Official and popular analysis of the predicament facing the US dollar has for
the most part been distinctly unwilling to come fully to grips with the stark
truth about the real nature of this deepening crisis and the escalating risks
that are surfacing. Far too much optimism and wishful thinking, and scarce
courageous realism, is a recipe for an even worse disaster than the one we're
suffering at present.
We have seen in
Part 1 the profound risks of a dollar crisis being triggered if global
demand for US Treasuries remains high and that the debt bubble persistently and
destructively sucks all the air out
of the global credit markets. However, if global demand for Treasuries is not
sustained at a very high level, there exists an entirely different, yet equally
destructive set of impending and mounting risks that a dollar crisis might be
triggered.
Like it or not, the US dollar still constitutes the de facto central framework
of the present global financial order - the dollar is its fundamental support
structure, much like the steel framework that supported the Twin Towers in New
York. The global crisis is sending shockwaves of ever increasing intensity
throughout the present order. Few thought the shaking would reach its present
intensity and scope, and no one really knows how powerful and destructive the
shaking might get before the crisis is over.
The initial, knee-jerk reaction in this situation has been to reach out and
grab tightly onto the framework with both hands (that is, in an exceptionally
risk-averse reflex, flee into the dollar for relative safety) and hold on for
dear life. This reaction of global investors is motivated partly by logic but
also in large part by the strong psychological components of uncertainty, fear
and even panic.
As China Banking Regulatory Commission deputy head Luo Ping stated on February
12, in his own reactive-style retort to the unfolding crisis, Treasuries are
just about the only safe-haven option in perilous times. However, his
clarification on the next day appeared a bit less knee-jerk and more rational,
stating that gold and selected government bonds (but not those of the US) look
more attractive to China from a risk assessment standpoint, because China
rightly fears its dollar-denominated holdings will almost certainly be inflated
away over time by the US policy of issuing huge new sums of dollar-denominated
debt in the form of Treasuries.
This brings us to the crux of the matter of escalating risks for the dollar. In
the current fiscal year alone, the US is expected to issue somewhere between
US$2 trillion and $2.5 trillion in new debt. It could conceivably exceed that
amount if the crisis worsens and more money than anticipated is required to
rescue the financial and economic sectors from ruin, or if virtually the entire
financial sector has to be nationalized to prevent a total collapse. That is a
prospect that is swiftly becoming more and more likely. A running estimate by
Bloomberg News recently put the total so far of all the new sums of dollars the
US government has spent, lent and/or committed to spend due to this crisis at
about $9.7 trillion and counting!
To deal with a crisis that fundamentally arose, at length, out of the
escalating risks of shortsightedly spending in colossal sums of dollar-debasing
debt, the US government is attempting to "solve" the crisis by frantically
spending gigantic additional sums of new dollar-debasing debt. Before this
crisis spending binge was undertaken, the dollar's strength had already been
greatly undermined over the past four decades by a combination of shortsighted
dollar-debasing government policies and the accumulation of huge sums of debt
since the 1980s.
According to official calculations, it required $5.54 in 2008 to equal the
purchasing power of just $1.00 in 1970. This comparison illustrates the potency
of inflation in undermining the value of a mere fiat currency such as the
dollar.
But now, the US government is risking setting in motion inflationary forces
that are profoundly more potent and difficult to manage. Virtually every
economist on the planet calls this situation one that has the real potential
for seriously and permanently damaging the dollar by inflating away too much of
its remaining value not very far down the road. They also warn that,
specifically due to the extremely risky monetary and budgetary policies now
being embarked upon, the timing will be absolutely crucial for future Fed
watchfulness and actions aimed at preventing a catastrophic, uncontrolled rise
in dollar inflation.
They further warn that the severely weakened US financial and economic systems
will be very slow to recover strength and stability and will likely be unable
to withstand the tightening measures that will be needed further down the road
so as to keep inflation from running out of control. The US may therefore be
condemning its own currency to collapse by enacting such shortsighted policies.
In spite of such warnings, extremely potent inflationary, dollar-debasing
policies are being enacted anyway. Is this the picture of a fundamentally sound
global financial and economic superpower worthy of international respect,
confidence and trust, or the picture of an erstwhile global financial and
economic empire that is even now falling over the threshold into collapse? This
is absolutely a valid question to pose at this juncture. Why?
What's the salient point here? International trust and confidence in the
monetary, financial and economic policies of the US government are far more
crucial now, right in the midst of this deepening global crisis, than at any
previous time in history because these policies will directly and indirectly
affect the dollar, either for good or for bad. Since the dollar does still
constitute the central framework of the present global financial order, and
since the shaking of present order is only intensifying, international
confidence and trust in the dollar as a safe store of wealth is absolutely
essential.
If that trust and confidence in the dollar should be sufficiently undermined
anytime soon by risky policy, then the present global crisis will almost
certainly turn into a global catastrophe - the perfect storm against the dollar
alluded to in the introduction of this article. The importance of international
trust and confidence cannot be over-emphasized for the dollar, a mere fiat
currency that is backed by no hard assets at all (such as gold), but only by
the pledge of the US government to stand by it and not to default on its
international debt.
The massive global rush into the dollar as a safe haven would appear to
indicate that we don't have much to worry about respecting international trust
and confidence in the dollar. That might well be true if it could be clearly
established that such a global move has been strategic in nature and well
thought-out and as such has come as a result of rationality, logic and reason
much more than being merely a tactical move as a result of fear and panic. Some
important questions must be posed here:
Are investors such as China, which likely holds 70% of its reserves in
dollar-denominated assets, satisfied to remain in the dollar for the
foreseeable future, and satisfied to increase exposure to the dollar, or do its
central bank governors increasingly find themselves having to hold their noses,
as it were, with respect to their exposure to the dollar? Is their concern
flaring?
Are global doubts and fears mounting with respect to the appeal of the dollar
as a safe store of wealth beyond the short term?
If the answer to the question above is yes, then is the appeal of the dollar
being undermined mostly because of fears over the potential effects of the
dollar-debasing policies that are now irreversibly being implemented in
Washington?
Are key investors like China's central bank increasingly looking for ways to
reduce exposure to the dollar?
Is the dollar facing significantly increasing competition from other safe haven
stores of wealth, such as gold?
Gold's increasing appeal as a safe haven, demonstrated by its ongoing surge,
adequately answers the last question. From the start of January 2009 until
mid-February, gold has surged from around $800 per ounce to near $1,000 per
ounce and is likely to rise further. This surge coincides with the raft of
official data releases since the start of 2009 that demonstrate the US and
global financial systems and economies are moving deeper into crisis. Investors
increasingly see the value of investing in hard assets, and in times of
uncertainty and crisis gold and other precious metals are usually the ultimate
investment in that category.
As for the answers to the remaining questions posed above, even before Premier
Wen Jiabao last week publicly warned the US of his government's concern about
the safety of China's US holdings (see
Wen puts US honor on the debt line, Asia Times Online, March 14, 2009)
consider the recent comments of Luo Ping, China's Banking Regulatory Commission
deputy head, referred to above:
"We hate you guys. Once you start
issuing $1 trillion-$2 trillion ... we know the dollar is going to depreciate,
so we hate you guys but there is nothing much we can do."
Also
note the recent comments of Yu Yongding, a prominent former advisor to China's
central bank, as reported by Bloomberg News on February 11, 2009:
China
should seek guarantees that its $682 billion holdings of US government debt
won't be eroded by "reckless policies", said Yu Yongding, a former adviser to
the central bank. The US "should make the Chinese feel confident that the value
of the assets at least will not be eroded in a significant way," said Yu, who
now heads the World Economics and Politics Institute at the Chinese Academy of
Social Sciences
Also, as reported by Bloomberg News on February
11, 2009:
China may voice its concerns over US government finances and
the potential for a weaker dollar when Secretary of State Hillary Clinton
visits China on February 20, according to He Zhicheng, an economist at
Agricultural Bank of China, the nation's third-largest lender by assets. "In
talks with Clinton, China will ask for a guarantee that the US will support the
dollar's exchange rate and make sure China's dollar-denominated assets are
safe," said He in Beijing. "That would be one of the prerequisites for more
purchases."
Now, note the clarification offered by Luo Ping on
the next day, as reported by Reuters News Service:
Buying US Treasury
bonds is an option - but not the only option - for China, which is aware that
huge debt issuance by Washington would reduce the value of China's existing
portfolio, a banking regulator said in remarks published on Friday. In an
elaboration of his remarks, the China News Service paraphrased Luo as saying:
"Compared with gold or bonds issued by other countries and regions, US Treasury
bonds are still an option (for China). But if the US government issues a large
amount of Treasury bonds amid efforts to deal with the economic crisis, all
investors who hold US Treasuries will suffer losses."
Now, note
these statements made by Chinese officials, advisors and experts as reported by
the official Xinhua News Agency on February 18, 2009:
"To rescue the
ailing US economy by increasing government borrowing will create a record-high
federal deficit," said Yu Zuyao, economist with the Chinese Academy of Social
Sciences, a government think tank. "This can further lead to catastrophic
consequences such as serious inflation and US dollar depreciation," he said
Tuesday. China faced high depreciation risk to its foreign exchange reserves,
US Treasury bonds and other US dollar-denominated assets, Yu said.
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