11.12.2010 0

The Dollar Run Begins?

China’s credit rating agency, Dagong, has once again downgraded the U.S. credit rating, this time down to A+. The agency cited the Federal Reserve’s proposed $600 billion in purchases of U.S. treasuries, writing that the “move entirely encroaches on the interests of the creditors, indicating the decline of the U.S. government’s intention of debt repayment.”

While the Fed and the mainstream media looks at the central bank printing money to buy the national debt as being somehow related to reducing unemployment or restoring robust economic growth, the Chinese and the rest of the world see it for what it is: Papering over the debt.

It has begun an international revolt against U.S. dollar depreciation. Germany’s finance minister called the action “clueless” and said it would “create extra problems for the world.” Brazil’s finance minister said it would start a “currency war.” Now, China is calling for the G20 to have a role in Federal Reserve policy. So is Russia.

Dallas Fed head Richard Fisher openly criticized the move: “One cost is the risk of being perceived as embarking on the slippery slope of debt monetization. We know that once a central bank is perceived as targeting government debt yields at a time of persistent budget deficits, concern about debt monetization quickly arises.”

Which is exactly what it looks like. As Americans for Limited Government President Bill Wilson recently noted, “the nation’s central bank will be the largest holder of the national debt in the entire world next year. The Fed already holds $839 billion of treasuries, and was already on pace to have over $1 trillion in treasuries by August, 2011, more than China, Japan, or any other foreign creditor.”

Wilson continued, “With another $600 billion on top of the Fed’s expected trillion-dollar stake in the debt, the signal we are sending to the world is that to pay for our obligations we are printing a ton of new money. In the next three years alone, $5.2 trillion of debt will be coming due. In addition, the Obama Administration plans on increasing the debt another $3.6 trillion over that same period. That means that the Treasury has to sell $8.8 trillion of debt over three years, or $2.93 trillion every year.”

That’s bad, because as Wilson explains, “$2.93 trillion a year is more than the Treasury has ever had to sell. Approximately $630 billion more than it has ever sold. So it is little surprise that now the Fed is coming out saying it is buying another $600 billion of treasuries. This action by the Fed has nothing to do with ‘a stronger pace of economic recovery,’ as the central bank claims. It has everything to do with the fact that we are broke, and we’re printing money to pay the bills.”

That means the Fed actually has little choice other but to print the money. Although, it could simply say “no” to Congress and the Treasury. The Fed told the Treasury to take a hike back in the 1950’s when the Truman Administration wanted debt monetization to finance the Korean War. The Fed’s stand back then set the stage for the independence of the central bank. Today, if it did so, it could force Congress to drastically rein in spending.

Instead the central bank is acquiescing fiscal authorities, accepting without condition becoming the lender of first resort to the reckless Congress.

But lest there was any doubt about the faithlessness and credit unworthiness of the United States, one need not look any further than the preliminary recommendations of Barack Obama’s National Commission on Fiscal Responsibility and Reform.

Wilson ripped the commission as proceeding from “the wrong premise,” a mere reduction of the annual $1.3 trillion deficit — over thirty years. “The deficit commission does not contemplate a balanced budget until 2040. It never contemplates reducing the overall $13.7 trillion debt, which will continue to grow year-on-end,” Wilson said, adding, “We don’t have thirty years to balance the budget.”

Wilson urged national lawmakers to immediately focus on balancing the budget, setting the stage to pay down and, eventually, to retire the national debt. But it’s very unlikely. Even House Republicans, in their Pledge to America, only contemplate a paltry $100 billion of cuts next year, which will come nowhere near balancing the budget.

Is it any wonder China has once again downgraded us? Interestingly, recently Reuters quoted Herbert Kaufman, professor emeritus of the W.P. Carey School of Business at Arizona State University commenting on the downgrade as if it were hypothetical, “Since they are a large holder of U.S. Treasuries, it is not to their advantage to downgrade.”

Except it was not a hypothetical. China has downgraded us, because they understand that printing hundreds of billions of monopoly money is nothing more than the “pretended payment” of debt Adam Smith warned against in The Wealth of Nations.

So, if it’s “not to their advantage to downgrade,” why did China do it? Because, Dagong writes, “an overall crisis might be triggered by the U.S. government’s policy to continuously depreciate the U.S. dollar against the will of creditors.” So, our creditors are getting ready to pull the plug. They are reaching the tipping point.

The numbers speak for themselves. If Congress refuses to cut spending, the Fed will be forced to print about $600 billion every year for the next three years to buy new treasuries, increasing its own balance sheet from $2.34 trillion to $4.14 trillion if all other things remain constant. That will increase the Fed’s treasuries holdings to $2.6 trillion.

That’s a 76 percent increase in the Fed’s balance sheet and a 214 percent increase in its treasuries holdings, which will certainly result in further dollar depreciation.  It’s already depreciated about 30 percent in the last 8 years. The Chinese hold about $868.4 billion of treasuries. The Fed’s intervention into the treasuries market certainly makes U.S. debt less attractive, raising the specter that the Chinese and others will dump their holdings.

What is the tipping point? It is fear. It is panic. It is when our creditors believe they will get less money in return for holding the assets than by selling them for whatever the market will fetch. Both our monetary and fiscal authorities are playing with fire. They are assuming that the current monetary system with the dollar being the world’s peg will not change, when everything changes.

In the least, the U.S. is taking an awful risk and doing little to mitigate the downside potential for another crisis. We’re gambling.

The dynamic where countries keep pouring money into U.S. debt is subject to change, precisely because it is based on market variables. In this case, the variables are rather predictable. The more treasuries the Fed buys, the less marketable they become, the less China and others buy, and therefore the more debt the Fed needs to buy to finance the United States’ unsustainable spending obligations.

When countries don’t want to buy the dollar, it is a short step to them choosing to dump the dollar. That sparks a dollar run. And only way to prevent it is to act immediately to balance the budget and restore international trust in the full faith and credit of the United States.

Robert Romano is the Senior Editor of Americans for Limited Government (ALG) News Bureau.

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