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A brief note on the US Dollar. Is this like August 1914?

8 November 2007

I strongly recommend attention to the US dollar, as it breaks down to multi decade lows — or record lows — vs. almost every other currency (except the Zimbabwe dollar).

It is almost impossible to exaggerate the seriousness of this situation. For Americans “currency crisis” and “currency flight” are things that happen to other, lesser nations. But our history as a well-managed nation, a tradition established by Alexander Hamilton in the difficult days following the US revolution, ended long ago. We have become the world’s greatest debtor — both in terms of annual borrowing (approx. 6% of our national income) and accumulated debts.

We have with no plans, perhaps no intention, of paying back the debt. That shows a moral weakness. For good reason Adam Smith wrote “A Theory of Moral Sentiments” before “Wealth of Nations.” Our behavior has been and is irresponsible, and now the bills are coming due.

We’ve been warned repeatedly over the past two decades. By both US and international agencies. By the major ratings agencies. By many of the global investment banks. By sages like Warren Buffett. By former high officials like Richard Rubin. By academics at our major universities. Perhaps the clearest analysis was by Paul Kennedy in his 1987 book The Rise and Fall of Great Powers.

It’s not knowable how this will play out. The factors are not just economic — what will private foreign holders of US debt do — but political. What will our creditors — Asian central banks and the oil exporting nations — do as irresistible forces push the dollar down?

An analysis of this is beyond the scope of a blog. There are many fine reports on the web. Here is one thought. In an age of nukes and 4GW, conventional war between major powers is unlikely — perhaps obsolete. But political stresses remain a fact of life and must be expressed. Perhaps money has replaced bullets as the new form of combat. WWII was as much a war between competing economies as between armies. Modern financial systems allow us to eliminate bombs as the intermediate step, for pure economic warfare.

If so, then the current situation looks much like Summer 1914. The situation is unstable on many levels. Massive accumulated tensions, waiting for the weak link to snap. It could be anything, something trivial.

Please share your comments by posting below (brief and relevant, please), or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

For more information about this subject

  1. A brief note on the US Dollar. Is this like August 1914?  (8 November 2007) — How the current situation is as unstable financially as was Europe geopolitically in early 1914.
  2. The post-WWII geopolitical regime is dying. Chapter One   (21 November 2007) — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
  3. We have been warned. Death of the post-WWII geopolitical regime, Chapter II  (28 November 2007) — A long list of the warnings we have ignored, from individual experts and major financial institutions (links included).
  4. Death of the post-WWII geopolitical regime, III – death by debt  (8 January 2008) – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
  5. Geopolitical implications of the current economic downturn  (24 January 2008) – How will this recession end?  With re-balancing of the global economy, so that the US goods and services are again competitive.  No more trade deficit, and we can pay out debts.
  6. A happy ending to the current economic recession (12 February 2008) – The political actions which might end this downturn, and their long-term implications.
  7. What will America look like after this recession?  (18 March 208)  — More forecasts.  The recession might change so many things, from the distribution of wealth within the US to the ranking of global powers.
  8. The most important story in this week’s newspapers   (22 May 2008) — How solvent is the US government? They report the facts to us every year.

To see the all posts on this subject, go to the archive for The End of the Post-WWII Geopolitical Regime.

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9 Comments leave one →
  1. nweaver permalink
    8 November 2007 5:10 pm

    A very critical issue, but it actually is within scope of several blogs, which should be in people’s RSS readers if they want to track this issue in gory detail:

    Noreil Roubini and Brad Setzer have covered a lot of these issues

    http://www.rgemonitor.com/blog/roubini/

    http://www.rgemonitor.com/blog/setser/

    (Note that Roubini is very VERY bearish, Setzer a bit less so, but both are widely regarded experts in currency collapses, currency manipulations, etc)

    Felix Salmon is another source

    http://www.felixsalmon.com/

    although he’s a bit broader these days. If you want finance, sign up fro the finance only RSS feed.

    One thing which is really interesting is that so much of the collapse could be exaggerated should the Chinese choose to stop stabilizing the RMB vs the dollar, and instead let it float. Never get in a position where the people you declare are your enemies are able to say “We’re reposessing…”

    One for the 4GW theorists however, is is it possible to ENGINEER a crisis? That is, if we are waiting for a “Wile E Coyote” momement in some market, what would it take to precipitate a crisis in that market?

    Also, the one other curency to add to the list of “not trouncing the dollar”, the swiss franc:

    (credit to Cactus at Angry Bear)

    Like

  2. dalurch permalink
    8 November 2007 10:24 pm

    Has anyone out there read David Hackett Fischer, The Great Wave: Price Revolutions and the Rhythm of History (Oxford UP, 1996)? He warned us that increasingly wild, irrational market fluctuations will signal the end of a long cycle of protracted inflation, to be followed by a resounding crash. Reviewers sneered ten years ago, but today he sounds like Elijah.

    Like

  3. fabiusmaximus2000 permalink*
    9 November 2007 1:23 am

    I have not Fischer’s book, but in both finance and engineering it’s a truism that systems stress to edges of their operating envelope tend to fluctuate wildly. A major danger signal.

    Nweaver: Obviously I believe a blog can comment on this issue, as I just did so. Both Prof Roubini and (especially) Brad Setser (Council on Foreign Relations) comment about currency dynamics on their blogs, but their serious analysis is done in long papers. Brad’s blognotes mostly relate current news and others’ analysis to the well-developed view of his papers. (Nouriel’s work these days mostly concerns the US economy.) The subject is too complex for brief treatment. I agree that both blogs are essential reading for anyone closely following the US and global economy.

    The idea that China would “stop stabilizing the RMB/USD” is, in my opinion, very unlikely. To exaggerate, it is not likely that the head of the People’s Bank of China (PBOC) will push the red button on his desk and destabilize the global economy. Central banks are among the most reactive, incrementalist, and conservative institutions humanity has ever devised. More likely private bond investors will flee the US dollar, unhappy with poor returns and worried about more losses in the future. Currency flight will put the Central Banks that are supporting the USD in a painful spot. I doubt they will want to finance other folks’ flight from a currency that they’re supporting.

    Like

  4. nweaver permalink
    9 November 2007 1:41 pm

    Yet Another Comment on the situation.

    Is the United States headed for double bubble trouble?“, Richard Baldwin, VOX, 2 October 2007

    The anatomy of dollar depreciation“, Giancarlo Corsetti, Vox, 6 November 2007

    For those willing to try to internally translate a high-level economics discussion to English. Although still blog postings, the base articles are cited for those who want the hardcore Econ analysis.

    Fabius Maximus replies: Both are excellent articles, well worth reading!

    Like

  5. maximilliangc permalink
    18 November 2007 9:28 pm

    “waiting for the weak link to snap.” “It could be anything, something trivial.”

    Yeah,, something, “anything.” “Oil leaders’ private debate televised by mistake“, The Observer (18 November 2007) — Excerpt:

    “They said Opec should formally express its concern about the weakness of the dollar when the cartel makes its official declaration at the close of the summit today. But the Saudis, the world’s largest oil producers and de facto head of Opec, vetoed the proposal. Saud al-Faisal, the Saudi foreign minister, warned that even the mere mention to journalists of the fact that leaders were discussing the weak dollar would cause the US currency to plummet.”

    “Unfortunately his words and those of everyone at the meeting were being broadcast via a live television feed to a group of astonished reporters. ‘I couldn’t believe it,’ said one who was there. ‘When I realised they didn’t know they were being broadcast live, I frantically started taking notes.'” MaXimillian

    Fabius Maximus replies: Why should this surprise anyone? It is a revelation of the blindingly obvious. That is, this barely qualifies as news.

    Like

  6. oldskeptic permalink
    28 February 2008 7:55 am

    Note that Greenspan (yes that Greenspan) just ‘advised’ some Middle East oil countries to decouple their currencies from the US dollar! Great he continues his life’s successful work to destroy the dollar.
    There need be no conspiracy or ‘evil’ plans for Saudia Arabia/China, et al, to remove their US$ life suport system. Their economies are coming under incredible inflationary pressures and they will HAVE to decouple and float in the near future, just to save themselves.

    It will happen when the pain of losses, from the loss of value of their US assets, is overshadowed by the pain of inflation (and the riots in the street from rising food prices). When? This year maybe, next year at the latest. You could argue (like some have) that they should have done this far sooner (e.g. Henry Liu in Asia Times).

    “Our behavior has been and is irresponsible, and now the bills are coming due.” True, but a bit harsh on the ordinary people who have (or will soon) lost their jobs. They have had no say in the post Bretton Woods economic system developed since the 80’s (TINA and all that), those who argued against were ignored or lost their careers or even jailed. I would rephrase it as “their (as in the elites) behaviour ….”.

    Also it is a bit hard to condemn ordinary people when the entire financial system has been geared to increasing their debt, with all those wonderful marketing tricks. And Govts jumping on the bandwagon. Haven’t heard a single politician saying, “hold back”, or taking a single action to stop this nonsense. Or any Reserve Bank in the world reining it in at any point. Nope, not when there was so much money to be made. Politicians regularly parachuting into very highly paying jobs in the financial industry is just the same as Generals jumping into defence companies and we all know what that achieves.

    I have to laugh (bitterly) at watching the banks, etc, lining up for Govt handouts (ie our tax money, which is a bit rich because they never paid any tax – “thats for the small people”). And spending tens (or hundreds of millions) campaigning for decades on tax reductions, privitisation, deregulation, ‘globalisation’, right wing think tanks, pliable politicians, et al.

    The US dollar is dead, but it is not going to be, as it should have been, an orderly (and quite logical and very beneficial to the US as well) transition. It will be an unholy mess, with very unexpected and probably very unpleasant fallout. Not 1914, more early 1929 I think. We have 1939 to look forward to (if we stay stupid).

    Fabius Maximus replies: Complaining about collective responsibility is like complaining about death. Yes, it is unfair. So what? Take notes; give them to God after you die. Nobody down here can do anything about either.

    The point of a democracy — or democratic republic, if you wish to be technical — is that it tells people that they are responsible for the outcomes of their society, for which they will enjoy/suffer anyway. It encourages them to take responsibility for their fate, and incents them to get involved in their government. Vote, walk precincts, riot — whatever.

    If we do not rule ourselves then someone will rule us. Those are the only two choices.

    If you do not like it, then add that to your list. Mine is very, very long. None of these things are at the top.

    Like

  7. Stephan permalink
    4 June 2008 9:39 pm

    I don’t understand the apocalypsic tone of these posts on this site… OK. There is a credit problem and the US-Government itself is in great debt. The same has happened and happend again in history; French revolutionist government had to handle awful inflation in the changing years, when it invented the paper-money. The UK had also inflation in the 20’s of last century just as Germany twice (23 and after WWII), Italy normally has an all-time inflation; and all these countries still exist and they do not far too bad.

    So what’s your problem; you have to prepare for some hard years but after this your right back.
    Hope my post was not to hard to read, I’m not an native speaker. Greets

    Fabius Maximus replies: I do not understand your point. Nobody here forecasts the apocalypse, in the sense of the end of life itself. Does this mean that anything else is trivial, not worth avoiding? Do you cross the street without looking — after all, the worst likely outcome is losing a few limbs and massive scars? Life will go on!

    The French Revolution was a horror show, leaving scars on France for many generations afterwards. The UK economy of the 1920’s was terrible, whose imbalance lead to the even worse 1930’s — far worse for the UK than Scandinavia or Germany. The Weimer inflation of 1923 destroyed the foundations of that regime, paving the way for Hitler.

    These nations still exist, but does that mean we should willfully court the pain of those past generations. After all Hitler was not so bad — Europe survived! The tens of millions who died would have died eventually anyway.

    Like

  8. bhenderson permalink
    26 June 2008 5:26 pm

    It has been theorized through a decade or more of research that switching the US from the current Federal income tax based revenue system to a retail sales tax (AKA the “Fair Tax”)system would make the US the world’s largest tax haven. The result would include the repatriation of off shore accounts as well as open the door to foreign investors looking for a safe & tax free home. We could refinance our nation’s debt at greatly reduced interest rates and increase federal tax collections from foreign tourists whose spending currently contributes little to the federal coffers.

    Your comments, please
    .
    .
    Fabius Maximus replies: (1) This is outside the scope of both this site and my expertise. Here are a few comments, however, for whatever they are worth.

    (2) A fair tax is unlikely to happen, in my opinion. Like massive military reform — “what if we abolished the Army?” — it is too hypothetical for my taste.

    (3) There is research suggesting that the upper limit for a sales tax is aprox 10%, after which avoidance increases to levels forcing breakdown of the system. Which is why nations with high consumption taxes use VAT (value added taxes). Either slow, phased-in implementation or extensive small scale testing would be necessary to prove feasibility. Saying “tough enforcement” would suffice is like “tough enforcement” of gun controls — which have proved ineffectual (or worse) in the UK and Australia.

    Like

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