Page 2 of 2 Dollar's wounds reopen
By W Joseph Stroupe
In a similar vein, Richard Fisher, president of the Dallas Federal Reserve
Bank, issued a warning on May 23 against monetizing US debt through Fed
purchases of Treasuries, agencies and other assets. He warned that this risky
policy is making global investors increasingly nervous. He further warned that
the Fed's challenge is to reassure the markets that the Fed isn't simply making
itself "the handmaiden" to fiscal profligacy, almost as if the promise itself
is enough. He said:
I think the trick here is to assist the functioning
of the private markets without signaling in any way, shape or form that the
Federal Reserve will be party to monetizing fiscal largess, deficits or the
stimulus program.
But investors are drawing that very
conclusion as they judge the
Fed, not by its reassuring words, but rather by its ever more risky policies
and actions. And with huge new sums of Treasuries flooding the market as the
Treasury issues trillions of dollars in new debt this fiscal year alone,
investors are demanding higher yields/lower note prices before they purchase
the assets.
In all likelihood, the Fed will be required to significantly step up its own
purchases of the longer-dated Treasuries in an effort to keep escalating yields
from getting out of control and completely negating its efforts to keep
monetary policy hyper-loose. But such a dollar-debasing move (the printing of
yet more huge sums of dollars) will only further convince investors that
hyper-inflation is inevitable, and that realization will further weaken the
appeal of the dollar today, sending it immediately lower.
It certainly appears as if the Fed doesn't get it; officials definitely seem to
think they can reassure global investors merely by repeating the assurances
quoted above, but without actually changing course in any meaningful way. They
absolutely aren't listening to the wisdom and warning of Angela Merkel and
those like her.
The question is whether central banks which already have large holdings of
dollars, such as China's central bank, will dramatically increase their
exposure to the risky dollar in an effort to stem its decline in order to keep
their holdings from being eroded away.
Considering the record level of angst over their already-large exposure to the
dollar, it appears highly unlikely they will significantly increase their
exposure now, when dollar risks are dramatically increasing. Note the June 2
comments of the official state media, China Daily, in this regard, in its
article entitled, "Geithner Sells a Devalued Dollar":
Another reason
for the dollar's weakness is the grim prospect facing US public finance.
Investors are worried about the US government's record budget deficit. The
Barack Obama administration may have to issue a mammoth $3.25 trillion of
T-bills to fill the financial black hole of such a massive deficit. This is
bound to scare investors away from the dollar-denominated long-term treasury
bills.
When the interest rate is virtually zero and other traditional options have
been exhausted, the Federal Reserve has no choice but to resort to
"quantitative easing" and buying of T-bills. But it will swell the supply of
base money, and thereby heighten the risk of devaluation of the dollar. Though
the devaluation of dollar may be good news for US exports, it will erode
investor confidence, and might even lead to the collapse of the dollar's
hegemony.
Savvy investors are doing precisely what Bill Gross,
founder of the largest bond fund in the world, PIMCO (Pacific Investment
Management Company), advised them to do on June 3. He warned that US finances
are seriously deteriorating and that investors should rapidly diversify their
dollar holdings before central banks inevitably do so. Gross has significantly
reduced US government bond holdings of all flavors within his Total Return
Fund, following his own advice to global investors.
Beginning of the end for the bubble?
The present trend of selling dollars to buy hard assets, though still a
fledgling trend, carries significant risks of turning into a veritable stampede
some distance down the present path. How so? How might this mounting trend out
of the dollar into hard assets begin to significantly feed upon itself to
become a stampede?
Assuming that the ongoing emerging market rally is for real, as evidence
strongly indicates it is, then every dollar sold to buy into that rally weakens
the currency further. As investors carefully monitor the ever-declining value
of the dollar, they will seek to hedge their losses by selling dollars for hard
assets, which will only further increase the supply of dollars and further
weaken the currency.
Few investors will have the stomach for riding the dollar down too far if the
dollar's decline accelerates too much, or even if it remains somewhat gradual
but does not turn around soon. Thus, the cycle feeds upon itself, potentially
becoming a stampede out of the dollar, risking a rupture of the Treasuries
bubble and a catastrophe for US finances as yields and interest rates spike,
out-of-control monetary tightening takes over and an even more massive credit
seizure grips the US.
Since so much wealth is at present parked in short-dated Treasuries, investors
who refuse to roll over their holdings into new Treasuries but instead demand
to refund their Treasuries so as to buy something else, could place the US
Treasury in a profound bind if the current fledgling trend does turn into
anything remotely resembling a stampede.
That is especially so if global investors keep refusing to purchase the
longer-dated Treasuries, thus denying the Treasury a critical source of dollars
with which to issue refunds demanded by investors who aren't rolling over into
new notes or bonds.
The real question here, when considering a possible rupture of the Treasuries
bubble, is whether the ongoing dollar-selloff/dollar weakness cycle will feed
upon itself to a sufficient degree that the dollar's decline becomes
accelerated and chaotic, or whether it will possibly remain more gradual and
orderly. The answer to that question depends upon investor psychology and
events that may affect that psychology.
If a dollar panic gets underway, then we'll be looking at a stampede and a
full-blown rupture of the Treasuries bubble, as well as a concomitant dollar
crisis, renewed US financial collapse and a subsequent full-blown economic
depression.
Thus, the stakes are unimaginably high for the US as regards maintaining global
confidence in dollar assets. In a perverse sort of way, the global crisis we've
already endured, one that emanated from the US, has produced just what the
dollar needed - extreme risk aversion and a massive flight into the dollar. But
the currency is now beginning to lose the contest for global appeal as
investors begin to give the nod to hard assets. Can the dollar stem its losses
and hold onto what remains of investor appeal? Could it even recover its
losses?
Next: A new global driver for growth
W Joseph Stroupe is a strategic forecasting expert and editor of Global
Events Magazine online atwww.globaleventsmagazine.com
(Copyright 2009 Global Events Magazine, all rights reserved.)
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