The swansong for the Greeenback

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Jan 26, 2006
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The Swansong for the Greenback
by Mike Whitney
www.dissidentvoice.org
June 3, 2006

The great dollar sell-off has begun in earnest, although to a large extent, it's being concealed from the public.

Wary currency traders have been expecting a dollar-slide for months but were nervous about the possibility of widespread panic. Everyone from Bill Gates to Paul Volcker has predicted that the current trade deficit of $800 billion (7% of GDP) would inevitably produce a weaker dollar, so it is only natural that China, Japan and other foreign lenders would begin to cut back on their purchases. The danger to the United States, however, remains extreme. If the transition doesn’t go smoothly, it could precipitate a run on the dollar and trigger economic pandemonium. No one wants to see the world’s economic powerhouse pirouetting through the ether in flames. By the same token, no one wants to be the last man holding onto stockpiles of scrip that are diminishing in value.

The delicacy of the situation explains the sudden appointment of Henry Paulson as Treasury Secretary. Paulson is a brainy insider who has the bona fides to manage a very tricky “retreat” from the dollar. America’s economic future will depend heavily on his ability to steer the ship of state through troubled waters.

As we said, there was no doubt that China, Japan and others would eventually reduce their dollar holdings as America’s debt continued to mount. What is surprising though is that a sell-off did not occur earlier when Bush enshrined his reckless tax cuts and profligate spending as “permanent”. The administration’s fondness for living beyond its means has never been in doubt, now the greenback will pay the price for Bush’s excessiveness.

Of course, Bush is not the main scoundrel in this morality play. The Federal Reserve has weakened the dollar enormously by engineering one monetary coup after another. Greenspan’s “cheap money” policy has created massive equity bubbles that appear whenever interest rates are absurdly low. When the stock market crashed in the late ‘90s, millions of working class people lost their retirement and life savings overnight, while wealthy insiders walked away unscathed. Undaunted by the economic carnage he produced, Greenspan again lowered interest rates to a ridiculous 1% in 2001 which created a $9 trillion housing bubble, “the largest equity bubble of all time” (says The Economist). Now, as interest rates inch higher, the housing industry is lumbering towards the power-lines and certain death. The effects on the world economy will be catastrophic.

Under Greenspan, the money supply expanded at an unbelievable rate. “From 1982 to 1992, it went from a “modest” 8% year-on-year expansion. However, from 1992 to 2002 it moved into overdrive with the deregulation of global markets with a year-on-year expansion of more than 12%. Since the 2002 post-9/11 crash, the money supply has been expanding at greater than 15%”, more than doubling in less than a decade. (Nigel Maund, “Fiat and Credit”)

Now there are signs that foreign lenders are tired of the weakening dollar and are reducing their stockpiles of greenbacks and dollar-denominated securities. The Gold Forecaster reports in its recent article “The US Dollar and its Prospects”:

Last month saw the U.K. and Caribbean Banks buy a disproportionately large amount of U.S. Treasury assets. It appears that this is part of an international dollar liquidity management program. If this is correct the two centers will buy even more from now on, as other foreigners reduce their purchases of the U.S. dollar.

This means that China and Japan have begun to reduce their purchases of US Treasuries but, surprisingly, some mysterious third party has begun to pick up the slack.

Who is crazy enough to increase their dollar holdings when most analysts are predicting a loss in value?

Apparently, the Bush administration (along with the Federal Reserve) is purchasing its own debt (Treasuries) to control the rate at which the dollar declines. It’s a good strategy, but it can’t last forever.

If the dollar began a sudden nosedive, central banks around the world would quickly ditch their stockpiles and ignite a global economic firestorm. By purchasing its own debt, the US hopes to engineer a “soft landing” while maintaining its status as the world’s “reserve currency.”

As the world’s reserve currency, the Fed can simply print money that the rest of the world accepts as payment for its manufactured goods and resources. It’s the slickest deal on earth. As one admiring currency trader said, “It’s like having a mint in your own backyard.”

The system was put in place after the vast devastation of World War II and has made the Federal Reserve the de facto steward of the global economic system. Nearly 70% of the reserves in foreign central banks are either dollars or dollar-denominated securities. This is as close to a monopoly as it gets.

The expansion of the dollar is the greatest fiat-money experiment in history. The awesome power of the greenback extends to all markets, and yet, is completely disconnected from the traditional means of measuring value, like the gold standard.

It’s clear that Bush believes that the dollar can survive “devaluation” if the US is able to control the vast oil resources in the Middle East. Foreign countries will be forced to use the dollar in their oil purchases regardless of the staggering trade deficits. The dollar’s value will continue to be pegged to oil while its future will increasingly depend on the military’s success in I