Dollar Danger

Earthside Comments: The new Congress taking office today and the new president taking office in a couple of weeks are already demonstrating that they cannot lead.

It doesn't take a lot of courage or vision to propose spending massive amounts of money to solve problems, especially if it is money borrowed from the future to be repaid after the politicians' terms of office expire. Indeed, Obama, the Dimocrats and the now-cowed Republicans are turning "spending like a drunken sailor" into a moral imperative!

Real leadership would be to at least make a down payment on an annual trillion dollar plus deficit with some cuts in military spending and increased taxes on unearned income. But Obama and the new Dimocrats are too eager to shift money to their campaign contributors, and the establishment bond dealers and lenders ... while at the same time 'cleverly' funding "infrastructure" improvements.

But, just wait until those monthly federal deficit numbers start coming in later this year. The 'Obama rally' will come to a screeching stop in a busted dollar and spiraling inflation.

Indeed, the precursors of this calamity may already be in the works.

Willem Buiter Warns of Massive Dollar Collapse | London Telegraph

The long-held assumption that US assets - particularly government bonds - are a safe haven will soon be overturned as investors lose their patience with the world's biggest economy, according to Willem Buiter.

Professor Buiter, a former Monetary Policy Committee member who is now at the London School of Economics, said this increasing disenchantment would result in an exodus of foreign cash from the US.

The warning comes despite the dollar having strengthened significantly against other major currencies, including sterling and the euro, after hitting historic lows last year. It will reignite fears about the currency's prospects, as well as sparking fears about the sustainability of President-Elect Barack Obama's mooted plans for a Keynesian-style increase in public spending to pull the US out of recession.

Writing on his blog, Prof Buiter said: "There will, before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury bills and bonds are still viewed as a safe haven by many. But learning takes place.

He said that the dollar had been kept elevated in recent years by what some called "dark matter" or "American alpha" - an assumption that the US could earn more on its overseas investments than foreign investors could make on their American assets. However, this notion had been gradually dismantled in recent years, before being dealt a fatal blow by the current financial crisis, he said

"The past eight years of imperial overstretch, hubris and domestic and international abuse of power on the part of the Bush administration has left the US materially weakened financially, economically, politically and morally," he said. "Even the most hard-nosed, Guantanamo Bay-indifferent potential foreign investor in the US must recognise that its financial system has collapsed.

He said investors would, rightly, suspect that the US would have to generate major inflation to whittle away its debt and this dollar collapse means that the US has less leeway for major spending plans than politicians realise.

Investors Dump $89 Billion in U.S. Securities in Historic Fire Sale | USA Today

The deep river of private money that helped knit together the global economy has abruptly dried up, new government figures show.

As the global financial crisis grew more severe this summer, foreigners sold almost $90 billion of U.S. securities — the greatest quarterly fire sale by overseas investors since the government began keeping track in 1960. U.S. investors also are retrenching; they unloaded about $85 billion worth of foreign holdings in the quarter, says the Commerce Department's Bureau of Economic Analysis.

"We've had a global panic. Everyone is pulling their money home," says economist Adam Posen of the Peterson Institute in Washington, D.C.

That's bad for economic growth in the U.S. because it threatens to starve capital-hungry companies and entrepreneurs. But it's especially serious for emerging-market countries that rely heavily on outside financing. Capital flows into countries such as South Korea, Turkey and Brazil were evaporating even before the mid-September Lehman Bros. bankruptcy made things worse.

The reversal of private capital flows signals an abrupt end to a nearly two-decades-long era of financial globalization, says economist Brad Setser of the Council on Foreign Relations. Private flows into and out of the U.S. for purchases of stocks, corporate bonds and federal agency bonds have dropped from around 18% of economic output to near zero "in a remarkably short period of time," Setser says.

The past five quarters — roughly since the August 2007 onset of the financial crisis — private foreign investors have been net sellers of U.S. securities. The turnabout represents a dramatic change from the first half of 2007 when foreign purchases of U.S. securities other than Treasuries averaged about $250 billion per quarter.

The past two quarters also have seen an about-face in cross-border bank flows as institutional investors found lenders unwilling to extend credit. In the first quarter of 2008, foreigners deposited more than $79 billion with U.S. banks. That flow reversed in the second quarter, as foreigners withdrew a staggering $256 billion, and the outflow continued in the third quarter with an additional $147 billion. Likewise, banks in the U.S. brought home more than $151 billion in the quarter, as overseas institutions repaid loans.

"Institutional investors, including banks, across the board are pulling their capital back home," says economist Eswar Prasad of the Brookings Institution.

One bright spot: Foreign central banks continue to spend heavily on U.S. government securities, allowing the U.S. to finance the gap between what it produces and consumes.

Ten Major Threats Facing The Dollar in 2009 | Eric deCarbonnel/MarketSkeptics.com

... The federal government is facing a record breaking budget deficit in 2009. According to the latest government figures, the deficit currently is expected to be $438 billion. For a reliable idea of what our 2009 deficit will look like, to this number we need to:

A) Add the cost of funding the on-going wars in Iraq and Afghanistan B) Add the cost of recent programs such as the TARP D) Add the cost of another stimulus package E) Add the cost of the programs promised to us by the new administration

After subtracting a further 500 billion for lost tax revenues due to our collapsing economy, it is easy to project a budget deficit of at least 2 trillion. So far, the deficit now totals $401.6 billion in just the first two months of this budget year, and, at this annual rate, the budget shortfall is already on track to exceed our expected number. All this isn't even taking into consideration our long term funding shortfall vis-a-vis baby boomers (the future of social security and Medicare is, unfortunately, clear: I would not expect it to be there when you retire (at least not anything like it is today)).

Our 2009 budget deficits will force the government to sell at least another 2 trillion treasuries this year. Taken together with planed sales by foreign central banks and the expected 1 trillion new bailouts mentioned above, at least 4 trillion treasuries will be sold in 2009. The question remains: who is going to buy them? The answer is that the fed will buy them with printed the money.