Government Panic Could Herald Dollar Panic

One of the few things more troubling for an economy than government intervention is government intervention driven by panic. Time and again, history has shown that when governments rush to engineer solutions to pressing problems, unintended difficulties arise.

In the current crisis, there is growing evidence that Washington is in a state of increasing panic. Despite its massive cash injections, market manipulations and ‘rescue’ plans, the recession is clearly deepening and spreading. With little to show thus far, politicians don’t know if they should redouble past efforts, break ground on new initiatives, or both. However all agree, unfortunately, that the consequences of doing too little far outweigh the consequences of doing too much.

Although there are many parallels between the current crisis and the Crash of 1929, one key difference is the global profile of the U.S. dollar. In 1929, the dollar was on the rise, and would soon eclipse the British Pound Sterling as the world’s ‘reserve’ currency. Furthermore, the American economy was fundamentally so strong that in 1934 America was the only major nation able to maintain a currency tied to gold.

Ever since, the U.S. dollar’s privileged ‘reserve’ status has been a principal factor in America’s continued prosperity. The dollar’s unassailable position has enabled successive American governments to disguise the vast depletion of America’s wealth and to successfully increase U.S. Treasury debt to where the published debt now accounts for some 100 percent of GDP. The total of U.S. Government debt, including IOU’s and unfunded programs, now stands at a staggering $50 trillion, or five times GDP! If the dollar were just another currency, this never would have been possible.

In today’s crisis however, the dollar is likely making its last star turn as the leading man in the global financial drama. Other stronger, less burdened currencies are waiting in the wings for the old gent to take his final bows.

The dollar’s demise is being catalyzed by the neglect of the Federal Government. Instead of enacting policies that would restructure the U.S. economy, and restore productive, non-inflationary wealth creation, Congress is simply financing the old crumbling edifice.

Faced with the growing realization that America is not doing the work necessary to right its economic ship, it will not be long before America’s primary creditors begin to seriously question the nation’s ability to service, let alone repay, its debts.

There is now the prospect (inconceivable until recently), that America could lose its prestigious ‘triple-A’ credit rating. In today’s risk adverse market, this could cost the Treasury one percent in interest on long bonds. Each additional percentage point of interest would cost America some $10 billion a year on each trillion dollars of new debt, or some $300 billion over the life of a 30-year bond.

Many of the foreign governments who hold huge amounts of U.S. dollar Treasury debt, such as China and Japan, have announced plans to spend money on their own ailing economies. Should these foreign central banks divert to domestic initiatives some of the funds used to buy U.S. Treasuries, serious upward pressure on U.S. interest rates will result. Should they actually sell parts or all of their holdings they will likely put serious downward pressure on the U.S. dollar. Last week, a Chinese official claimed the U.S. dollar should be phased out as the world’s ‘reserve’ currency.

In the short term, as dollar ‘carry-trades’ continue to be unwound and questions of political will and falling interest rates haunt the Euro and some other currencies, the U.S. dollar may be the recipient of some upward appreciation. But with the American Government appearing increasingly to be in panic mode, a run on the U.S. dollar could develop rapidly into cascading devaluation. Even if no such panic run materializes the long-term outlook for the U.S. dollar is one of high risk and low return. This beckons major upward pressure on precious metals.

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9 Responses to "Government Panic Could Herald Dollar Panic"

  1. Guest   January 8, 2009 at 8:46 am

    “Other stronger, less burdened currencies are waiting in the wings for the old gent to take his final bows.”Do you care to elaborate which currencies do you have in mind that will overtake the US dollar? Euro? Yen? Or gold? Or some Peter Schiff funny money?

  2. Anonymous   January 8, 2009 at 11:58 am

    First, the Swiss franc is a relatively well managed currency compared to the dollar. Regrettably, however, Switzerland is too small to provide a worldwide reserve currency.Second, with Germany still mostly in control, the Euro is currently well managed, but because of the demands of Club Med devaluators, that may not continue. Germans and Austrians know about hyperinflation from their first hand experience with it, back in the 1921-23 period, and don’t want it again. But, then, of course, there are the Italians, Greeks, Spanish, Portuguese, Maltese, Cypriots, and the French. They want the Euro printed heavily, and devalued, to beggar their neighbors, and stimulate their economies.Finally, there is gold. It is the ultimate currency and is still waiting in the wing, having been thrown out of its position as the world’s exchange currency for a mere 34 years. Aside from constant manipulation at COMEX and at the London Bullion Market, gold is the best managed currency, because God is the central banker. Humans still cannot print it!

    • Anonymous   January 8, 2009 at 12:10 pm

      but humans can mine it.

  3. g Anton   January 8, 2009 at 4:27 pm

    A crash of the dollar would hurt foreign central banks holding obscene amounts of dollar financial assets as much (and in some cases more) then it would the United States. In other words, countries holding large amounts of US assets (like China and Russia) are selling as much and as fast as they safely can, but they are selling with restaint and in special circumstances to avoid an extensive world-wide rush to market of US dollar assets (which would probably make US assets practically worthless and result in the crash of the US dollar). Given the fragile condition of the world economy, a crash of the US dollar would not be in the best interests of any country right now.

  4. farnorth5   January 8, 2009 at 7:34 pm

    Further to the g Anton comment:It is true that a “crashed “U.S.Dollar is in no one,s interest but it is easy to see China/Japan/Mid East Royals not buying ADDITIONAL DOLLARS (The New Trillion Dollar Defecits).With the age of Computers/Internet everyone has access to the same information.FAST RESULTS IN 2009 !!!! Who knows we may see up front and personal the 2009 CRASH of the existing archaic World Money System .Bring on BRETTON WOODS #3 …

  5. ram chandar   January 8, 2009 at 9:47 pm

    why is dollar the reserve currency? why can’t i pay for oil or commodities in euro or yen?

  6. Guest   January 8, 2009 at 10:14 pm

    Sorry, this distinguished politician and investment banker doesn’t know what he is talking about. He talks about macro issues without having ever studied macroeconomics. And arrogantly criticizes the consensus among serious economists (the risk is doing too little) when this consensus is being already proven riught. this is the same kind of “expert” that plagued the media and financial institutions in the boom years. By the way, the American prosperity was not based on the dollar as a reseve currency, seigneurage was a relatively small thing all during these decades

    • ram chandar   January 9, 2009 at 2:18 am

      now, this is not a good way to refute someone’s editorial. you are just blabbing along your way without providing facts.

  7. RudyG   January 9, 2009 at 7:07 am

    Given the scale of the 21st century’s global market, is the supply of gold still large enough to act as the international reserve? In this new era of devaluation, why wouldn’t silver–much more plentiful–be a more viable instrument?