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Will the US Dollar Drown in an Ocean of Debt?Gary Dorsch About $3.6 trillion of market value was wiped-out from global stock markets in the three days between Sept 15-17th, triggered by the bankruptcy filing by Lehman Brothers, and fireworks in the $62 trillion credit default swap market. The collapse of Bear Stearns, Merrill Lynch's eleventh-hour flight for safety into the arms of Bank of America, and the meltdown at American International Group, were all linked to credit default swaps on mortgages that led to the fall of these titans. Investors pulled out a record $144.5-billion from US money-market funds on Sept 17th, and yields on three-month US Treasury bills plunged to 0.02%, the lowest since World War II, after the Reserve Primary Fund became the first money-market fund in 14-years to "break the buck" and exposed investors to losses. The TED Spread, the difference between US Treasury bill and Eurodollar rates, soared to a record 3.13%, far above average of 0.90% over the past two years. The panicked selling in money market funds was directly linked to the seizing up of the credit markets - including a $52 billion contraction in commercial paper - and rumors of additional money market funds "breaking the buck," or dropping below $1 net asset value. The Fed injected $250 billion of liquidity worldwide on Thursday during European trading hours to head off an avalanche of sell orders that could have brought large tracts of the US credit markets to a complete halt. "The US was literally days away from a complete meltdown of our financial system, with all the implications here at home and globally," said Senator Christopher Dodd. Around 3-pm on Sept 18th, US Treasury chief Henry Paulson leaked word to CNBC that a massive government led bailout of the banks would soon be launched. Speculators scrambled to cover short positions in financial stocks, fueling a 1,000-point advance in the Dow Jones Industrials from the depths of hell.  Traders on the floor of the New York Stock Exchange erupted into cheers, as word spread of a grand Treasury plan to unclog the arteries of the banking system and prevent the US economy from suffering a fatal heart attack. But the US dollar began to suffer a massive hangover from the Treasury's plan due to a soaring debt burden. The $700 billion the US Treasury is seeking from Congress to buy toxic mortgages comes at a time when the federal budget deficit is already soaring. The US budget deficit for the year that begins Oct 1st is expected to hit $482 billion, a record in dollar terms, but Goldman Sachs predicts the number could reach $586 billion, if tax revenues slow. It does not include $300 billion for the Federal Housing Administration to refinance failing mortgages into new, reduced-principal loans with a federal guarantee, passed as part of a broad housing rescue bill. Federal takeovers of Fannie Mae, Freddie Mac, and AIG, the central bank's expansion of lending to financial firms will add $455 billion to borrowing demands. And at least $87 billion in repayments to JP Morgan for underpinning trades with bankrupt investment bank Lehman Brothers is also part of the taxpayer tab. It's not certain if the entire $700 billion the Treasury is seeking to soak up bad mortgages will be needed. But when all the numbers are tallied up, in the worst-case scenario, the US government's borrowing demands could reach $1.8 trillion in fiscal 2009, or about 13% of US gross domestic product. President George Bush's secretive Working Group on Financial Markets, (aka: the infamous "Plunge Protection Team" - PPT) will be working overtime, pulling all the strings at their disposal, in order to find a way to prevent a tsunami of new government debt from swamping the bond markets, and sending interest rates sharply higher. But the US government's choices are clear - either increase taxes to cover the debt, instruct the Federal Reserve to print more money to inflate the debt away, or allow interest rates to rise sharply to attract overseas lenders. The Fed opted for monetization on Sept 19th, when it printed $69 billion out of thin-air, in order to buy debt issued by Fannie Mae, Freddie Mac and Federal Home Loan Banks through primary dealers. According to the Fed, the agency discount notes amount to about 5% of the assets of the money market mutual fund industry, so the step was an effort to firm up this market, and prevent money funds from falling under $1 /share. Word of the Fed's monetization sent the Euro soaring 3.5 US-cents the next day to a high of $1.4825.  The amount of US Treasuries outstanding has been rising at a rapid clip, and stands at $9.6 trillion, up from $4.5 trillion when President Bush took office in 2000. The cost of servicing the interest on the debt has risen to $400 billion annually. The US Treasury relies heavily on wealthy investors from overseas, who own $2.7 trillion of the Treasury's debt, to help keep US bond yields artificially low. In the first half of 2008, the OPEC cartel collected $645 billion from oil exports, and Saudi Arabia accounted for one-third of that total, raking in $192 billion. High oil prices keep petrodollars flowing into the coffers of the Arabian oil kingdoms, which peg their currencies to the US dollar. Trading through their brokers in London and Dubai, the Arab oil kingdoms recycled $280 billion into US Treasuries over the past 12-months, to prevent their dollar-pegs from breaking apart. Throughout the US-dollar's tortuous 40% slide over the past six-years, the Arab oil kingdoms in the Persian Gulf stayed loyal to their US dollar pegs, even while the Fed's indifference to the sliding US dollar sent inflation shock waves through their dollar-linked economies. In return, the US armed forces defend the Arab Oil kingdoms from Iran's mullahs, who are close to acquiring nuclear weapons, and are closely aligned with the Kremlin, and Venezuela's mercurial kingpin Hugo Chavez, - forming the Axis of Oil. However, the cozy ties between the Gulf States and the US Treasury can change, if the Democrats capture the White House in November. On August 31st, South Carolina Senator Lindsey Graham reminded the Arab oil kingdoms that Democratic vice-presidential nominee Joe Biden lacked the backbone to stand up to powerful foes or to fix broken governments in the Middle East. "Biden voted against the first Gulf War to evict Saddam Hussein from Kuwait. He opposed the surge in Iraq. He wants to partition Iraq," Graham said. If Biden becomes the architect of US foreign policy in the Middle East, the Arab oil kingdoms might flee the US Treasury market, and take the US dollar off artificial life support.  China is the second largest holder of US Treasuries, after Japan, and recycled two-thirds its trade surplus into the US Treasury and agency market. However, Beijing has suffered huge losses on its US debt investments, due to the US dollar's 18% devaluation against the Chinese yuan since mid-2005. Beijing accepts the pain of holding depreciating US Treasuries, in return for free and unfettered access to the US consumer market, under a gentleman's agreement with the Bush clan. However, if the Democrats gain control of the White House and Congress, Beijing could come under heavy pressure to speed up the devaluation of the dollar against the yuan, or face big tariffs on its exports to the United States. Beijing could respond by dumping US Treasuries, thereby driving US mortgage rates higher and crippling the US banking system and real estate market. Big changes in US foreign policy in the Persian Gulf and towards China, could dry up the flow of capital to the US Treasury markets from abroad, at a time when it's needed the most. Worse yet, the Arab oil kingdoms and China could become net sellers of US Treasuries in the year ahead, if the Democrats enact a hasty US troop withdrawal from Iraq, or fashion protectionist legislation aimed at Beijing... To read the rest of this article, click on the link below: http://www.sirchartsalot.com/article.php?id=95 Sep 25, 2008 321gold Ltd |
