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Why the dollar rally is going to fail

user profile picture Chris Martenson Oct 11, 2008
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Through all of this crisis, as regulators and politicians and bureaucrats have labored to inject needed funds back into failing financial institutions, few are asking the harder questions.

Such as:

  • Does this crisis represent something deeper, like a general and unavoidable failure of our entire monetary system?
  • Are the failing institutions worth saving?
  • Will it work?
  • Can the government afford it?

I understand the desire and urgency to "get something done," but I worry that a failed effort will be worse than no effort.  Why?  Because our monetary system is, to put it bluntly, somewhat of a Ponzi scheme, and therefore depends more thoroughly on trust than other systems.

After all, when a currency is backed only by a taxing authority, it is critical that the legitimacy and omnipotence of that authority not be called into question.

People are beginning to ask questions.

This next article is a real doozy and directly calls into question the last two questions I posed above: Will the rescue efforts work, and can the government afford it?

[quote]The 2009 budget deficit could be close to $2 trillion, or 12.5 percent of gross domestic product, more than twice the record of 6 percent set in 1983, according to David Greenlaw, Morgan Stanley’s chief economist. Two weeks ago, budget analysts said the measures might push deficit to as much as $1.5 trillion. [/quote]

Link (Bloomberg) 

Back in August, which seems like another lifetime ago already, I was calling for a US government deficit of between $1 trillion and $2 trillion and leaning towards the high end of that range.  Now it seems that others are ready to publicly admit to the same range.

This is the most remarkable of all the possible data because it is a staggering proposition.  More than twice the old record.  12.5% of GDP.

For the boom years of 2003-2007, the US was borrowing 80% of the world’s entire pool of savings to fund its deficits and excess consumption.  We borrowed between $600 billion and $800 billion during those years.

Now, in a world of declining prospects, the US finds itself in need of 200% to 300% more than that.  While I recognize that people tend to save more during downturns, there are also fewer profits to save, so we might expect that the "plan" at this point is for the US to assume it can borrow more than 200% of next year’s savings.  The entire world’s savings.

I flat out do not think this is a workable plan.

There is no way to pull this off legitimately.  Which leaves us with the illegitimate option – direct money printing by the Fed.  I am sorry to say it, but I simply do not see any other mechanism by which the needed amounts can be secured by the US government.

This means that the dollar is at severe risk of decline, and certainly borrowing costs (interest rates) are going to rise, which will only exacerbate the borrowing needs as higher interest rates enforce higher payments.  The first signs are appearing that this dynamic is already in play (from the same article as above):

[quote]That means a lot more borrowing by Treasury, which will push up interest rates, said Greenlaw. "The Treasury’s going to be ramping up supply dramatically over the course of coming months to meet this enormous federal budget obligation,” Greenlaw told Bloomberg this week. "The supply will trigger some elevation in yields.”

Treasuries have fallen the past four days even as stocks sank, a sign investors are preparing for bigger U.S. government borrowing. [/quote]

Now the reason this gets really dicey is that the US government, in its infinite wisdom, has been engaged in a form of ARM financing of its own.  Over the past decade, as interest rates have fallen, the US Government has slowly turned more and more to shorter duration T-bills as the means of financing its operations.   This made sense, in a short-term way, as the T-bills came with the lowest interest rates and hence the lowest interest costs.

But, and here’s the big thing, these T-bills need to be "rolled over" every time they come due.  This means that if a billion dollars of T-bills mature, a fresh offering of another billion dollars must be made. 

The total amount of T-bills now stands at $1.48 trillion, representing another $1.48 trillion that MUST be "rolled over" twice a year, at a minimum, but more likely three times, when we average out the three- and six-month issues.  That is, 28% of all outstanding "debt held by the public" is basically an adjustable rate mortgage that needs to be refi-ed three times per year. 

Plus, there are whatever Treasury notes and bonds and TIPS are coming due as well, and that pool is $3.7 trillion in size, so we might guess that $0.5 trillion of those come due in any given year.

So even as the US is seeking to borrow another $1.5 – $2 trillion this next year, there’s another $1.5 – $2 trillion that must be "rolled over" in open market auctions.  What this means is that somebody has to willingly buy those bills and bonds when they come due.  If not, then we could face the mother of all catastrophes, the failure of a US government debt auction, which also goes by the very unpleasant name of "sovereign default."

This will not happen, though, because the Fed would almost certainly step in and buy those bonds.  A US government default would basically light up the "tilt" indicator on the global financial game, so it would be avoided at any cost.  The Fed, of course, would use its magic checkbook and create the needed money out of thin air, the most inflationary of all possible actions.

I just don’t think that there’s $3 to $4 trillion of extra cash lying around the world right now, ready to be deployed in the US. 
So there it is, that’s the reason I think the recent dollar rally is the biggest suckers rally of the year. 

This is certainly part of the G7 discussions that are ongoing right now.  Each country has enormous borrowing needs of its own, and I can only imagine how tense the situation is in that room right now. Germany must be having a fit right about now, seeing that the US is actively lobbying to unleash the inflationary monsters.

So, to answer my own questions:

  • This crisis represents a generalized failure of the monetary system, and the sooner we get to that  conclusion, the sooner we can begin to talk about solutions that treat the cause, not the symptoms.
  • The failed institutions are not worth saving, because they represent a model that is now broken beyond repair.
  • The current bailout plan cannot work, because it is too small and it is directed at the symptoms, not the causes.
  • The government cannot afford the cure.  But even worse, the US government is already insolvent (when factoring in entitlement liabilities), and nobody is asking how borrowing an additional 12.5% of GDP does anything but make that problem worse.