[Dialogue] Is the Dollar about to take a real tumble?

[Ed Reames]

I picked this up from another listserv.

Ed Reames
La Rivera de Belén, Costa Rica


SPEAKING FREELY
Crisis towers over the dollar
By W Joseph Stroupe
http://atimes.com/atimes/Global_Economy/FK25Dj03.html

Speaking Freely is an Asia Times Online feature that allows guest
writers to have their say. Please click here if you are interested in
contributing.

When analyzing such matters as the vulnerability of the US economy and
the chances of its collapse, it is vital to avoid the two extremes of
"calamity howling" on one hand and investing blind faith in the status
quo on the other. Unforeseen and unexpected attack-induced collapses of
grand proportions can and do occur. The sudden collapse of both towers
of New York's World Trade Center, for example, took everyone by surprise
- who could have foreseen that the two towers, which survived the
massive lateral impact of two huge planes, would, only minutes later,
collapse vertically upon themselves, their own massive weight ensuring
their demise?

Structurally, the two towers were impressive indeed. They had actually
been designed to take a lateral and direct impact of a Boeing 747 jumbo
jet and survive without collapsing. Nonetheless, certain fundamental
structural vulnerabilities did exist in the towers. These were not
entirely evident before September 11, 2001, but were hidden beneath
their massive and stable outward appearance. When those vulnerabilities
were carefully targeted and exploited, down the massive towers came
within mere minutes of the attack.

Do similar deep structural vulnerabilities exist within the US economy?
Are these currently being exploited by the al-Qaeda and others to cause
a US economic collapse? Are the apparent strength, stability and
imposing size of the US economy deceptively masking an imminent
collapse, as the Twin Towers did? Have the initial stages of an attack
on the towering US economy, which might bring about a vertical collapse,
already begun?

Faulty Towers

The collapse of the Twin Towers was a harsh lesson in the realities of
the vulnerability of US infrastructure. In the case of the attack on the
towers, the planes struck near the top of the structures. Had they
struck nearer to the street level, there might have been a chance to
extinguish the resulting fires before the primary steel structural beams
weakened. Had they struck the top, the vertical collapses that ensued
would have been highly unlikely as the primary steel structural beams
wouldn't have been possible.

Fundamental vulnerabilities exist in the US economy too. But there also
exists a widespread consensus that there is little real chance of a
collapse, no matter what the attack might be. Even most contrarian
experts dismiss the possibility of an actual collapse. They generally
speak only of a prolonged "bear" period for the economy, not a collapse.
The towers also enjoyed such widespread confidence before September 11.
The previous targeting of the towers in 1993 and their survival only
reinforced this misplaced confidence.

Vertical collapse

Just before September 11, 2001, the US economy was also extremely
unlikely to be susceptible to a sideways hit. It did show its resilience
in the immediate aftermath of the attacks on its economic
infrastructure. But the key to the success of the attacks, from
al-Qaeda's perspective, was the igniting of the jet fuel and its impact
on the primary steel support girders. Hence it was not the immediate
result of the impact itself, but rather the delayed result of the fire
that counted. The steel girders were the actual framework of the towers,
around which the structures were constructed. When the flames softened
the framework, the whole structure caved in.

The US economy is also constructed around a fundamental framework - its
currency, the almighty dollar, and the apparently firm and virtually
unbreakable international support it enjoys. Similar to the framework of
the Twin Towers that supported their massive weight, the dollar supports
a massive load of debt, now totaling well over US$7 trillion in the
public sector alone. Much of this debt load is, in effect, tenuously
suspended at the upper portions of the US economic structure, where it
places an undue load upon the lower, traditionally more stable part of
the economic framework. This is true for a number of reasons.

Federal Reserve Board and government policies over the past 20 years or
so have been extremely shortsighted, leveraging the economy's future
stability and strength by means of large and perpetual deficit spending.
The US government, and its citizens as well, have acted as if there
would never come a day of accounting for the immense debt being amassed,
that somehow the amassing of such debt didn't matter. Nothing could be
further from the truth. And since the economic slowdown of 2000, Fed and
administrative policies have caused a pointed and massive ballooning of
very risky forms of public and private debt, all built upon the
structural framework we call the dollar. One such form of debt is the
massive selling of treasury notes to foreign central banks - most
notably to the big Asian economies. Another is the Fed policy of
"prolonged monetary accommodation", meaning keeping interest rates at
artificially low levels, printing new money at the rate of nearly $1.5
trillion per year and the massive creation of easy credit.

In the past three to four years, debt encouraged by such policies has
mushroomed almost beyond imagination. So, in effect, there now exists a
mountainous load of debt concentrated within the upper sections of the
US economy, where it cannot easily be neutralized to the ground level in
an orderly fashion. How much of such massive weight can the framework,
the dollar, carry and support before the structure caves in?

Is there already a fire in the immediate vicinity of that framework and
are the steel girders already beginning to soften? The traditional
international support for the dollar and the US government's foreign and
economic policies is beginning to waver. Why? Because al-Qaeda has
lighted a fire of sorts in the vicinity of the dollar framework. It has
succeeded in instigating the US to take economic and foreign policy
measures that have resulted in a loosening of the firm "girders" of
international support for dollar and US policies. Al-Qaeda has
indirectly lit the fires of controversy over the rightfulness and
permanence, and even the desirability, of continued US global dominance
in the diplomatic, economic and military spheres.

Now that fire is raging, and ferociously eating into the girders.
Controversial and ill-advised unilateral US economic and foreign
policies since September 11 are only fueling that fire. In the immediate
aftermath of the re-election of President George W Bush, international
support for the dollar and for related US economic and foreign policies
is noticeably weakening, at a time when it is most needed to support an
unprecedented and mushrooming mountain load of debt. Recently, voices
from within the government of Norway have called for a switch from the
dollar toward the euro for international petro-transactions. The
governor of the Bank of Japan has recently stated that having the dollar
as the sole global currency is a marked disadvantage and danger, and
recommended moving toward adopting the euro as a global currency
alongside the dollar. The appetite of the big Asian economies to
continue buying dollar assets is waning - last month the US barely
achieved the $60 billion of foreign cash inflow required each month to
keep it afloat. Hence the possibility of a Twin Towers-like vertical
collapse of the US economy is becoming greater, not lesser.

The following highlight the extent of the mounting debt and the risk
involved:

* The total US public national debt now exceeds $7 trillion.
* When Social Security, Medicare, Medicaid, military and government
pensions are added in, the total national debt exceeds $51 trillion,
according to Fortune magazine - that's nearly five times the gross
domestic product (GDP).
* The current year's deficit alone approaches $1 trillion when you add
the off-budget items.
* Derivatives (highly leveraged and enormously risky instruments such as
interest-rate futures, options and swaps) now total $180 trillion, 17
times the GDP. Warren Buffet calls derivatives "instruments of mass
destruction". Many financial institutions have become highly invested in
derivatives. Government-sponsored enterprises such as Fannie Mae (the
Federal National Mortgage Association) and Freddie Mac (the Federal Home
Loan Mortgage Corp) use derivatives heavily. Because of the inherent
nature of derivatives, these instruments and those using them are
extremely sensitive even to small and moderate interest-rate increases.
* The total US consumer debt is more than $8 trillion.

The Japan Times recently stated, "Stephen Roach, Morgan Stanley's
perceptive economist, drew attention to the fact that some of the
numbers are nothing short of frightening. The US currently has $38
trillion in debts, and there is a $54 trillion federal funding gap - the
difference between what the government is committed to pay out and what
it will receive in tax revenues."

The Fed has kept interest rates artificially low for long, thereby
creating enormous amounts of cheap and easy money and has also pursued a
policy of "monetary inflation" (declining the value of the dollar) by
printing nearly $1.5 trillion a year. These prolonged policies have
artificially created huge and growing (1) credit, (2) real-estate and
other asset and (3) stock-market bubbles. However, with interest rates
rising, the bubbles are about to burst.

The price:earnings ratio is at historic highs - a sure sign of a general
stock market bubble. "Smart Money" Warren Buffet has mostly pulled out
of the US stock market because stocks are so greatly overpriced. What
goes up must come down, and the US stock market is way up, far higher
than can be justified by reason and facts.

The troubled dollar

Is international support for the dollar and for US policies eroding?
Yes, it most certainly is. A powerful case can be made that it has been
US policies and actions since September 11 that have resulted in a
powerful upswing in terrorism worldwide along with an equally powerful
elevation in Middle East instability resulting in sustained crude oil
price hike and a resulting dollar decline, both of which are threatening
to render serious damage to the big Asian economies. Firm international
support for the dollar is certainly flagging. The largest Asian central
banks have gone on record that they are curbing their purchases of US
debt. And they are also diversifying their huge reserves, steadily
moving away from the dollar. The risks have simply become too many and
too serious.

International fears of a disorderly, or possibly even a catastrophic,
decline in the dollar have been pointedly heightened. Asian central
banks are being forced by the varied and serious risks to hedge their
bets, not wanting to be ill-prepared in the event of a disorderly
decline in the dollar. Russia is also steadily decreasing the percentage
of its reserves denominated in dollars, moving toward a level of 50:50
split between dollars and euros. Russia is the key player here, the one
the entire world is intently watching. It alone can play the key role in
either restoring the flagging international support for the dollar, or
completely undermine its remaining support, precipitating a vertical
collapse.

President Vladimir Putin has stated both publicly and privately that
invoicing Russia's crude-oil and gas exports to the European Union in
euros instead of in dollars makes very good sense for both Russia and
the EU. Putin is known to have very close relations with "old Europe",
primarily Germany and France. His statements and those of German and
French leaders have even on occasion drawn attention to the fact that US
global dominance fundamentally rests on the fact that the dollar is the
international currency, and that if an exit from the dollar were to
occur in the sphere of global petro-transactions, the effect would be
seriously to undermine that global dominance. Furthermore, a number of
oil-exporting countries have already gone on public record as to their
preference to make an exit from petro-dollars in favor of petro-euros.
They have indicated that if Russia begins such a move to petro-euros,
they will rapidly follow Russia's lead. The net effect would be a rapid
international abandonment of the dollar as the international currency,
which would in turn "bring down the towers" of the heavily debt-ridden
US economy.

Al-Qaeda has recently mounted a second attack on the fundamental
framework of the US economy. Its clear strategy of attacking
oil-exporting infrastructure around the globe to tighten global supply
and drive up crude-oil prices is a further act of instigating a raging
fire in the immediate vicinity of the US economic girders. Al-Qaeda
knows crude oil is the economic lifeblood of industrialized economies.
And it also knows the fundamental fragility and deep imbalances that
exist in the US economy in particular. It fully understands that
international support for the dollar is weakening and that a sustained
elevated crude-oil price is the key to producing a set of circumstances
in which persistent inflation returns, requiring a set of interest-rate
hikes, which in turn will act like a needle to burst the credit,
real-estate and stock-market bubbles. The resulting decline of the
dollar will be steep and persistent, undermining what is left of
international support for dollar.

However, one huge problem that has been noted on the subject of
executing an exit from the dollar is the current enormous reserves held
by the big Asian economies - those reserves are largely denominated in
the US dollar. How can any of these Asian central banks or Russia, which
still holds a percentage of its $112 billion in total reserves in
dollar-denominated assets, execute an exit from the dollar without
simultaneously wiping out the immense value of their own dollar
reserves? On the surface, that problem seems virtually insurmountable.
But is it really?

If we look at Russia as an example, we learn that its central bank has
been moving rapidly over the past 15 months from a 75% holding of
dollars in its reserves to a 50% holding, significantly decreasing the
proportion of its reserves denominated in dollar. Significantly, it is
also well along in an effort to de-dollarize itself domestically in
favor of the euro, buying up its domestic dollars with windfalls coming
as a result of the elevated price of crude oil, and by that means it is
progressing steadily toward its stated goal of "diversification" of its
reserves away from the dollar. The rest of the world is forced to watch
what Russia does in that regard.

If Russia is perhaps positioning itself to make even a partial exit from
the dollar in the pricing of its petro-transactions, then the Asian and
other economies don't want to risk being left out in the cold,
unprepared, seeing the value of their own huge dollar reserves
undermined by a steep or chaotic decline in the value of the dollar.
They cannot afford to ignore Russia's moves. Hence as Russia moves to
decrease the percentage of its own holdings of dollars, so are the big
Asian economies, as well as many other economies around the globe. No
one wants to get burned in the event Russia moves to the euro.
Additionally, as the dollar continues to weaken and crude oil continues
to rise in price, having the dollar as the preferred international
currency for petro-transactions will become more of a liability,
especially for the big Asian economies, which are heavy importers of
crude oil. This fact will tend to further undermine Asian, as well as
the rest of international support for the dollar.

W Joseph Stroupe is editor in chief of Global Events Magazine, an online
geopolitical magazine specializing in strategic analysis and forecasting.

(Copyright 2004 W Joseph Stroupe.)





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