Dollar Doom Loop

The American dollar is in the midst of a large fall in its value, or depreciation, as measured against other major currencies. The decline has been steady since 2002 and our currency is down about 35 percent from that peak. After strengthening slightly more than 10 percent during the global financial crisis of the past 18 months, the dollar is again falling back toward its pre-crisis lows, representing its weakest international value since 1967.

But there is a definite possibility that the dollar could soon decline further or faster.

At the level of general economic strategy, the American government has responded to a financial sector crisis with an expansionary fiscal policy, and the Federal Reserve is implementing loose monetary policy. Andrew Haldane, responsible for financial stability at the Bank of England, puts it this way:

“For the authorities, [excessive risk-taking by the financial sector] poses a dilemma. Ex-ante, they may well say “never again.” But the ex-post costs of crisis mean such a statement lacks credibility. Knowing this, the rational response by market participants is to double their bets. This adds to the cost of future crises. And the larger these costs, the lower the credibility of “never again” announcements. This is a doom loop.” (link to the paper)

In addition to a financial crisis, we also have a large current account deficit, meaning that we buy more from the world than we sell. The deficit was $100 billion in the latest available (second quarter) data, which is around 3 percent of gross domestic product, and we finance that with capital inflows from abroad. (The current account deficit is down from around 6 percent, but two-thirds of the decline is due to the lower price of oil).

In the past, many of those inflows have been private investments of various kinds, but as investors around the world question whether United States government debt, and its dollars, are really worth the paper, it is increasingly difficult for us to finance our deficit with the outside world.

What does this mean for the dollar?

Treasury Secretary Timothy F. Geithner continues to repeat that a strong dollar is “very important” for the American economy, but United States fiscal and monetary policy pushes toward depreciation. To bail out our banks, we need cheap money, and this implies some inflation. To finance our current account deficit, investors need to think they are buying inexpensive assets from us. Everything points to a cheaper dollar. (The same thing is happening in Britain, but the Bank of England is increasingly explicit about this point and the unsavory broader situation.)

A “hard landing” scenario for the dollar could be painful.

The 1980s classic, Stephen Marris’s “Deficits and the Dollar: The World Economy at Risk,” stresses that a rapidly falling dollar would push up United States inflation, resulting in higher interest rates and a deep recession (pp. lx-lxi). Writing in the latest edition of Foreign Affairs, Fred Bergsten emphasizes that such outcomes are still possible today. A weakening dollar will cause inflation fears, so yields on long-term government bonds will rise to compensate investors for inflation, and we will need to pay more and more to finance our large debts.

The idea that the American dollar might follow emerging markets such as Russia in 1998 and Argentina in 2002, or Britain in the 1970s — and so depreciate by 50 percent or more in a relatively short time — is certainly implausible now. But such a “doom scenario” is not unrealistic in the future without change.

In this context, the American government needs to control its budget deficit to keep this adjustment on track, and to stop confidence in the dollar from falling further. Our government collects far too little in taxes for what it spends. There is no choice but to raise taxes soon and rein in spending.

Short-term rates (controlled by the Fed) will stay low, while long-term rates (market-determined and affected by trust in our Treasury and Fed to keep the value of dollar strong) will rise as people fear their dollar investments will be debased. There is no doubt that both the Fed and the Bank of England know what is happening. The spread between short- and long-term rates (known as the “yield curve”) will rise, and banks will benefit; would-be home buyers and people with overdrafts or outstanding credit card balances pay more, while savers get little.

This is how the public pays for the past losses of our financial system.

We don’t have to do this again and again. We could start by changing our financial system from the roots. We need to credibly remove the promise to bail out our large banks each time they fail. This means forcing them to hold more capital, dividing them up so they are smaller, and then letting them fail when they make poor gambles.

The Treasury’s past and current close connections to Goldman Sachs, Citigroup and other major investment banks illustrate how our own doom machine functions. We need to break up these “banks” so they are small enough to fail, and also ensure that no bank, regardless of its connections, is able to demand that the Fed and the Treasury support its solvency in the future to prevent financial collapse.

In this context, a weakening dollar helps the administration to put an unstable financial system back on its feet — and to crank up our “doom machine.”

By Peter Boone and Simon Johnson

This is a slightly modified version of a post that appeared this morning on the NYT Economix blog; it appears here with permission.  If you wish to reproduce the entire post, please contact the New York Times.

53 thoughts on “Dollar Doom Loop

  1. The Fed/Treasury wants to reduce debt levels through inflation, which can only be a longer term goal. Thus a weakening dollar is guaranteed for many years to come in this scenario.

    Fed Governor Mishkin was praising some types of bubbles the other day — presumably, the “good bubbles” are the kind the Fed is blowing right now.

    On the other hand, the Fed must tighten & unwind at some point to ensure we don’t become Argentina in 2002.

    These goals are mutually contradictory. It is a myth that there is a correctly timed exit strategy for the Fed. Once again, we are forced to trust the Central Bank, which has shown its incompetence and non-accountability in the past, and is demonstrating that once again.

    The claim that it is bank solvency that this policy is designed to foster is most likely correct, but as you say, it will do little for household solvency as purchasing power declines for the only people in the world who must use dollars — Americans.

  2. “The idea that the American dollar might follow emerging markets such as Russia in 1998 and Argentina in 2002, or Britain in the 1970s — and so depreciate by 50 percent or more in a relatively short time — is certainly implausible now. But such a “doom scenario” is not unrealistic in the future without change.”

    Implausible? No! It is NOT implausible. We take in 2 trillion and spend 4 trillion a year. Our interest on debt is 3/4’s of a trillion. We can NOT finance our debt any longer and are using Quantitative Easing “printing” to cover the massive gap.

    “In this context, the American government needs to control its budget deficit to keep this adjustment on track, and to stop confidence in the dollar from falling further. Our government collects far too little in taxes for what it spends. There is no choice but to raise taxes soon and rein in spending.”

    In this context the author is totally out of touch with the reality and that reality is WE ARE INSOLVENT. 12 trillion in federal debt 60 trillion in unfunded liabilities (Social Security, Medicare Parts A & D, add in two wars, 11 trillion in TALP, TARP, PPIP and more, add in that we are on the hook for at least another 11 trillion. Folks, when you have 100 trillion in debt, when you spend twice what you take in a year and when you can’t borrow that 2x difference the GIG IS UP.

  3. From a behavioral perspective, the will to change course often requires a crisis. If last year’s crisis wasn’t sufficient impetus, perhaps a $ crash will do the trick.

    As best I can tell, policy seems to be aimed at letting the financial sector lead the real sector to growth- a policy which, in my view, is betting on a broken transmission mechanism (and one which never worked well when it was operational).

    If current policy can’t get the real sector moving, unemployment stays high, and the fiscal deficit expands (I have some graphs on my blog if you haven’t looked at the deficit and receipts vs. payrolls). Each bond auction then becomes a potential crisis point.

    I think predicting crashes is a tough game, but I won’t be surprised at all if the $ does an imitation of a “banana republic” currency.

  4. It’s a beautiful poem with honest words, but why do you always show it to your other beau before me?? He must be a dandy boy.

  5. We all know at this point that our banking system is being used as an unregulated bonus-seeking mechanism for bankers, now underwritten by taxpayers with $23.7 trillion worth of national wealth.

    Bankers lent pretend money to home buyers to award themselves actual money in bonuses — making home prices balloon and, in the process, bankrupting America’s treasury, currency, the states, and many of its citizens.

  6. There’s a lot of nonsense in this post. The crashing dollar is not caused by trade deficits or by irresponsible government spending. It is caused by speculation enabled by the Fed. Money flows not trade flows are the tail wagging the dog. What keeps the Treasury bond market afloat? Does a 4% 30 year bond yield suggest a dollar crash? How do you get US inflation with industrial capacity below 70% and unemployment approaching 20%?

    What we will get instead is repeated asset bubbles like the one now taking place in the stock market. What we have is a world of funny money which provides the only game in town. We have id iots in the Congress writing 1136 page financial reform bills giving closed door discretionary enabling to our casino economy, which continues conducting business as usual. There is no possible basis for confidence in the dollar. The dollar is merely a unit of account for trading purposes. Investors can own this or that or the other thing, but the values change minute by minute and the leverage is colossal and one party’s gain is another’s loss.

    There is no ‘solution’ to this problem; there is only a question: will the country’s so called leaders respond to ANY of the problems experienced by real people whose efforts keep the country going by bringing in the food and taking out the trash? So far, the evidence suggests that they prefer writing nonsense like this to justify their continued privileged positions. Apres lui le deluge!

  7. Karl at Market Ticker has a chart today that shows the value of the stock market over that last few months as almost an exact mirror image of the dollar, meaning the lower dollar is driving somehow the stock market higher.

    This is the kind of chart that should cause just a few questions in the mind of any sane person about the role the Fed has been playing these past few months since the crash.

  8. I’m off topic here, but I think it’s important for the readers of this blog to be aware of what is going on with the draft legislation for finance/bank reform. Chris Dodd seems to be taking his responsibilities much more seriously than Barney Frank. You can read about it in the NYT story by Stephen Labaton.

  9. Really what the Fed should have been doing all along, but especially now, is accumulating as much foreign currencey reserves as possible, printing dollars and buying other currencies.

    This allows them to build the reserves at the expense of the Chinese, who have to take the dollars off the market and will give them the reserves to manage the dollar’s decline if/when the Chinese revalue/float.

  10. PRI’s “Marketplace” had this same topic last night, saying that the only reason why every president and treasury secretary says that a high value dollar is important is “inertia”, and they aren’t really sure what saying otherwise would do to the value of the dollar in the shorterm. They made the same claim that the fed policy is directly contradictory to a strong dollar.

    These sort of stories on Baseline always unsettle me.

  11. Here! Here! And, you reference but a few of the major challenges and realities. Add to your analysis the 10.2 %/17.5% unemployment that is projected to worsen, and not correct for years. Add the fact that the entire middle class in the U.S. has been effectively and literally bankrupted, and have nothing, at best. Add the fact that 33% of all U.S. homes are underwater (a primary store of middle class wealth). Add 401K, 529, Investment, Savings, Cash for the middle class being vaporized. Add the fact that the U.S. pays at least double what any other western civilized country pays for healthcare, that doesn’t even cover 1/6 of its population, yet has refused to enact meaningful reform, or even attempt to limit the obscene profits of big pharma and big insurance…….etc…..etc…..etc…..

    The U.S. is insolvent. And, it is insolvent with a massive unemployment rate. No savings. Huge expenses including two never ending wars. Precipitously falling revenues. And, no viable means of reversing it. It will not be a pleasant landing from my vantage point.

  12. Spoken like a true IMF man: tight fiscal policy, tigthen up monetary policy.

    I agree that the financial sector needs fundamental reform but this is not an emerging market and raising taxes and cutting spending now would be like adding fuel to a brush fire.

    This isn’t a run of the mill emerging market financial crisis. This is a crisis every bit similar to the Great Depression and Japan. The policy response should be clear enough.

  13. Paul,
    I think that’s a great post/link you gave. It brings a very interesting question I think, and a question I wonder how many policy makers such as Larry Summers ever think about: Could MILD deflation actually be good for an economy long-term?? By that I mean NOT long-term deflation is good, but a relatively short period of deflation could be good, looking from a long-term view of the economy. It sounds insane, but I don’t think it hurts to ponder.

  14. a rapidly falling dollar would push up United States inflation, resulting in higher interest rates and a deep recession (pp. lx-lxi). Writing in the latest edition of Foreign Affairs, Fred Bergsten emphasizes that such outcomes are still possible today. A weakening dollar will cause inflation fears, so yields on long-term government bonds will rise to compensate investors for inflation, and we will need to pay more and more to finance our large debts.

    Why do you think this? Even if inflation passed through one for one to interest rates, there is still teh stock of existing government debt that would be devalued by inflation. So even if the cost of financing current deficits rose, the real cost of debt service would certainly rise as a result of inflation. And of course this would be an even bigger boon to firms and households than to the federal government.

    But historically, inflation in the US is *not* passed through one for one to interest rates. The simple correlation coefficient between the annual change in the CPI and the real rate on long-term treasuries is around -0.5, i.e. only about half of changes in inflation are reflected in long rates. (That’s why the 1970s was the only sustained period of negative long rates in postwar history.) So if historical patterns hold, higher inflation would make financing new debt cheaper as well.

    There are serious arguments that a higher inflation rate would be a very good thing for the US right now. There are also arguments that it would be a bad thing — but higher cost of government borrowing is not one of them.

  15. The dollar has been over valued for decades. A crash in the value may be hard, but a gradual decline would be good for us. They say that the dollar is the world’s reserve currency. What that really means is that central banks of other countries have been buying dollars to prop it up against their currencies. That is good for their economies, but it results in lost jobs, lost manufacturing capacity and lost wealth for America The artificailly strong dollar has been a disater for us.

  16. Look at Japan, at their out of control budget deficits especially. If that caused inflation, they’d have it. They have had to engage in more and more deficit spending to keep above deflation.

    Deflation is our threat here.

  17. Lebaton’s story might as well be a Dodd press release. Dodd’s bill doesn’t regulate OTC derivates; it gives his cloakroom agency the power to write wholesale exemptions from regulation. There is not one mandatory derivatives constraint in the entire bill. The only thing Dodd takes seriously is his hairdoo and the contributors who line his pockets.

    What exactly does this bill do that will correct anything of importance?

  18. This piece doesn’t say one word about OTC derivatives. Apparently, he doesn’t think them important.

    The fact that Dodd’s bill mentions things like hedge funds and swaps and derivatives doesn’t mean it does anything about them. What it does is give a bunch of clowns like the ones running things now a blank check to do whatever they want to do on an ad hoc basis. This is not regulation; it is capitulation.

  19. @Lark:

    Inflation is really the expansion of the money supply, making the value of each dollar worth less. Japan was NOT the largest debtor country mired with over 100 trillion of debt and off balance sheet liabilities – we are.

    You might re-look at this, IMO you are comparing oranges to watermelons.

  20. Japan was NOT the largest debtor country

    Japan’s debt-to-GDP ratio is about 200. Second highest in the OECD is Italy, at 125 or so. The US is less than 100. So, um, yes it is.

  21. The problem with Barney Frank (who should wear a helmet given his mental abilities) is he can’t differentiate between green weeds and green counterfeit and he is allowing Ben the counterfeiter to continue while legalizing weed.


    The Constitution lists 2 crimes by name: Counterfeiting and treason. Bernake hides behind the FR act of 1913 but what he is doing is in stark contrast to our constitution. But when the head of the House Banking committee is this s tupid what can we expect?

    Dodds is another “should be helmet wearing m*r*n” creating 4 branches of government to create money is just another form of counterfeiter.

    About the only thing Greenspan got right was this “In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value.”

  22. Fiat currency value has two components, quantity and quality. Quantity means nothing if there is not enough trust in the currency.

  23. @Hillbilly Daryl:

    Super, super points. I take exception to just one, U3 and U6 is really at 22%. I rely on Shadow Statistics since the BLS uses the Bith Death Model which lags 12 months on economic data and uses the seasonal adjustment and a host of other bogus data to finesse statistics. Another useless governmental waste of our tax dollars, which we work from January until September for.

  24. The USA is in dire financial and consequent economic position that only Simon Johnson and a small enlightened group of others realize and understand. The rest of USA will only wakeup,too late, once the objective economic conditions become too painful to accept and mindlessly politicize the situation to their detriment. Dems and GOP have the same world view since they have all been captured by capitalist oligarchs.

  25. For goodness sakes! It’s all the fault of the central bank that Glass-Steagell was repealed, right? It was the fault of the Fed that the attorney general elected not to pursue anti-trust violations against the banks, right? It was the fault of the central bank that the SEC and other administrative arms of the government were put on such a tight leash by assorted administrations that they couldn’t and wouldn’t do their job, right?

    On the other hand, I’ll not defend either Greenspan, an Ayn Rand worshipper (hence a fool), or Bernanke who was too quick by far, in my view, to hand the big banks the keys to the vault.

  26. On a long term time frame I pretty much agree with this article, but as Jake Chase mentions above, where do we find any of this in the markets? If everyone is imminently worried about a dollar crash or large devaluation shouldn’t Treasury rates reflect that worry? I hardly think the yield curve suggests anything of the sort for the immediate future. Bid to cover ratios on the ongoing piles of debt we are issuing are averaging something like 2.5, which is a long way from a failed auction or even a large interest rate dislocation. Sure India buying the IMF’s gold recently and other various and sundry stories on the margins show that countries are slowly moving towards slight diversification, but there are so many current deflationary versus inflationary crosswinds that trying to predict anything on either side of the argument for the next year or two seems like pure guesswork to me.

    For my money, it seems most of the dollar re-deflation from March til now is just moving back out the risk curve to emerging markets, in other words a carry trade on the dollar. However, since the yield curve has barely moved in all that time (some volatility but mostly holding now where it was then) and indirect bidders on Treasuries are averaging 44% for 2009, I don’t see where there is evidence yet that foreign central banks actually care much beyond grumbling and complaining that the dollar is sinking and the yields on Treasuries are low. They know they are losing money, but they are caught in the same global trap we are, just on the other side of the trade. Rebalancing will only come through events forcing our hand through pain and suffering, not from measured and rational choices. Our political and economic worlds aren’t set up for long term thinking.

  27. I guess US very well understands that it is in a TINA (There Is No Alternative) position.. China does not want it’s currency to appreciate.. If it’s currency becomes equal to 1USD, then US firms will start moving back the manufacturing jobs to US! and China does not want that to happen.. China’s domestic demand cannot replace the US consumer power.. So as long as this position continues, the game will go on! If USD depreciates a lot (which I don’e foresee in the near future), it will lead to worldwide chaos and probably few military clashes also, which will be beneficial to major military supplier countries.. As long as US maintains it’s military superiority, no one may question it’s economic blunders.. I guess DC (and may be even the wall street) understands it much better than us..

  28. My Summary Highlights of The Bank of England Speech:

    The evolution of the banking and financial system has been accompanied by a growing support system from the public sector to the point where “Today, perhaps the biggest risk to the sovereign (state) comes from the banks.”

    There is a downside to product diversification by banks. The sensitivity of a bank’s portfolio to individual asset risk is reduced; however, this comes at the expense of increasing portfolio systematic risk. “ By increasing the similarity of banks’ asset portfolios, it increases the (financial) system’s sensitivity to aggregate (economic) fluctuations.” It “increases the risk of adversity being socialised and prosperity privatised.” Breaking up big banks into smaller specializesd (less diversified) units may reduce the overall risk of the financial system. The recent experience of hedge funds may provide some guidance. “Hedge funds started this crisis in the doghouse. Yet they are the dog that has not barked. Their industrial structure may explain why. Unlike banking, the hedge fund sector does not comprise a small number of large players, but
    rather a large number of relatively small players. The largest hedge funds typically have assets under management of less than $40bn, the largest banks
    assets in excess of $3 trillion. Unlike banking, concentration in the hedge fund sector is low and has been falling. The top 5 hedge funds comprise around 8% of total assets, down from 30% a decade ago (Chart 10). Unlike banking, the business models of hedge funds are typically specialised rather than diversified. And unlike banking, entry and exit rates from the hedge fund industry are both high. The annual
    average attrition rate for hedge funds is around 5%. At present, it is around double that. Among US banks, the average attrition rate over the past few
    decades has been less than 0.1%; it has not come close to hitting 5% at any point since the Great Depression. It may be coincidence that the structure of the hedge fund sector emerged in the absence of state regulation and state support. It may be coincidence that the majority of hedge funds operate as partnerships with unlimited liability. It may be coincidence that, despite their moniker of “highly-leveraged institutions”, most hedge funds today operate with leverage less than a tenth that of the largest global banks. Or perhaps it might be that the structure of this sector delivered greater systemic robustness than could be achieved through prudential regulation. If so, that is an important lesson for other parts of the financial system.”

    Banks “game the state”, and exploit the state safety net. “State support stokes future risk-taking incentives, as owners of banks adapt their strategies to maximise expected profits. So it was in the run-up to the present crisis, “ when banks adopted riskier strategies through a combination of increased leverage, proprietary trading, and by increasing the riskiness of their asset pool. The riskier strategies result in higher payoffs in good times and deep losses in bad times, “ often cushioned by the state.”

  29. Is the US a financially / economically well run country that can deal with its problems?

    It’s hard to think so from the recent history of fostering bubbles, proping up banks and looters, and its near inability to correct a seriously dysfunctional medical / insurance system – even when successfull models for the latter can be found in most of the industrialized nations.

    And not a lot seems to have changed since the change of regime in January. There’s an old adage about big oil tankers being slow to turn around – maybe a foundering oil tanker can’t turn around.

  30. Didn’t japan have a lot of foreigners *owing* them money?

    Didn’t Japan have a large friend willing to help them behind the scenes?

  31. “As long as US maintains it’s military superiority, no one may question it’s economic blunders.”

    Continued loss of manufacturing erodes the capability to maintain military superiority. Reduced manufacturing means a reduced domestic supply chain, including less young talent entering the technical and scientific workforce, leading to less innovation. How clearly is this understood by our “leadership” aka “Ivy League geniuses”.

  32. Debt to GDP? How about Debt to GDP and Unfunded Liabilities?

    GDP………….14 trillion baked 30% with imputations & Hedonics
    Debt…………12 trillion
    Social Security.18 trillion
    Medicare A……37 trillion
    Medicare B……37 trillion
    Medicare D……16 trillion
    TARP/TALP/PPIP..11-22 trillion
    2 Wars………. 2 trillion

    We owe $144,000,000,000,000.00 (trillion) and we earn 14,000,000,000,000.00 (trillion.) Debt-to-GDP less than 100%.

    Ha, funny! By my math we owe 1,028% more than we earn. And, oh by the way, I’m not backing out Clinton/Boskin Hedonics (Greek for “feels good” or weighting or imputations or the bogus deflater). Let me explain this more clearly: You own a house? Yes? They BEA figures you’d pay 3,000 a month in rent (just a guess as I don’t know your region) and then they add that 3,000 to GDP.

  33. Sooner or later Joe Sixpack might start to see it that way. If and when he does, your handle will suddenly be quite relevant.

  34. From the large banks perspective, having a larger portfolio actually reduces their own risks. The banks may infact increase their reserves to further derisk, which could potentially undo the fiscal expansion. So, the better scenario for the government would be to tax the banks and get back the money spent on bailouts.

  35. Swap this.

    Be practical.

    The following is a fictitious scenario full of exaggeration to make a point.

    Example : Here’s the deal. I’m the Fed. And I’m going to buy this blog.

    I’ll offer you 10 trillion US dollars for this blog.

    You think about if for a while, weigh the pros and cons, impact your options and finally decide to say “ok”.

    Now, here is the sum total of all of the work I need to do to take ownership of this blog : I need to type $10,000,000,000,000 into my computer and hit send to bloggy.

    If the dollar crashes tomorrow, so what? I own this blog and the biggest army in the world (with thousands of military bases around the world) which I can use to resolve ownership disputes.

    In other words, the faster I can type money, the faster I can buy the world. It leads to a crash – but – it makes the American Dream of the common citizen finally come true.

    The crash of the USD destabilises the US; martial law is declared; MSM plus *perfect* Internet surveillance; and dependency on centralised water and food production allow perfect population control. And the only job in town is working for the military/police/security teams. A total lock-down.

    Which means : Peace, security, full employment, no trouble-makers can budge an inch (literally) and military glory. The American dream finally comes true. Law and Order to the highest degree. Like Goldman’s HFT trading record : absolute perfection.

    Now, about the dollar carry trade : do you think anybody actually plans on paying back a penny of that money? Do you think : There will be a race to unwind the carry trade OR everybody is now planning on defaulting?

    How can you enforce your loans when the entire world is defaulting on debt issued in USD at the same time – including the USA?

    Not one single US economic policy decision made any sense. Find me one person who thinks that the Obamarama economic team is making sense? They aren’t stupid. But their policies sure are – if you want the US to continue to be a free nation?

    I would suggest : the USD is long past the devaluation phase? It seems to have become a global race to see how much bogus money can be traded for hard assets before the Big Default and littering is finally punished with lethal injections?

    There is no way that the swaps and derivatives can be closed out in an orderly fashion? So, print like crazy, build up your military and enjoy the show?

    And all this coming from a person who feels that there is actually a simple, quick and practical solution to the US economic problems.

    Oh well, just thinking out loud here…

    May all beneficial wishes come true in beneficial ways!


  36. It is wrong to assume the solvency of banks can be assured by maintaining the current yield curve. Assuming an annual deficit of $2tr all funded by banks’ purchase of US treasuries in the next 5 years, the net interest margin is at most 3%, that means income of $30b per year. Based on IMF figures, US banks still need to write off at least another $300b of toxic assets related to mortgages and about $200b related to CRE. And we are not including credit cards losses and leveraged buyouts and other unknown unknowns. There is still a hole of over $300b even after 5 years. After these next 5 years, all this pretending mark-to-fiction accounting becomes the only way forward, assuming the market still buys this “bs” and China have not found use for any additional foreign reserves into domestic spending (like funding the humongous holes of losses of their own banks from the current credit binge) . It is inevitable that the day of reckoning for the whole financial system would come sooner than later, that US debt rating would be downgraded, and the last resort is a US default.

  37. Just a part of the catastrophe being caused to the American economy by the vast fellatio being given to the financial sector by our government. The oligarchs are alive and well for the moment, but then…… Whee, it’s over the edge for all of us!!

    I can’t wait to hear what Sheila Bair has to say. She’s one of the few in Washington who is actually doing a bang up job. Such a shame that what she does has an essentially small effect on things.

    I think that his may put us on the brink of the new exchange currency gaining traction globally. Next year should be an amazing roller coaster ride, with states failing, foreclosures heading upward, and joblessness getting worse. Wonder where the Fed will find props for our poor dollar?

  38. I credit you as inventor of the world’s first financial “perpetual motion machine”. Nonsense!

  39. Japan has proven that deficit spending does not cure deflation, Weimar Germany and Zimbawe too has proven that. Printing leads only to a deeper hole, why are we still trying it?

    Just because we did not try that during the Great Depression doesn’t mean it will work. Just because Bernanke’s career is based on hypothetical printing as the solution to the Great Depression doesn’t make it true. Numerous economists with sounder mathematical background like Steve Keen has pointed out the faults in bernanke’s helicopter theory. Just because bernake ignores them doesn’t make Japan and Zimbawe’s experiences irrelevant to us.

    In Mathematics there is a method of generalization call proof by induction. Bernanke and the likes of Krugman and Keynes, obviously weak at Mathematics, cannot understand proof by induction. Yet we trust them with the printing press and our future generations, that is how absurd America is. Train more lawyers, train more economists and accountants, import engineers from India – failure of our education system.

  40. This post ignores some important factors in the equation:

    – What about the fact that a declining dollar will make US exports cheaper and thereby increase US exports?

    – What about the fact that we have a huge reserve of unemployed people, and a huge reserve of empty manufacturing space waiting to be mobilized in response to growth in US exports?

    – What about the fact that most recent research on the subject of the pass-through effect between exchange rates and inflation has found a very weak link, and so it is unclear whether a decline in the USD will cause a significant surge in inflation. Look at history of the Yen/USD; why haven’t previous substantial devaluations of the USD caused massive inflation?

    – What about the fact that China is refusing to let the USD devalue against the RMB?

    – What about the fact that our economy is at over 10% unemployment even with crazy low interest rates, suggesting a lot of weakness, and making a serious effort to balance the Federal budget now will almost certainly trigger another recession?

  41. On the competitive international market, American workers aren’t worth what they want to be paid.

    Lower US wages and devaluation of the USD act to correct that.

  42. Good point.

    I use the price of an engineer to evaluate currencies. Engineers are mobile and socially “sticky”.

    In other words, engineers are mobile (like capital) but you can’t speculate in engineers because the transaction costs (moving them, working them into an organization) is too high. They will only move to a different country if the target economy has developed a significant productivity delta.

    Second – engineers are people. They value more than money. If an economy offers a good social environment for them (by birth ie family, nice surroundings, etc) then they will factor this into their economic equation automatically.

    Put it all together and you have a good measure of the value of a currency?

    Just thinking about it : this might be a good theme for a blog post here? The cost of an industrial engineer in various countries (including benefits if possible)? The new Big Mac index?

    Namke von Federlein

  43. “It “increases the risk of adversity being socialised and prosperity privatised.”

    This is a serious and ongoing problem, as Garrett Hardin pointed out many years ago. Because of the economic and political power of the elites, who benefit from it, it is difficult to combat. Unfortunately, change often comes through crisis and catastrophe. Yet in the current crisis the justified anger of the public has been directed at a few individuals or channeled towards the government.

  44. A key aspect of the Fed’s QE program to buy MBS is to cap long yields.

    Keeping yields on long MBS serves as a cap on the long bond.

    If the Fed stick to their word and stop purchasing MBS, or worse, start unwinding their MBS in an open market, long yields will rocket, with predictable effects on inflation.

    The only bright spot is that lending might actually increase, since banks would have to put some reserves to work.

    The downside is rising yields might lead to further selling and a bond meltdown, perhaps wiping out US banks who are sitting on billions of QE-propped up paper.

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