The Greenback Blues: Something’s gotta give

Mike Whitney
The Intelligence Daily News Service
August 23, 2008

As Greenspan’s massive equity bubble continues to lose gas,  balance sheets will have to be mended and lending will slow to a crawl. In a matter of weeks, the euro has been pounded into pulp while the dollar has regained much of its former glory. The mighty greenback has surged 6% in the last month alone. Wow. Apparently, the early reports of the dollar’s demise have been greatly exaggerated. The euro, on the other hand, has been caught in the same recessionary-downdraft that is buffeting a number of other currencies, all of which are unwinding at the same time although unevenly. Currency markets don’t move in straight lines. But don’t be fooled, most paper money is steadily losing value due to the unprecedented expansion of credit which started at the Federal Reserve. Investors are moving to cash and hunkering down; the stock and bond markets are just too risky and real estate is in a shambles. As Greenspan’s massive equity bubble continues to lose gas, balance sheets will have to be mended and lending will slow to a crawl. At present, Germany’s slowdown and Spain’s housing crash are drawing most of the attention but, the spotlight is shifting fast. Next week it could be shining down on the America’s failing banking system or poor corporate-earnings reports in the US. Then it will be the dollar marching off to the gallows.

Europe’s troubles have put to rest to idea that other countries can
“decouple” from the US and prosper without the help of the US consumer. That
might be true in the long-term, but falling demand is already visible
everywhere. Retail and auto sales are taking a thumping and 2009 is shaping
up to be even tougher. It’s looking more and more like the European Central
Bank was faked-out by the early signs of inflation and missed the
deflationary sledgehammer that was about to come crashing down. It was a
rookie error by European Central Bank (ECB) chief Jean Claude Trichet and it
could cost him his job. Raising interest rates while sliding into the jaws
of recession is madness. Now all of Europe is headed for a hard landing and
there’s no way to soften the blow. The ECB doesn’t have the same tools as
the Fed; Trichet can’t simply backstop the whole system with green paper and
T-Bills like Bernanke. He can either slash rates or sit on his hands and
hope for the best.

The UK Telegraph’s Ambrose Evans-Pritchard, sums up Europe’s woes in last
week’s article “ECB Slammed as Europe Crumbles”:

“The economies of Germany, France and Italy all contracted in the first
quarter and may now be in full recession, shattering assumptions that Europe
would prove able to shrug off the effects of the credit crunch….The picture
is darkening so fast in Spain that Prime Minister Jose Luis Zapatero
canceled holidays and called his cabinet back to Madrid yesterday for the
first emergency session of its kind since the Franco dictatorship.

Growth has turned negative in Ireland, Denmark, Latvia, and Estonia, while
grinding to a halt in Sweden and The Netherlands. Iceland contracted by a
staggering 3.7pc. The grim data from Eurostat follows a recession warning in
Britain, and shock news that the Japanese economy had shrunk 0.6pc in the
second quarter. Almost the entire bloc of rich Organization for Economic
Co-operation and Development (OECD) countries - still two thirds of the
world economy - are now in the grip of a major downturn.”

Evans-Pritchard’s article reads like a chapter from the Book of Revelation
all that’s missing is the plague of locusts. The ECB is in a pickle and will
have to allow the economy to cool off so the credit excesses can work
themselves out. It’s like a pig passing through the belly of the boa; it
takes time. As a result, deficits are expected to soar in the south
(particularly Spain, Greece and Italy) while growth in the industrial north,
Germany, will continue to shrink. Also, Spain, Ireland and England are
undergoing the biggest housing meltdown in history after indulging in the
same mortgage hanky-panky that took place in the US. Billions of dollars of
low interest loans, that were issued to unqualified mortgage applicants, are
gumming up the whole system and sending foreclosures skyrocketing. Now the
losses have to be written down and thousands of unoccupied houses sold at
auction. It’s a disaster.

The problem is so big that the future of the EU and the euro are now very
much in doubt. Currency traders are expecting the ECB to lower rates (and
weaken the euro) just as the future’s market is wagering that the Fed will
raise rates to fight inflation. But don’t bet on it. Interest rates are
going down not up, regardless of the Fed’s impressive PR campaign. Bernanke
is just waiting for Trichet to make his move before he produces the Fed’s-scimitar
and begins slashing rates. Keep in mind, the Federal Reserve is essentially
the board of directors for the nations banks. If Bernanke is forced to
choose between the people who depend on the dollar as a reliable store of
value or bailing out the high-stakes gamblers who run the banks; the Fed
chief will choose the banks 100 per cent of the time. In Vegas, that’s
called a “sure thing”.

The perception that the dollar is getting stronger is mostly an illusion.
Deflation is “dollar positive” because investors who flee from toxic assets
naturally move into cash. But that doesn’t mean they have faith in the
dollar; far from it. The fundamentals for the greenback get worse by the
day. Fiscal and trade deficits are out of control, the national debt is
tipping $10 trillion, foreign investment is drying up, and confidence in US
leadership has never been lower. The dollar is on a time-line of roughly 6
to 18 months before it’s rolled into spools and sold as toilet paper. Paper
currency is a country’s IOU; and foreign central banks are wary of taking
checks from a country that no longer wins wars or has the capacity to pay
off its debts. That’s why, for the first time, there’s serious talk about
the US losing its triple A rating on government debt. And it could happen
sooner than anyone thinks. Every time the Fed uses the dollar to prop up the
faltering banking system or provide limitless capital for defunct GSEs like
Fannie Mae and Freddie Mac; the dollar comes under greater and greater
pressure. At a certain point the dollar will crumble and the country will
have to sell off its assets and industries to pay the bills. That’s when the
private equity vultures and Sovereign Wealth Funds will swoop down and
scavenge anything of value for pennies on the dollar.

As the US housing market continues to collapse, trillions of dollars in
equity and credit are disappearing in a deflationary bonfire. When a
$400,000 home–with no down payment and negative equity–goes into
foreclosure; $400,000 vanishes from the digital-pool of credit and has to be
written down as a loss. So far, much of the losses have not yet been
accounted for because the banks are using their own internal models for
determining the value of their downgraded assets. Two weeks ago, Merrill
Lynch sold $30 billion of Mortgage-backed junk for 20 cents on the dollar.
But they also financed the deal, which means that they really only got 5
cents on the dollar! This reflects the true “market value” of these assets.
They are virtually worthless. Naturally, Merrill’s sale sent tremors through
Wall Street where banks and other financial institutions are sitting on
trillions of dollars of this garbage marking it down at a few percentage
points every reporting period rather than doing what Merrill did and putting
it all behind them. As a result, the banks have less capital to lend, which
means economic activity will continue to slow and the country will go into a
deep recession. The point is, that the Federal Reserve now holds about $400
billion of this junk-paper on their balance sheets and the US Treasury is
planning to take on hundreds of billions more (perhaps as mush as $800
billion more under the new legislation!) to prop up Fannie Mae and Freddie
Mac. The Bush administration is using the credibility of the dollar as
collateral in its plan to bail out the most reckless, high-stakes Wall
Street gamblers and their multi-trillion dollar Ponzi scheme that has blown
up in their faces.

So, how does this affect the dollar?

The nation’s debts are entirely balanced atop its currency. The greenback is
like a circus strongman holding a barbell precariously over his head; as the
weight is increased, the sweat begins to appear on his brow while the veins
in his neck and forehead begin to bulge. Finally, the knees buckle and the
over-matched weightlifter crashes to the canvas in a heap. That’s the future
of the dollar in a nutshell. Its just a matter of time.

But how does that explain the sudden fall in gold prices; after all, gold is
the logical alternative to paper money, right?

Wrong. Gold is “real money” alright, but it’s also a commodity. And when
commodities are smashed by a deflationary tidal wave–as they have been the
last few weeks– gold will follow them into the basement. In truth, gold has
taken an even worse pasting than the euro; free-falling from $980 per ounce
in mid-July to $786 at Friday’s market close. $194 in a month. Goldbugs are
so fanatically committed to their views about “real currency” and “fiat
money”, that any correction in the market is seen as proof of government
manipulation. (Even though they are right many times) There’s plenty of
evidence of meddling in the currency markets, just as one would expect.
After all, the western banking system, led by the Fed, operates as a cartel.
The head honchos are about as committed to free markets as Bush is to
democracy, which isn’t saying much. It’s all a public relations ruse that’s
used to defend a de facto monopoly; the paper money scam. So, we shouldn’t
be surprised when foreign central banks unexplainably purchase $28 billion
of US government securities at the 11th hour (as they did last month) to
conceal our massive trade imbalance and prop up the waning dollar. Don’t
forget, it’s their chestnuts they’re keeping out of the fire, too. But, that
doesn’t mean the Fed has superhuman powers or that every time gold goes into
a tailspin its because the black helicopters fired lasers into the currency
markets. When the economy is in the grips of deflation; all asset-classes
get dragged down, gold included. Many of the hedge funds and other big
market players are selling their gold positions recognizing that the
commodities boom is over and it’s time to move on. That doesn’t mean that
gold won’t rebound sharply when Bernanke slashes rates or if Bush blows up
some new part of the globe. It simply means that in the short term, “cash is
king”. Pension funds and hedge funds will continue to deleverage to reduce
their credit exposure to put themselves in a better position to roll over
their debt. That means that gold’s slide could last a while. This doesn’t
look like a conspiracy to me, but I have my tin-foil hat in hand just in
case.

No one knows where the bottom is for gold, but one thing is certain; it’s
future looks a lot brighter than the dollar’s. The Bush administration has
yet to demonstrate that it can enforce Dollar Hegemony via military
intervention. That is a very big deal indeed. If the dollar isn’t backed by
Middle East oil, then the $6 trillion stockpile of dollars and
dollar-denominated assets that are languishing in foreign central banks and
sovereign wealth funds, will continue to dwindle until the dollar’s position
as “reserve currency” comes to an end.

That’s one doomsday scenario, but there is another one, too. If Bernanke and
Paulson continue to pile all of the nation’s credit problems (bad paper) on
top of the greenback; foreign capital will head for the exits and the dollar
will crash. Either way, the dollar’s troubles are mounting and something’s
got to give.

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