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Thread: If the US Dollar Plummets

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    Default If the US Dollar Plummets

    http://www.cfr.org/publication/19164
    If the U.S. Dollar Plummets

    CPA Contingency Planning Memorandum No. 1

    Author: Brad W. Setser, Fellow for Geoeconomics
    Publisher: Council on Foreign Relations Press

    Release Date: April 2009

    10 pages


    DOWNLOAD THE FULL TEXT OF THE MEMORANDUM HERE (432K PDF)
    http://www.cfr.org/content/publicati...encymemo_1.pdf
    "Overview
    The scale of financing needed to support the U.S. fiscal deficit—together with the Federal Reserve’s policy of keeping U.S. interest rates low to ward off deflation—has revived concerns about a sudden and sharp depreciation of the U.S. dollar. This Center for Preventive Action Contingency Planning Memorandum by Brad W. Setser examines potential triggers and indicators of such a crisis and posits concrete policy options to limit U.S. vulnerability to the possibility of a plummeting dollar. It argues that the obvious long-term response to the risk of a dollar crisis is to limit buildup of the United States’ external debt, and recommends that larger reserves—and well-understood mechanisms for borrowing foreign exchange reserves from major foreign central banks—would help to reduce the United States’ vulnerability to such a crisis.

    The Center for Preventive Action (CPA) Contingency Roundtable series seeks to organize focused discussions on plausible short to medium term contingencies that could seriously threaten U.S. interests. Contingency meeting topics range from specific states or regions of concern to more thematic issues and draw on the expertise of government and nongovernment experts. The goal of the meeting series is not only to raise awareness among U.S. government officials and the expert community of potential crises but also to generate practical policy options to lessen the likelihood of the contingency and to reduce the negative consequences should it occur. A summary memo of the resulting recommendations is distributed to participants and important policymakers."

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    Default Re: If the US Dollar Plummets

    Several comments ...

    The Council on Foreign Relations has been uncannily accurate in regard to 'predicting' major and significant changes ( like for example $100 a barrel oil prices) , and the actual events occurring in rapid succession. Conspiracy theorists speculate that the CFR is not actually 'predicting' anything, but that they actually have the de-facto capacity to make such events happen after they reach a consensus that they should happen ...




    The CFR is certainly not alone in their prediction. A number of analysts have been pointing out that the US is for the first time employing 'quantitative easing', which is nothing more than a bookkeeping scheme which allows a government to 'borrow money from themselves'. However, the additional dollars that are being 'borrowed from themselves' are freshly printed !




    As long as the USA remains heavily in debt to other nations, it is those other nations and not the USA who truly control the future fate of the US dollar. Along those lines, both Russia and China are actively taking measures which would permanently trash the US's dollar's traditional role as THE currency of international trade / commodity pricing.




    If the US dollar does lose it's status as the world's 'reserve currency', the US will also lose the de-facto profits that have traditionally been derived from seignorage. In essence, this means that the US gov't has traditionally gained $0.98 worth of purchasing power for every newly printed dollar (which actually costs 2 cents to print up). However, the concept can only apply if the worldwide demand for that particular currency is at least equal to the amount of additional currency that is being printed - something which has traditionally been the case for the US dollar - but which is now rapidly changing.




    Without a doubt, since Obama's election the number of 'international US dollars' have been increasing at a record pace ...




    Without 'seignor' currency status, printing up one additional dollar creates zero additional purchasing power - because international lenders / trading partners realize the 'dilution' effect and merely reduce the former purchasing power of pre-existing US dollars proportionately to maintain a constant purchasing power total. This of course translates into what Americans have called 'price inflation', where every internationally traded commodity, good, or service quickly increases in terms of its US dollar denominated price.

    Also, once international loss of US dollar purchasing power is recognized by international lenders, the interest rate they demand for future loans ( = future US treasury bond sales in addition to private sector lending ) will be increased in an attempt to offset the US dollar's declining purchasing power relative to the Euros or Yen or Yuan or Rubles that the international lenders 'keep their books' with. In other words, they are reluctant to loan 100 billion yen today in the form of 1 billion US dollars when the future 1.1 billion dollars they will be paid back only convert back into 90 billion yen !

    Based on the 'slope' of the international currency expansion graph above, it's reasonable to deduce that a 20% annual devaluation of US dollar purchasing power, and 21% US dollar interest rates, could quickly manifest themselves if international lenders stop co-operating with the US FED's money printing scheme. This has happened in the past i.e. Jimmy Carter's 'stagflation'. However at that time, it was also possible for some percentage of US workers to successfully demand pay raises in order to offset the loss of purchasing power, higher prices, and higher interest rates they were experiencing - because at that time the US total supply of domestic consumer goods still consisted of more than 50% US 'content'.

    Arguably, today, with much wider US dependence on foreign imports from everything from automotive to durable goods to food, the ability for US workers to successfully demand pay raises is out of the question (at least that is the case for non-gov't job US workers in non gov't subsidized US industries). Attempting to do so will simply result in their US jobs being outsourced or their US employer going bankrupt. As a result, US workers should start thinking in terms of experiencing a 20% annual decline in their de-facto standard of living for the next couple of years at least ... since this is the period of time in which the US is already 'committed' to spend trillions of additional stimulus / bailout dollars which don't yet exist, which can't be obtained via increased tax revenues, and which can't be easily borrowed from increasingly reluctant foreign lenders.

    Cumulatively speaking, 2 solid years worth of 20% loss in US dollar purchasing power would result in a 44% reduction in the de-facto US standard of living with all else being equal. However, the US gov't insures that all else will NOT be equal since it has umpteen social welfare benefit programs which insure that 'poor' Americans are maintained at a gov't determined 'minimum acceptable standard of living'. Thus it's reasonably safe to assume that 'poor' Americans will not see their standard of living decline much. It is also reasonable to assume that 'rich' Americans will also avoid any significant decline in their standard of living, since they have the expertise and wherewithal at their disposal to invest in currencies / commodities / stocks & bonds that are denominated in some currency other than the US dollar. Thus the segment of the US population which is likely to experience the brunt of the coming decline in cumulative US standard of living will be the 'middle class'.

    ~
    Last edited by Melonie; 05-25-2009 at 02:30 PM.

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    Default Re: If the US Dollar Plummets

    the basic concept involved is 'financial equilibrium' ... which can only be avoided for relatively short periods of time.



    (snip)"The bottom line is that the attempt to save bank bondholders from losses – to provide monetary compensation without economic production – is not sound economic policy but is instead a grand monetary experiment that has never been tried in the developed world except in Germany circa 1921. This policy can only have one of two effects: either it will crowd out over $1 trillion of gross domestic investment that would otherwise have occurred if the appropriate losses had been wiped off the ledger (instead of making bank bondholders whole), or it will result in a stunning and durable increase in the quantity of base money, which will ultimately be accompanied not by a year or two of 5-6% inflation, but most probably by a near-doubling of the U.S. price level over the next decade. As I've noted previously, the growth rate of government spending is better correlated with subsequent inflation than even growth in money supply itself, particularly at 4-year intervals. Regardless of near-term deflation pressures from a continued mortgage crisis, our present course is consistent with double digit inflation once any incipient recovery emerges.

    As Nobel economist Joseph Stiglitz recently noted, the bureaucrats that designed this bailout are “either in the pocket of the banks or they're incompetent. It's a real redistribution and a tax on all American savers. This is a strategy trying to recreate the bubble. That's not likely to provide a long-run solution. It's a solution that says let's kick the can down the road a little bit. They haven't thought enough about the determinants of the flow of credit and lending.”

    Not that anyone is listening, unfortunately.

    The second fact is that as a result of more than a trillion dollars of new issuance of Treasury securities with relatively short durations, it is a tautology that there is a mountain of what is mistakenly viewed as “cash on the sidelines” invested in these securities. This mountain of “sideline cash” exists and must continue to exist as long as these additional government securities remain outstanding. It is an error to view outstanding debt securities as if they are “liquidity” poised to “flow back into the stock market.” The faith in that myth may very well spur some speculation in stocks, but it is a belief that is utterly detached from reality. The mountain of outstanding money market securities is the result of government debt issuance that must be held by somebody until those securities are retired. It is not spendable “liquidity” – it is a pile of IOUs printed up as evidence of money that has already been squandered. The analysts and financial news reporters who observe this enormous swamp of short-term money market securities, and talk about “cash on the sidelines” as if it is spendable in aggregate immediately reveal themselves to be unaware of the concept of equilibrium and of the nature of secondary markets (where there must be a buyer for every security sold, and a seller for every security bought). "(snip)

    (snip)"Since the subject of this comment is equilibrium, a few notes about the savings-investment identity are appropriate.

    Let's begin with several basic premises (actually accounting definitions)

    Income that is not consumed represents “savings.”

    Output that is not consumed represents “investment,” even if it is unintentional “inventory investment.”

    GDP can be defined as the total value of income or, equivalently, as the total value of output. These numbers are the same (aside from a purely statistical discrepancy). The total income in the economy is either consumed or it ends up financing “investment.” The total output of the economy is either consumed or it represents “investment.”

    Given these facts, total savings – by definition – are equal to total investment. In any economy, money flows from savers to investors will have occurred in a manner that makes this savings-investment identity true. If the money did not flow, then either the income was not earned, or the production and consumption did not happen. Whatever happens in the economy, and however it happens, we can be certain that when we add it all up at the end, total savings will have been equal to total investment. This is not a theory. It is algebra. It is an accounting identity.

    When people think of saving as something that depresses the economy, they are thinking of the Keynesian setup, where Keynes specifically and explicitly assumed that investment was constant. In that sort of setup, it is impossible for the economy as a whole to save more, since by definition, holding investment constant must also hold total savings constant. So the attempt to save a greater amount must fail. Let total savings S be equal to some percentage “s” of total income Y. Then S = sY. In Keynes' setup, the attempt to save a greater proportion of income as savings must result in a reduction in total income Y (or GDP). For example, suppose that total savings are $10 and GDP is $100, so that s = 10%. If you try to boost up s to 20% of income, but you're restraining total savings to $10, then GDP must fall to $50 (that is, $10 = 20% of $50).

    At present, it is not valid to say that the economy is weak because people are saving too much, because if gross savings were up, gross investment would also be up. One might say that the economy is weak because people are unsuccessfully attempting to save more, but it is far more accurate to say that the economy is weak because gross investment is collapsing despite a greater willingness of individuals to save. If we don't get those distinctions right, we'll end up with policies aimed at discouraging savings, which by their very nature will end up discouraging investment and will make the economy suffer interminably. Growth-oriented policies encourage new investment, and require an economy with the capacity to save in order to finance that investment. As long as we have a set of economic policies aimed at running massive government deficits at the same time individuals are encouraged not to save, we will risk driving this economy into the ground for a very, very long time. "(snip)

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