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Policymakers Have Created a Perfect Storm

June 11, 2009 by  


As the Dollar Falls Off the Cliff …

By Paul Craig Roberts

Economic news remains focused on banks and housing, while the threat mounts to the US dollar from massive federal budget deficits in fiscal years 2009 and 2010.

Earlier this year the dollar’s exchange value rose against currencies, such as the euro. UK pound, and Swiss franc, against which the dollar had been steadily falling.  The dollar’s rise made US policymakers complacent, even though the rise was due to flight from over-leveraged financial instruments and falling stock markets into “safe” Treasuries.  Since April, however, the dollar has steadily declined as investors and foreign central banks realize that the massive federal budget deficits are likely to be monetized.

What happens to the dollar will be the key driver of what lies ahead.  The likely scenario could be nasty.

America’s trading partners do not have large enough trade surpluses to finance a federal budget deficit swollen to $2 trillion by gratuitous wars, recession, bailouts, and stimulus programs.  Moreover,  concern over the dollar’s future is causing America’s foreign creditors to seek alternatives to US debt in which to hold their foreign reserves.

According to a recent report in the online edition of Pravda, Russia’s central bank now holds a larger proportion of its reserves in euros than in US dollars.  On May 18 the Financial Times reported that China and Brazil are considering bypassing the dollar and conducting their mutual trade in their own currencies.  Other reports say that China has increased its gold reserves by 75 per cent in recent years.

China’s premier, Wen Jiabao, has publicly expressed his concern about the future of the dollar.  Arrogant, hubris-filled American officials and their yes-men economists discount Chinese warnings, arguing that the Chinese have no choice but to support the dollar by purchasing Washington’s red ink.  Otherwise, they say, China stands to lose the value of its large dollar portfolio.

China sees it differently.  It is obvious to Chinese officials that neither China nor the entire world has enough spare money to purchase $4 trillion of US Treasuries over the next two years.  According to the London Telegraph on May 27, Dallas Federal Reserve Bank president Richard Fisher was repeatedly grilled by senior officials of the Chinese government during his recent visit about whether the Federal Reserve was going to finance the US budget deficit by printing money.  According to Fisher, “I must have been asked about that a hundred times in China.  I was asked at every single meeting about our purchases of Treasuries.  That seemed to be the principal preoccupation of those that were invested with their surpluses mostly in the United States.”

US Treasury Secretary Timothy Geithner has gone to China to calm the fears.  However, even before he arrived, a Chinese central bank spokesman gave Geithner the message that the US should not assume China will continue to finance Washington’s extravagant budgets.  The governor of China’s central bank is calling for the abandonment of the dollar as reserve currency, using the International Monetary Fund’s Special Drawing Rights in its place.

President Lyndon Johnson’s “guns and butter” policy during the 1960s forced president Richard Nixon to eliminate the gold backing that the dollar had as world reserve currency, putting foreign central banks on the same fiat money standard as the US economy.  In its first four months, the Obama administration has outdone president Johnson.  Instead of ending war, Obama has expanded America’s war of aggression in Afghanistan and spread it into Pakistan.  War, bailouts, and stimulus plans have pushed the government’s annual operating budget 50 per cent into the red.

Washington’s financial irresponsibility has brought pressure on the dollar and the US bond market.  Federal Reserve Chairman Bernanke thought he could push down interest rates on Treasuries by purchasing $300 billion of them.  However, the result was to cause a sharp drop in Treasury prices and a rise in interest rates. 

As monetization of federal debt goes forward, US interest rates will continue to rise, worsening the problems in the real estate sector.  The dollar will continue to lose value, making it harder for the US to finance its budget and trade deficits.  Domestic inflation will raise its ugly head despite high unemployment.

The incompetents who manage US economic policy have created a perfect storm.

The Obama-Federal Reserve-Wall Street plan for the US to spend its way out of its problems is coming unglued.  The reckless spending is pushing the dollar down and  interest rates up.

Every sector of the US economy is in trouble.  Former US manufacturing firms have been turned into marketing companies trying to sell their foreign-made goods to domestic consumers who have seen their jobs be moved offshore.  Much of what is left of US manufacturing–the auto industry–is in bankruptcy.  More decline awaits housing and commercial real estate.  The dollar is sliding, and interest rates are rising, despite the Federal Reserve’s attempts to hold interest rates down. 

When the Reagan administration cured stagflation, the result was a secular bull-market in US Treasuries that lasted 28 years.  That bull market is over.  Americans’ living standards are headed down.  The American standard of living has been destroyed by wars, by offshoring of jobs, by financial deregulation, by trillion dollar handouts to financial gangsters who have, so far, destroyed half of Americans’ retirement savings, and by the monetization of debt.

The next shoe to drop will be the dollar’s loss of the reserve currency role.  Then the US, an import-dependent country, will no longer be able to pay for its imports.  Shortages will worsen price inflation and disrupt deliveries. 

Life for most Americans will become truly stressful.

Paul Craig Roberts was Assistant Secretary of the Treasury in the Reagan administration.

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