announced his plan to purchase $1 trillion in mortgage and Treasury bonds in order to help the housing market with low interest rates, interest rates have risen. When will the Fed remember that printing money does not lower long-term interest rates?

According to Bloomberg (June 3), Bank of America strategists are recommending that investors buy Fannie Mae bonds because the rise in interest rates means the Fed will ramp up its purchases in order to prevent rising interest rates from adversely impacting the struggling housing market. When will financial gurus remember that printing money does not lower interest rates?

Treasury Secretary Geithner is another economic incompetent. He told China that he stood for a “strong dollar,” but that China should let its currency appreciate relative to the dollar, which, of course, would mean a weaker dollar. He simultaneously told China that their investments in US Treasury bonds were safe.

His Chinese university audience, being economically literate, laughed at Geithner. It apparently did not dawn on the US Treasury Secretary that if Chinese money is rising in value relative to the US dollar, the value of Chinese investments in dollar-denominated US Treasury bonds is falling.

Congressional Democrats are proving themselves to be as stupid as the Republicans. According to the Associated Press, the Democrats have reached agreement to appropriate another $100 billion to continue the wars in Iraq and Afghanistan through the end of the year. What are the Democrats thinking? The federal budget for this year is already 50% in the red. Why add another $100 billion to the red ink, which has to be monetized, thus causing inflation, higher interest rates, and a weaker dollar.

The red ink that Washington is generating is a far greater threat to Americans than any foreign “enemies.”

The hubris is extraordinary. A bankrupt government that has to send its Treasury Secretary begging to China thinks it can spend limitless amounts in a futile effort to control the culture, mores, and political system of distant Afghanistan.