Where Were You the Day the Dollar Died?
Welcome to Bernankeville, the City of Jokernomics
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“Where were you when the dollar died?”
That’s a question people will be asking you in the not-too-distant future. The past few weeks have seen several events transpire that spell the inevitable ruin of the dollar. As usual, only some of these events have been reported in the mainstream press, leaving most Americans blissfully clueless about the catastrophe roaring towards them.
Most people are aware that Federal Reserve Chairman Ben Bernanke recently announced the Fed would begin “purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.” Additionally, the Fed “will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities.” Taken together, the Fed will “increase the Committee’s holdings” of long-term securities to the tune of $85 billion per month, at least through the end of the year. And then? The Fed “will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases”, use its “other policy tools” until such time as the labor market—read “unemployment rate”—improves “substantially”. How much is “substantially”? Mr. Bernanke didn’t say. For all practical purposes, this third round of Qualitative Easing (QE3, as it’s being called) will go on and on and on…until Mr. Bernanke says “enough”. So, at least in theory, QE3 will obviate the need for QE4, QE5, QE6 and so on…because it’s QE “Until”.
Of course, the markets and banks rejoiced! The Fed will save us! Viva le Fed! Viva le Keynes! Viva le Bernanke! Viva le…wait a minute! Did you say…QE THREE? Whatever happened to QEs 1 and 2?
QE1 occurred in late 2008, when the Fed bought 1.25 trillion dollars worth of mortgage-backed securities (minus 61 cents) from banks in an effort to shore up a weak economy. It got the money to do this literally out of thin air: “...the mortgage team would decide to buy a bond, they’d push a button on the computer—“and voila, money is created.”” That, of course, is a special power the Fed has—to will money into existence with the push of a button. So…where did all that money go? It “remains in bank reserve accounts collecting interest and dust. The Fed reports that the accumulated excess reserves of depository institutions now total nearly $1.6 trillion.” Oddly enough, that $1.6 trillion dollar figure is almost exactly the amount of the Federal Budget deficit for that year! “So here we have the anomalous situation of a $1.6 trillion hole in the federal budget, and $1.6 trillion created by the Fed that is now sitting idle in bank reserve accounts. If the intent of “quantitative easing” was to stimulate the economy, it might have worked better if the money earmarked for the purchase of Treasuries had been delivered directly to the Treasury. That was actually how it was done before 1935, when the law was changed to require private bond dealers to be cut into the deal.”
And QE2? That ran from November 2010 until June 30, 2011. It only involved $600 billion dollars of magic computer money, but strangely enough, the government never actually GOT that money! It went “straight into the reserve accounts of banks, where it still sits today. Worse, it went into the reserve accounts of foreign banks, on which the Federal Reserve is now paying 0.25-percent interest.”
So, we had QE1 and QE2, yet now we need QE3? Also, if $1.25 trillion (minus 61 cents) followed by $600 billion (give or take a few pennies) hasn’t given us robust economic growth, full employment and a lemonade spring on every lawn, why will a paltry $85 billion a month do anything? Because Mr. Bernanke and all of the Federal Reserve governors, except for that malcontent Jeffrey M. Lacker (President of the Federal Reserve Bank of Richmond, VA), agreed that it would, of course!
Only…not everyone is convinced that the Fed is doing the right thing. Another well-known malcontent, Ron Paul, has been saying for years that other countries will abandon the dollar as the world’s reserve currency of choice unless we start backing it with something real, like gold. In an article dated Sept. 3rd of this year, Dr. Paul said “If we act now to replace the fiat system with a stable dollar backed by precious metals or commodities, the dollar can regain its status as the safest store of value among all government currencies. If not, the rest of the world will abandon the dollar as the global reserve currency.”
Dr. Paul’s concerns are shared by Bill Hassiepen, VP and co-manager of Egan-Jones’ ratings desk. Hassiepen believes that the Fed’s “money printing” has not “really contributed to the improvement in the general economy” thus far. Instead, all it has done is “increase inflation and the cost structure in the general economy”. He “expects a ‘rapid uptick in gasoline and food prices’, which will affect households’ disposable income”. Unfortunately, “we have a Federal Reserve that simply does not recognize the inflationary impact of food and energy prices any longer”. Furthermore, “the United States’ financial flexibility is almost gone given $16 trillion in debt”—which is 104% of GDP—and there is no real plan to bring “the fiscal house under control”.
Jeff Cox of CNBC has pointed out four ways in which QE Infinity (as he calls it) can go wrong: Moral Hazard (Washington style), Moral Hazard (Wall Street version), Hurting Confidence, and “It may not work”. To Cox, the notion of Moral Hazard means “the rewarding of bad behavior”, which then naturally leads to more bad behavior. But, “it also extends to the notion that somebody will be there to support you no matter what”. In the case of Washington, the fear is that Congress and the White House will use this as an excuse to continue their profligate ways and put off getting the nation’s fiscal house in order “until”. For Wall Street, it means supporting the notion that the Fed will be around to make it all better regardless of the nasty booboos, giving Wall Street a chronic “sugar rush”—as evidenced by the immediate 200 point spike in the Dow Jones that followed the Fed’s announcement. In terms of confidence, QE Forever pushes the Fed’s balance sheet beyond $3 trillion, with no real end in sight. The good news: the Fed is willing to take extreme measures to pump up the economy. The bad news: the economy needs it, even after QEs 1 and 2. Given the need for QE3, people are starting to wonder just how much will finally be enough? That wondering, in and of itself, is enough to make some people nervous. That brings up the last point: what if this round of QE doesn’t work? What then? What other tricks can the Fed use to get the engine of the economy going?
The scary thing is…the answer is “not much”. If this doesn’t work, then there’s very little left for the Fed to try. In fact, this round of QE may be one round too many. Michael Pento of Pento Portfolio Strategies isn’t enthusiastic. “This is the nuclear option for them. This is a never-ending weapon that is being fired at the middle class.” He is concerned with the effects QE is having on future inflation and on savers who are getting no interest on their deposits. “If the unemployment rate stays elevated, as I know it will, and inflation eclipses (Bernanke’s) 2 percent target, what is his next move? What part of the Fed mandate takes precedence?” Pento’s bottom line? “Economic growth comes from more people working and more people becoming productive, and all the Fed can do is destroy our currency’s purchasing power.”
Pento isn’t the only one. Remember that ‘Sugar Rush’? Writing in the Telegraph of London, Liam Halligan, Chief Economist at Prosperity Capital Management, regards the latest round of QE as “the launch of a $1,500 billion funny money missile”, roughly the size of QE1 (albeit spread over a longer period of time). He writes: If “insanity” is doing the same thing again and again and expecting a different result, then it’s difficult to describe Bernanke’s latest initiative as anything other than insane. By focusing on MBS (Mortgage-Backed Securities) purchases, the Fed is trying to re-inflate America’s real estate bubble, in the hope that rising prices will encourage home-owners to spend more by re-mortgaging and getting even deeper into debt. America has done this before, repeatedly, and it always ends in tears.” Not only will this policy further damage America’s credit rating, but “...QE3 will do far more harm than good. By undermining the dollar and fuelling future inflation, it will discourage household spending by further debasing wages and pensions. By putting upward pressure on the cost of living, QE3 will eat further into real disposable incomes, forcing American consumers to retrench even more.”
The really interesting thing is that, unlike QE1, this time around Bernanke wasn’t facing a banking collapse or the possibility of deflation. No, the general consensus seems to be that it was done not to stave off another “Lehman moment”, but rather to please the politicians (especially Barack Obama, fighting a close race against Bernanke unfriend Mitt Romney) and the Banksters on Wall Street.
QE today, QE tomorrow, QE forever!
But, what’s done is done. QE today, QE tomorrow, QE forever! That really wasn’t the most interesting news in the world of finance to come out this month.
The most interesting announcements came a week before Mr. Bernanke gave us all QE ad infinitum. On September 6th, China announced that, from that day forward, any nation wishing to buy, sell or trade crude oil with them can do so using yuan, not dollars. The next day, Russia announced that they would supply China with all the crude oil they need, regardless of the amount, and that oil would not be sold or traded in dollars.
This wasn’t exactly sprung on the world out of the blue. At least as far back as 2007, it was reported that “Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme (to supplant the dollar with another currency), which will mean that oil will no longer be priced in dollars.”
Once again, a bit of historical review is appropriate. After the (Un)Civil War, the United States effectively went on the gold standard. This limited the money supply while easing trade with others nations that also used a gold-based money, such as the UK. However, many people believed a more flexible, larger money supply would be beneficial to the nation. These people by and large support a bimetallic standard in which silver and gold would share the burden of backing the nation’s currency. The situation simmered for some time—the country’s early experiences with bimetallism demonstrated the difficulties inherent in a fixed 15:1 silver to gold ratio, and the Panic of 1893 didn’t help—and ultimately resulted in William Jennings Bryant’s famous “Cross of Gold” speech at the 1896 Democratic Convention. Despite what is widely considered to be one of the great political speeches in American history, Bryant lost the election. In 1900, the United States formally established the gold standard.
The abandonment of the gold standard
The abandonment of the gold standard came about in two major steps. The first was in 1933 when President Franklin D. Roosevelt ended the right of private citizens to surrender paper dollars for gold or own gold bullion. The second came in 1971 when President Richard M. Nixon “closed the gold window” when France came a’callin for her gold, bearing dollars. Prior to that, as a result of the 1944 Bretton Woods Agreement, the gold exchange standard allowed nations to hold US dollars (and British pounds sterling) as reserves because these currencies were “exchangeable for gold”. Nixon’s de facto default—the act of closing the gold window—left those nations holding paper dollars rather than gold. The situation could have spiraled out of control very quickly; save for the fact that in 1973 Saudi Arabia declared that henceforth it would only trade oil in US dollars. By 1975, the rest of OPEC had fallen into line, and the petrodollar—child of Nixon, birthed by Henry Kissinger—was created.
And so things have stood since 1975…until the first week in September 2012. Having the world’s currency at its fingertips let America have all the fun that a pure fiat currency allows. For the 34 years before the gold window closed, the money supply grew less than two fold. In the 34 years since then, the money supply has grown more than thirteen fold, with a corresponding increase in inflation and reciprocal devaluation of the dollar.
Comes now QE3…or perhaps we should just begin calling it “Jokernomics”. “Hubba hubba hubba, money money money; who do you trust?” Certainly not the American dollar, if you’re Russia or China. Not Iran, who will shortly discover (if they haven’t already) that dollar-based sanctions have little meaning if they can sell their oil to China for yuan. Not Ukraine, who made the same deal with Russia for rubles in April of 2011. Not Ron Paul, or any of his devotees. Not any Austrian economist worthy of the name. The Austrians and Ron Paul have warned for years that creating money out of thin air ultimately leads to inflation, devaluation and other bad things. But surely the dollar is strong enough to bend a bit, without breaking? After all, it’s backed by the strength of the American economy, the strongest economy in the world. Right?
US credit rating
Possibly not. The day after Mr. Bernanke’s QE3 announcement, the rating agency Egan-Jones cut the US credit rating to AA- from AA, stating “that issuing more currency and depressing interest rates…does little to raise the U.S.‘s real gross domestic product, but reduces the value of the dollar…this increases the cost of commodities, which will pressure the profitability of businesses and increase the costs of consumers thereby reducing consumer purchasing power”.
This is the second time Egan-Jones has downgraded the USA’s credit, having cut the AA+ rating down to AA in April 2012 for “a lack of progress in cutting the mounting federal debt.”
The Price of Politics” by Bob Woodward
A recent article in the Washington Post excerpting the upcoming book “The Price of Politics” by Bob Woodward reveals the fragility of the US economy. Mr. Woodward describes a meeting between President Obama and Treasury Secretary Timothy “Turbo” Geithner that took place on July 23, 2011. The night before, House Speaker John A. Boehner had withdrawn from negotiations to raise the federal debt limit and prevent a governmental default. This was about 10 days before the $14 trillion debt ceiling would be reached, and the government would run out of money. The fear was that failing to extend the debt limit could trigger a worldwide economic meltdown as confidence in US Treasury securities collapsed.
According to Woodward, “Boehner said he believed that he and the others—Senate Minority Leader Mitch McConnell, Senate Majority Leader Harry M. Reid and House Minority Leader Nancy Pelosi—had a plan. He told Obama: We think we can work this out. Give us a little more time. We’ll come back to you. We are not going to negotiate this with you.” Obama objected, reminding Boehner “I’ve got to sign this bill.” Boehner challenged him: “Mr. President, as I read the Constitution, the Congress writes the laws. You get to decide if you want to sign them.”
Harry Reid, Majority Leader of the Senate, then spoke up, telling the President that the Congressional leaders—himself, Speaker Boehner, House Minority Leader Nancy Pelosi and Senate Minority Leader Mitch McConnell—wanted to speak privately, and asked the President to give them some time. “This was it. Congress was taking over. The leaders were asking the president to leave the meeting he had called in the White House.” The President then responded “Fine. Talk. Knock yourselves out…just do it—if you can”.
Prior to this meeting, the four congressional leaders had tentatively worked out a plan to extend the debt limit, but would require that the issue be re-visited during the 2012 campaign. Obama, on the other hand, was insistent that any agreement extend through and past Election Day, 2012. “I am not going to sign a bill that requires me to deal with the debt ceiling a second time before the election,” Obama told Boehner. Boehner responded that they were too close to default, and that Congress was going to move forward on their own, to which Obama replied that he would veto such a bill—despite the fact that they were only a few days away from only having a half-day’s worth of money in the Treasury, far closer to default than the public had been told.
When the President told his senior staff, he instructed them “to figure out Plan B…how do we get out of this thing?” But, there WAS no Plan B.
Ultimately, the House Republicans caved in to Obama’s (and Harry Reid’s) demands and accepted a plan that would carry the country through the 2012 election, while also postponing $2.4 trillion in spending cuts until early 2013. However, the most crucial part of the Woodward article concerns a conversation that occurred in the White House after the House had passed a bill that would have required another debt ceiling increase before the 2012 election. Obama, faced with the possibility that the Senate would also pass the bill, asked his senior staff—including Geithner, senior political adviser David Plouffe and chief of staff William Daley—what would happen if he vetoed the bill?
“It would have massive effects,” Geithner said. With an upcoming Treasury auction in just a few days, “Why would anyone buy US bonds if it’s an open question whether we are going to have the authority to pay for them?” Even worse, “Suppose we have an auction and no one shows up?” The possible fallout from that—a mass dumping of US Treasuries, plummeting prices, skyrocketing interest rates, the collapse of the US dollar and thus the economy—would be literally unimaginable.
That wasn’t Obama’s main concern. Obama’s main concern was “what happens next time?” Emboldened Republicans would be coming back right before the election, and be willing to impose conditions on the next debt ceiling increase. Obama was unwilling to allow that to happen, insisting “they had to break the Republicans on this”.
Geithner’s response was that they had no other options. “The 2008 financial crisis will be seen as a minor blip if we default,” he said. Obama insisted that he was not going to cave, period. He got up, and left.
Geithner later told others “...the people who would bear the pain of that (a global collapse) would be the people less prepared, less able to absorb that cost. It would be something you could not cure. It is not something you can come back and say, a week later, ‘Oh, we fixed it.’ It would be indelible, incurable. It would last for generations.”
Indelible. Incurable. Lasting for generations, and hitting those least able to deal with it the hardest. All because the Treasury held an auction and nobody came, because they had no faith in the US Government’s ability to pay its bills. Because President Obama didn’t want to give up a bit of political leverage to his opponents.
Fortunately, it never came to that. However, if the situation can be brought to that level of seriousness once, why not again? The world has traded in petrodollars for 37 years. Now, that era is passing. At the same time, “Helicopter Ben” Bernanke has announced that he will buy securities (and continue buying Treasury certificates) indefinitely. Effectively, the printing presses will run as long as the electricity stays on, monetizing the Federal debt without limit. Every time this has been done historically, the result has been the same: hyperinflation and economic collapse inevitably follow. Consider post-WWI Weimar Republic Germany, where between 1921 and 1924 paper currency became the next best thing to worthless. It did, however, make reasonably attractive wallpaper.
The dollar—and let’s go ahead and call it what it is, the petrodollar—has been the world’s reserve currency for nearly four decades. Backed by Saudi oil and American economic strength, it has waxed and waned, but always been the currency of last resort. Now, with Russia and China leading the way, dollars are being abandoned in favor of other currencies. So, who benefits from QE3? Certainly not the American taxpayer! The currency wars are coming, and the dollar is falling while the ruble is up. “Bernanke’s action is a clear signal that Dollar weakness is coming, but also a result of confidence in the ability of banks to remain robust in the scenario of major currency re-alignment.” Well, at least the banks will be taken care of…for a moment there, I was worried about the poor Banksters!
What about the rest of us? While our politicians wallowed in the orgies of self-congratulation and opponent bashing that are the Republican and Democratic conventions, the world was changing in fundamental ways. No longer is the dollar King of Currencies; Russia and China will see to that. And, with the Fed’s printing presses running flat out, how long will it be before someone realizes that all that pretty paper is pretty much worthless…except as toilet tissue? Just how long can the Fed’s Jokernomics last before the Bat of hyperinflation shows up to ruin the party?
Sadly, given the complete inability of Congress to get its financial act together—1200-plus days with no budget and counting, deficits extending as far as the eye can see, lobbyists and special interest groups howling to high heaven and low hell the second any of their sacred cows is threatened—I don’t think it’ll be all that long.