Defusing the Dollar Bomb

Already lost is the fact that by the time Obama took office in early 2009, the Fed had already fired every monetary bullet fighting the early stages of the FIRE economy depression. Only fiscal stimulus remained to pull the nation out of a spin dive. But can we afford it?

Buried far deeper in the bottomless abyss of America’s forgotten past are the darkest days of the Carter administration when US deficits spiraled out of control. Gold prices doubled and doubled again as one hundred articles pronounced the dollar doomed.

“Shrinking Role for US Money”
Oct. 15, 1979 (TIME Magazine)

“Frenzy in the gold and currency markets heightens an urgent issue.

“From the harried canyons of Wall Street to the outwardly calm boardrooms of Zurich, the world’s financial centers experienced a whiff of panic last week. In two days of frantic trading, the price of gold on the London exchange soared a breathtaking $50 per oz. to $447 at one point; then it plunged back down almost as steeply, closing the week at $385. Silver, platinum and copper also gyrated wildly. Said a New York bullion trader: ‘The market’s gone bananas.’

“The madness, as usual, was not over precious metals so much as money—specifically the battered US dollar. Once again greenbacks were being sold off heavily in world markets in exchange for more robust currencies. Struggling to keep the buck from plunging further, which would hurt West German exports, the Bundesbank spent $1.2 billion in deutsche marks to buy up unwanted dollars last week. By happenstance, as the buck was worrying down again, central bankers, finance ministers and some 6,000 other leading moneymen were gathering in Belgrade, Yugoslavia, for the annual meeting of the 138-nation International Monetary Fund. Treasury Secretary G. William Miller and Federal Reserve Chairman Paul Volcker had hardly arrived when they were besieged with calls for US action to stem the panic.”

Twenty years before GATA and conspirational gold manipulation theories appeared, real live gold manipulation occurred out in the open, with Volcker in the lead.

“Volcker promptly returned to Washington to draft plans for what could be the second massive dollar-rescue program the US has had to mount in eleven months. Among the steps under discussion:

“LARGER GOLD SALES. The 750,000 oz. of Fort Knox bullion the US now sells monthly might be doubled, in hopes that this might help drive prices down. Hinting at such a strategy, Under Secretary of the Treasury Anthony Solomon said last week that the gold boom was ‘extremely unhealthy for the world economy.’”

Owners of US debt held a mere fraction of a percent of GDP on those days, modest by today’s standards. Yet when the US started running a tiny sub-billion dollar trade deficit lenders demanded that future US bonds be issued in local currencies, aka Carter Bonds.

“MORE ‘CARTER BONDS.’ Since last November the US has sold $4.2 billion of so-called Carter bonds in West Germany in order to raise marks for the dollar defense. Plans have been worked out to issue more such bonds.

“The foreign moneymen worry about the Carter Administration’s resolve to hold down inflation at the cost of higher unemployment as the 1980 political campaign picks up steam. They found fresh reason for skepticism last week: it was revealed that to get the unions to join in the Carter anti-inflation program, the Administration agreed not to try to penalize any violators of the ‘voluntary’ wage and price guidelines. Miller attempted to soothe his colleagues in Belgrade by promising that the Administration would ‘stay the course’ in battling inflation, but doubt remained. Said one West German Cabinet minister: ‘The problem is Carter’s chaotic leadership.’”

The macroeconomic backdrop for the FIRE Economy Depression is 50 percent 1975 and 50 percent 1930. Three items top the 1930 depression versus 1970s recession comparison checklist. One, is the economy collapsing under the strain of a post credit bubble debt deflation? Check. Two, is monetary ammo exhausted and deficit spending the remaining line of defense? Check. Three, is US a net creditor? No it is not. This will prove to be the critical difference as US creditors back away from the dollar like a construction crew from an unexploded bomb discovered while digging the foundation for a new building–very carefully.

You’ve heard apologists for America’s unofficial weak dollar policy explain that the US external debt position does not expose the US to balance of payments crisis such as led Argentina down a road to ruin that culminated in a currency crash and capital flight in 2001. You see, the US owes its foreign debts in its own currency.

Not if current trends continue and the US owes more and more in short term debt and soon Obama Bonds:

“Top Chinese banker Guo Shuqing calls for wider use of yuan”
June 15, 2009 (Telegraph – Malcolm Moore in Shanghai)

“The head of China’s second-largest bank has said the United States government should start issuing bonds in yuan, rather than dollars, in the latest indication of the increasing importance of the Chinese currency.

“It was the first time the head of a major Chinese bank has called for the wider use of the yuan, although a chorus of senior government officials have already voiced their concerns about the stability of the dollar and have said the yuan should be used more widely.

“‘I think the US government and the World Bank can consider the issuing of renminbi bonds,’ he said, asking for a ‘mutual cooperation’ between the US and China to promote Chinese financial services. He said bond issuance could be relatively small, at between 1bn and 3bn yuan (£100m to £300m).”

Shuqing’s shot added to the salvo of criticisms launched by Chinese officials at the Obama administration, each claiming reckless public spending to bail out the FIRE economy and shaky banks stretched America’s credit limit. Only six months earlier, ex-New York Fed economist Richard C. Koo, now the Chief Economist of Nomura Research, pointed to the experience of Japan in the early 1990s as an object lesson on how not to manage debt deflation. He made a convincing case that aggressive monetary policy will prevent the US economy from collapsing into a deflationary spiral as in the 1930s, but that only fiscal stimulus can prevent the US economy from devolving into a Japan style “lost decade.”

Click here to read part I & II of Eric Janszen’s “The Cheh Shaped Recovery.”