And So It Begins (Dollar Warnings)
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2009-10-23 08:47 by Karl Denninger
in Monetary Ignore this thread
And So It Begins (Dollar Warnings)

I have been on a potential dollar dislocation - or collapse - for more than two years.  Indeed, back in the fall of 2007, it was one of the themes of petitions to Congress and letters I sent under personal cover to all 535 members.

The debt liquidation cycle of 2008/early-09 appeared to stop the deterioration.  Unfortunately that cycle was interrupted - intentionally - by enabling a continuing pattern of lies and fraud within our government.

This has reversed all of the gains that the dollar had made last fall and winter, despite the stock market and other asset prices being materially lower - by a lot - than when those warnings were issued.

Treasury is always "for a strong dollar" in word, but their view when it comes to deeds is another matter.  This is most unfortunate, as this, like Treasury's and The Fed's view when it comes to sweeping trouble under the rug and lying about asset quality has been proved wrong through time not only here in America but worldwide.

Japan is a prime example.  They adopted the same sort of "programs" we did when they ran into debt-based trouble in their economy two decades ago.  Instead of forcing those who had made bad loans and by doing so blown asset bubbles to eat them - even if it blew them up - they instead played extend and pretend - that the loans were good, that the asset quality was fine, that the banks had plenty of reserves.

The Japanese economy never recovered.  Instead it scraped along a deflationary bottom for a literal two decades, sustained only by the Yen Carry Trade.

But carry trades don't deploy the borrowed funds in the "host", or "funding" nation.  Indeed, the entire point is to borrow there cheaply and then "invest" (or trade) somewhere that has a higher return.  This drains the host just as does any parasite, and drain it did - for more than a decade, Japan's capital flows were turned inside-out.

Now it's our turn; the dollar has turned into the funding currency of choice, cutting off the last bit of Japan's bond appetite.  The government is now threatening to issue as much as $50 trillion Yen of bonds in the next year of "new issue" in an attempt to keep the game going, flooding the market.  This could in turn provoke a currency dislocation and drive the Yen/Dollar swap to 200, according to some observers.

There is a lesson there that is not lost on others; out of Australia we now have this:

In unusually pessimistic comments for a senior political figure, Senator Joyce said the US Government was running such large deficits and building up so much debt that it was in a similar position to Iceland or Germany before World War II.

In a Senate estimates hearing on Wednesday night, he asked Treasury secretary Ken Henry what would be the implications of an American debt default for the Australian economy.


''Far from turning around the [George] Bush legacy of deficits and debt, [US president Barack] Obama has made it worse. It has got all the hallmarks of a financial collapse about to happen in America.''

Senator Joyce said investor concerns about the American Government's ability to fund its deficits were already undermining the role of the US dollar in the international trading and financial system.

''The US dollar is almost becoming like junk bonds,'' he said.

Uhhhhhhh.... yeah. 


America had a justified hubris for decades coming out of WWII in terms of our manufacturing base and intellectual capital, both of which led to the dollar's strength and a fully-reasonable view that the dollar was indeed the global currency - whether others liked it or not.

But today this has changed.  The view that "deficits don't matter" and that The Dollar can be debased by outrageously ridiculous spending patterns in the Congress has undermined the foundation on which the dollar relies for that reserve status.  Political promises have put into place a budgetary structure in our government that defines more than half of all the money spent every year as "mandatory", going to either Social Security and Medicare or debt interest, and another 1/4 being spent on defense.  Of those four categories only two - interest and the military - are defined as enumerated and proper powers in The Constitution, yet the demographic and political realities turn the other two into "mandatory" categories that are impossible to challenge or modify.  Those who have tried to do anything other than enlarge either have been swiftly booted from office.

Mathematics, however, trump politics.  The mathematical reality is that you can only sustain deficit spending policies (whether by government or private debt acquisition) if GDP grows faster than debt and that growth has to come from the private sector, not government transfer payments, or the deficit percentage and impact will grow faster than GDP.  This is, again, mathematics and cannot be avoided, since the government is only a fraction of the entire economy (and even in a command economy can't be more than 100% of it!)

Again I present the graph that I have shown before on what happens if you don't obey the realities of mathematics:

This isn't conjecture.  It isn't politics.  It is mathematical reality.

There has been NO - underline that - NO - recognition of the mathematical realities that underlie debt and GDP growth within our government, including Congress and regulators.


This is precisely the same road that Japan went down after the Nikkei topped and then crashed when their debt bubble blew up. 

A raw refusal to recognize the mathematical realities has led The Fed and Treasury to instead make legitimate outright fraudulent accounting, enabling banks and others to arbitrarily defer recognition of losses based on nothing more than a hope that through currency debasement popped bubbles can be re-inflated.

History tells us that such strategies never succeed, especially in an import-based economy, which we are, as input costs are tied directly to currency debasement and worse, those foreign interests that hold necessary imports also tend to hold significant currency reserves.  As those reserves are debased the holders of these resources will raise prices and/or constrain supply so as to recover not only the current debasement but also the debasement of their reserves

Congress may not like the facts, but that doesn't change them.  Fraud never pays in the end, and despite all of the crooning and intentional diversion by people such as Bernanke, Summers and Geithner the above chart is a simple reflection of mathematical realities of compound growth - a reality that cannot be changed with "magic wand" waving or burying bad assets under a mountain of fraudulent accounting manipulation.