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Months or years from now, when analysts are studying the death of the U.S. dollar, they'll look back and see that the greenback's demise began on a specific day - Wednesday, April 27, 2011.
As in ... tomorrow.
At 12:15 p.m. tomorrow, at the conclusion of a two-day Federal Open Market Committee (FOMC) meeting, we'll find out whether U.S. Federal Reserve Chairman Ben S. Bernanke and his policymaking posse opted for a sharp increase in U.S. interest rates - which appears to me to be the only solution to a looming third-quarter crunch.
Unfortunately, I don't think that Bernanke & Co. will make the needed move.
And without that sharp rate increase tomorrow, investors can look forward to rampant inflation, an evisceration of the U.S. Treasury bond market and - in a worst-case scenario - the death of the dollar.
Let me show you why....
It's Time to Worry About the Death of the Dollar
For the last two years, the U.S. economy has been supported by the twin catalysts of fiscal and monetary stimuli.
Fiscal stimulus seems likely to continue for some time yet - even the most avid Tea Party budget cutters don't see their way to cutting more than $100 billion or so off this year's $1.6 trillion deficit.
But monetary stimulus is another matter.
The Fed's so-called "QE2" (quantitative easing/second round) purchases of U.S. Treasury bonds are supposed to come to a sharp end on June 30. That makes July a crucial month - for the American economy, for the country's bond markets and, most of all, for the performance of the dollar.
These crucial monetary-policy issues will be reviewed at the two-day policymaking FOMC meeting that begins today (Tuesday) and concludes tomorrow. Policymakers are expected to leave the benchmark Federal Funds target rate in its current range of 0.00% to 0.25%.
If Bernanke wants to devise a "QE3" to follow his QE2, he needs to do it now: The next FOMC meeting is in late June, which is far too close to the expiration of QE2.
The decision as to whether to end quantitative easing - or to extend it - will be a tough one, made no easier by the fact that there is a substantial-and-growing group in the FOMC that did not like QE2 and that will strongly resist a QE3.
This "anti-easing" contingent has a strong case - and its arguments will be bolstered by figures that show inflation taking off.
Bernanke can resist these arguments for a time - either by focusing on "core" inflation, which excludes food and energy, or by looking at the "Personal Consumption Expenditures" (PCE) deflator, which is reported a couple of months in arrears. However, even with only one additional set of data from the present, he may find it difficult to argue that inflation is no longer a problem - in which case QE3 will be impossible to launch.
And without QE3, the U.S. Treasury bond market will be in real trouble.
The Looming Third-Quarter "Crunch"
Since QE2 began in November, the Fed has been buying about two-thirds of the Treasury bonds issued - or about $600 billion of the $900 billion in total bonds to be issued between November and June.
April is a particularly favorable month for the government: Because of individual and corporate-tax payments, the net issuance this month may be around zero. July through September, on the other hand, will be big months for T-bond issuance - at least $150 billion per month is needed.
It could be a tricky time, however. Credit-rating heavyweight Standard & Poor's has threatened to cut the United States' top-tier credit rating: But Japan, the world's second-largest buyer of U.S. Treasuries, isn't likely to be in the market much at that time, as it will need the money for its own reconstruction program.
Hence, expect to see a third-quarter crunch in the American Treasury market. The crunch will be made worse by the acceleration in inflation that is likely to occur between now and then: If inflation is running at, say, 0.50% per month - the equivalent of 6% per annum - by the summer, a 10-year Treasury bond yield of 3.5% will look untenable.
And so will a Federal Funds rate that remains close to zero.
The bond market won't be the only one to experience pain. The crunch we're predicting will also put a serious hurting on the currency market - specifically on the U.S. dollar.
If the U.S. government is trying to raise money that the markets don't want to give it, the U.S. dollar will decline on international exchanges, because of the continuing U.S. balance-of-payments deficit.
Thus, a third-quarter Treasury bond crisis is likely to go hand-in-hand with a third-quarter dollar crisis, as markets start to treat the United States as they would the European "PIIGS" (Portugal, Ireland, Italy, Greece and Spain). Despite their struggles, most of those countries have sounder budget policies than this one, and all of them have sounder monetary policy, thanks to the European Central Bank (ECB).
Simply extending QE2, as Bernanke almost certainly wants, won't solve this problem. The Fed would then be buying both too much debt and not enough.
You see, Treasury bond purchases of $75 billion a month would be enough to push inflation sharply upwards: This is, after all, the very same policy that gave the German Weimar Republic its trillion-percent inflation. (See the accompanying graphic: "A Grim Reminder.")
On the other hand, even if the Fed buys $75 billion of Treasuries a month, the summer months will bring with them the need to place an additional $75 billion worth of bonds every month. And with inflation rapidly accelerating, the chances of a bond market and dollar crisis would still be great.
The One Way to Avoid the Death of the Dollar
With the U.S. market straining under the burden of rising inflation and some ill-advised monetary and fiscal moves, the death of the dollar is looming as a worst-case - but still possible - scenario.
The Fed has one chance to avoid this outcome.
But it has to act tomorrow.
Just to have a chance of staying level with inflation. U.S. central bank policymakers must boost short-term interest rates at least to the 3% level. That would burst the global commodities bubble, and reduce inflationary pressures.
With that accomplished, the Fed could then - if Bernanke & Co. wished - continue with a "modified QE3." For instance, perhaps it could buy $50 billion of bonds in the third quarter and $25 billion in the fourth quarter, thus breaking the Treasury bond market off its "Fed-bond-purchase fix," instead of making the market quit "cold turkey."
With inflationary pressure reduced by the interest-rate increase, the chances of a Treasury-bond-market meltdown would thus be reduced to almost zero. Interest rates would rise and bond prices would decline, but in an orderly manner. And inflation, if it continued, would do so at a more-moderate pace.
In fact, even inflation - should it remain stronger-than-desired - could be moderated, simply by raising rates a bit more, perhaps in several increments.
And the U.S. dollar would be saved.
There's only one problem with this scenario: I don't think it will happen. Bernanke won't boost rates. And we'll be back here sometime in the future, writing the epitaph for the death of the dollar.
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News and Related Story Links:
- Money Morning Commentary:
Inflation Fears: A Sanguine Fed is Underestimating the Escalating Threat - Money Morning News Archive:
News Stories About QE3. - Federal Open Market Committee:
2011 Meetings Calendar. - Wikipedia:
European PIGS (PIIGS). - The Wall Street Journal:
Bernanke To Field Questions For About 45 Minutes Wednesday. - Wikipedia: The Tea Party.
- European Central Bank:
Official Website. - Money Morning News Archive:
Quantitative Easing News Stories. - Investopedia:
Personal Consumption Expenditures. - Money Morning "Question of the Week" Feature:
Does the United States Still Deserve its "AAA" Credit Rating? - Money Morning News Analysis:
Rate Hikes by Foreign Central Banks Could End the Party for U.S. Investors
What will happen to gold and silver prices if the Death of the dollar happens???
Dear Martin! It looks very strange that Bernanke and Co. dreaming only for killing dollar. They are not a samurai and there is not any reason for him to kill themselves.
This quote is WILDLY inaccurate: " . . . even the most avid Tea Party budget cutters don't see their way to cutting more than $100 billion or so off this year's $1.6 trillion deficit."
Many Tea Party advocates would cut $1 trillion/year from the budget, effective almost immediately. Even a cursory reading of Tea Party papers, speeches, and budget positions demonstrates this.
Couldn't agree with you more Martin… Just remember Ben and Co. don't give two hoots about Mr. Public USA, whom I'm sure Ben and the Fed Owners consider as " slaves" to the privately owned Fed Reserve… Ben probably can't understand why the few Mr. Public USA's who know his fiscal policies were so doomed from the start, despise him so much. He should be on "America's Most Wanted" for the crimes he has committed against every single US Citizen. (Including the one's not yet born), that will have to pay for his ridiculous 'economics'.
Mr. Bernanke will be doing right, by keeping the rate low, if that is his plan.
He remembers what happened the last time he raised rates to combat inflation. It was the wrong move to take when all of the inflation was due to high-energy cost and speculation, such as the case is today. Runaway speculation is driving inflation and only when the consumer revolts like they did before will inflation go lower.
The economy is just months from going to pot. That's how long the current "Federal Tax-Return" stimulus will last. Had it not been for the tax return checks starting to get in the hands of the people that spend their money in America, we would already be in the fast lane for another crash.
There are still too many people that have ARM's, that are barely hanging on to their over priced mortgages. Had Mr. Bernanke been in touch with reality in 2007, and had not raised rates so aggressively, we would not have seen the catastrophe economic plunge that we endured.
I was hoping that Mr. Bernanke would get the FED’s top job due to the experience of seeing the results of raising the prime rate when it was not an appropriate move. Other Candidates for the FED's top position did not have his experience and are now too hawkish on raising the prime interest rate.
High-energy cost is the biggest problem in America today. It is sucking to much expendable income out of the economy. The economy flourished while President Clinton was in office due to cheap energy.
America has the resources to remain a Great Nation, but the speculators and the Oil industry is putting a burden on all Americans.
Fed member Plosser and John Hussman point out that the Fed faces a much bigger crisis than whether to continue QEII or not. Specifically the monetary cash base is much larger than at any time in our history relative to GDP. In other words the likelihood for those now content to hold cash, or get paid nothing for short-term notes, could reverse virtually overnight given an exogenous interest rate shock.
Just an increase of 0.25 % in short-term yields would dictate that the Fed reverse ALL of QEII on its balance sheet or risk runaway inflation as current "cash holders" search for higher yield. Fed member Yellen says this isn't an issue because the Fed has a new tool in which they can pay interest on excess reserves thus keeping that cash from entering the system at large.
Good luck with that.
Dear reader,… 2 years ago I did write from this same hotel room in China where I am writing now that not the EURO(still far from healthy) but by far the USD is the weakest one of the 2 ,… and that the money printing of the USA is second best behind Zimbabwe. The USA is near being brook,… only a few US citizens and not a handful of bankers and people in the US politics do realize this.
Reading the article of Martin Hutchinson I must say he is on the right track,….but there is so much wrong in the US economy that it might be too late and too little. ….. and then I read the vision of Lawrence Reno (just a reader like I am), and I must say he does not understand the mechanism of monotary politics and is just advising to continue on this fatal way,… he is already in the fast lane for another crash, a way bigger crash.
With all respect I hope I am wrong,… but I fear I am not, harmen de bondt
@Lawrence Reno — Japan held rates near ZERO for years, but without dealing with underlying problems … it left them 'stranded' for 20 years. We are now doing the EXACT SAME FAILED TACTIC. The article is correct, now is the time for Bernanke to start dealing with excess liquidity … Companies are lean, strong and watching for sensible policies … consumers and those on fixed incomes NEED inflation to stay DOWN. We've been through this before, and it's horrible … commodity prices will stabilize WHEN they stop stabbing the U.S. dollar to death, bleeding out till it dies. STOP PRINTING MONEY, RAISE INTEREST RATES TO INTERNATIONALLY COMPETITIVE LEVELS, GIVE THE CHINESE A REASON TO KEEP BUYING TREASURYS. DO IT NOW BEFORE THE LOOSE MONEY SPIRALS OUT OF CONTROL, SLASH FEDERAL SPENDING … NOW, NOW, NOW, NOW, NOW! @Lawrence does NOT understand that the Gub-Ment IS THE PROBLEM, NOT THE SOLUTION. Go get an education in reality.
David
I believe gold will hit $3400 to the ounce and silver will shoot to near the $240 mark near 2011 years end.
Gold hit about $1550 and silver $27 at the end of 2011.
Paper money can be conclude fail as a business medium for present world economy situation.
We must back to our traditional concept that use GOLD and SILVER as a business medium.
Pls study the history of ROM, US, Syria, Europe etc.
Thank you.
Publius is right on. Rand Paul has repeatedly called for much bigger cuts…and he's serious about it.
Mr. H, you don't need to join the sneering anti-Tea Party crowd. The Palin types may be clueless and weak-kneed, but the libertarian element is serious…just not big enough to make any real difference. Why? Because people believe they deserve something for nothing and they vote for the miscreants who promise them same.
@harmen de bondt, In reading your response to my writing, I failed to register the "being brook", and "monotary politics" you wrote of. Is this some new Chinese lingo?
I hope you and @Alistair Sinclair noticed the markets and Jim Cramer, liked Mr. Bernanke’s non-move. I feel vindicated with so much confidence shown to my way of thinking.
I believe Mr. Bernanke and the whole financial top decision makers team are deliberately pushing USD down. In order to avoid the counter attack from major economic players (eg. China) they need to do this (lowering the USD) in a very nice game, in which they seem to be extremely trying to fight the inflation!
Reading all above article and the comments, I think they have been successful on selling the act.
US needs to empower its economy and production base. they need global markets at hand. with a strong Dollar, the market will remain at the hands of "lower-priced-producers".
This process "WILL" have some serious impacts on some Americans, but I think it is the necessary "Strategy" (not a Tactic) to follow.
There is no solution to our debt problem. That time has passed long ago. What those that expect a rise in interest rates to accomplish are wrong! Consider: every 1% rise in interest rates will add $140 billion to the national debt. The three percent rise proposed will cost $420 per year. With that figure understood by the major purchasers of our debt, an early sell off of our bonds could result in a panic selling crises in both the dollar and bonds. The game Bernanke is playing is one of, trust what I tell you. By now he realizes that his game plan has failed. What is left for him is to keep the economy and confidence from crashing. They used to call it "jawboning." He has to continue, by any and all means, to take the unwanted bonds off the market. This to keep the free market from raising rates beyond his target.
Protect yourselves…
figure understood by the major purchasers of our debt, an early sell off of our bonds could result in a panic selling crises in both the dollar and bonds. The game Bernanke is playing is one of, trust what I tell you. By now he realizes that his game plan has failed. What is left for him is to keep the economy and confidence from crashing. They used to call it "jawboning." He has to continue, by any and all means, to take the unwanted bonds off the market. This to keep the free market from raising rates beyond his target.
Protect yourselves.
I guess everyone forgot that we don't make anything to trade on the world markets. Maybe China would like to buy a good tv or washing machine that will last 25 years! We cannot have a disposable ecomomy any more. Yes…lots of people here in the US are making a ton of money selling foreign goods. At some point there won't be any jobs left here and no money to buy the cheap foreign crap.
Yes the Fed will keep the rates low to fuel the stock market and speculation in the commodities market. You can't make a dime investing your money unless you are a broker. .7% at the bank or even less for a savings account. Legalize prostitution or tax porno!
Stop fooling yourselves… This is no greenback, it's the dollar. The greenback was taken from us years ago (1971) and had no ties to the FRB. As long as the Fed has control over the money there will be no change until we are bone dry. With them being the ones who decide the outcome of our demise. We lost the war decades ago…