Page 1 of 2 Dollar's wounds reopen
By W Joseph Stroupe
"Be careful what you wish for, you may receive it." The adage applies well to
the US Federal Reserve as it enters what may turn out to be an entirely new and
more dangerous phase of the financial and economic crisis that is still firmly
centered in the US - notwithstanding the ongoing Wall Street rally and
increased hopes that the worst is now over.
The Fed wished away the hysterical risk aversion reflex of global investors,
which came to a head in autumn 2008, when big Wall Street banks collapsed,
sending shockwaves around the globe. The position of Fed officials is, after
all, that this is a crisis sparked mostly by panic-stricken investors who've
artificially driven the value of America's innovative financial assets far
below
their true values, wrongfully smearing massive sums of such assets with the
label, "Toxic!".
The Fed believed it could breathe new life into those assets and into America's
asset bubble-based economy by getting credit flowing again and by replacing
investor fear with investor confidence - which inevitably translates into a
greater appetite for risk. A significant measure of risk appetite is now
returning. But the problem is, the US dollar isn't getting the benefit.
Instead, its wounds are only being reopened.
As of June 2, the dollar had hit new lows for 2009 against nearly all major
currencies, dropping a full 1% against the euro on that day alone, totally
ignoring Treasury Secretary Tim Geithner's statement during his visit to China
that the US favors a strong dollar. On May 27, the yield curve on Treasuries
steepened to a new record as the difference between the two-year and 10-year
notes reached 2.75%, steepening to about 2.78% on June 2.
Global investors, both private and official (central banks) are voicing ever
more loudly their intensifying fears over exposure to the dollar for anything
but the short term and their collapsing confidence in the currency as a safe
store of wealth beyond the short term.
Let's back away for a moment to look at this global crisis from a distance.
When the US housing bubble began to burst in 2006, inherently risky, innovative
financial assets backed by mortgage paper eventually began to be exposed for
what they really were ("toxic" assets) and in late July 2007 the now-famous
subprime crisis emerged.
The contagion of toxicity spread to infect virtually all such innovative
assets, wiping out huge sums of wealth and plunging US banks and other
financial institutions into crisis and ruin. The damage and destruction quickly
spread to the real economy, as a severe and persistent credit seizure virtually
shut down lending at all levels.
In the mounting storm, panicked, risk-averse global investors sold off
emerging-market assets and investments deemed risky and massively piled into
the dollar as a safe haven, lifting the currency. The Fed and other central
banks began spending many trillions of dollars aimed at stabilizing the
wobbling financial system and restoring confidence, which had utterly
collapsed. The financial system was barely saved from a complete meltdown by
such interventions, which continue to this very day.
Ominously, global investors, though giving the dollar the nod as a safe haven
in the storm, stampeded into the short end, virtually shunning the longer-dated
dollar assets altogether. That fact was a dead giveaway that the dollar's
well-known loss of strategic global appeal as a safe store of wealth had not
been in any way resolved, but only papered-over for the moment.
Reopened wounds
Now, as risk aversion recedes and risk appetite returns, global investors
realize they over-sold their non-dollar assets and investments in the emerging
markets when the crisis intensified last year. The emerging markets are widely
seen as those that will emerge from the crisis first, and assets in these
markets are very attractively priced. Hence, investors are now selling their
dollars to buy back into such assets deemed much safer stores of wealth than
the dollar in the face of the inevitable return of dollar inflation beyond the
short term.
That is driving up yields on a host of dollar-denominated financial assets such
as Treasuries and mortgage bonds and sending the dollar to new 2009 lows.
Emerging market indexes and commodities are surging as investor wealth pours in
once again. Profligate US spending and skyrocketing deficits, hyper-loose
monetary policies in this crisis, and collapsing confidence that the Fed will
actually be able to withdraw such policies and excess liquidity when required,
are all causing dollar inflation expectations to become deeply rooted in
investor psychology.
The overpowering perception on the part of global investors that the Fed,
Treasury and Administration are losing control of the US fiscal position, and
that inflation (more likely hyper-inflation) is virtually becoming inevitable
is threatening to wreak irreversible harm upon US finances and upon the dollar
itself.
Angela Merkel, the German chancellor, issued on June 2 a stern warning along
these very lines, a warning that was remarkable for its stark honesty and its
unprecedented violation of the cardinal rule of German politics that says
German politicians never comment on monetary policy of the central bank. Her
break with that rule indicates Berlin is extremely concerned about the
dangerous and risky hyper-inflationary and currency-debasing monetary policies
being undertaken in this crisis. Chancellor Merkel launched her attack on the
US Federal Reserve, the Bank of England and on the European Central Bank. She
said:
What other central banks have been doing must stop now. I am very
skeptical about the extent of the Fed's actions and the way the Bank of England
has carved its own little line in Europe.
Even the European Central Bank has somewhat bowed to international pressure
with its purchase of covered bonds. We must return to independent and sensible
monetary policies, otherwise we will be back to where we are now in 10 years'
time.
On June 3, Fed chairman Ben Bernanke himself issued a
warning that long-term deficits threaten the very financial stability of the
US. He further said:
In recent weeks, yields on longer-term Treasury
securities and fixed-rate mortgages have risen ... These increases appear to
reflect concerns about large federal deficits ...
He went on to
somewhat minimize the role of investor concern regarding US spending, seeking
to lay the record steepening of the bond yield curve off on other factors. It
seems that Fed officials don't want to see the full and stark truth about how
global investors are rapidly losing confidence in the US fiscal position and in
the dollar.
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