On Thursday, The Peoples Republic of China fired off the first volley in what could turn out to be economic Armageddon. China announced that it would begin to diversify its foreign-exchange reserves away from US dollar.
The only thing keeping the dollar atop its fragile perch is the fact that other countries have been willing to lap up the $600 billion of American red ink every year via the trade deficit. That amounts to roughly $2 billion per day or nearly 7% GDP.
Currently, China is holding $769 billion, the vast majority of its foreign exchange reserves. This is a humongous sum by any measurement and represents approximately 30% of Chinas gross domestic product. Regrettably, the Bush administrations wasteful spending makes the dollar look like a bad long term investment, so China will either have to change its strategy or face a huge loss on its reserves. Its a thorny predicament and one that China needs to handle delicately. If they move too aggressively it could trigger a sell-off and send the dollar plummeting.
It is unlikely that China will act recklessly, but even the mere suggestion of change has put the markets on edge.
Gold futures already jumped 4% in one week as large institutional buyers are voting with their feet that the dollar is headed for the dumpster. In fact, since Bush took office, gold has gone from the $200 range to $540 on Friday; a sure sign that investors have lost confidence in Washingtons ability to curb spending.
Even if China does not begin to cash in its greenbacks, we can expect to see considerable market volatility on Monday.
The Federal Reserve had anticipated Chinas action for some time. Thats why the Board of Governors of the Federal Reserve announced earlier this year that they would cease to publish the M3 monetary aggregate (including the following components: large-denomination time deposits, repurchase agreements, and Eurodollars.) That way the Fed can print enough money to absorb the shock waves of a massive sell-off without the nosy public knowing whats going on. Its a clever ruse, and an effective way of bilking the American people out of their hard-earned savings while the dollar continues to burrow into its earthen grave.
Greenspan knew this day was coming, thats probably why he chose to take an early retirement; splashing around in the Barbados while the dog-dung hits the fan. Heres what he said in April before the Senate Budget Committee:
The federal budget is on an unsustainable path, in which large deficits result in rising interest rates and ever-growing interest payments that augment deficits in future years. Unless that trend is reversed, at some point these deficits would cause the economy to stagnate or worse.
It was Greenspan and Bush who engineered that unsustainable path. He enthusiastically supported the presidents $450 billion per year tax cuts that redistributed Americas wealth to the 1% of the people that he represents. The tax cuts alone set the country on the road to catastrophe. The national debt has increased an unbelievable $3 trillion under the Bush-Greenspan cabal. He also endorsed the shaky lending practices (ARMs; adjustable rate mortgages, interest-only loans; $0 down payments) that inflated the housing bubble and caused an unprecedented wave of speculative buying. As the Fed continues to raise rates and tighten loan-requirements, the bubble is slowly limping towards the abyss carrying Americas economic future with it.
Greenspan anesthetized the country with low-interest rates while Bush and Co. maxed out the national credit card and loaded the boats with everything in the public till. Meanwhile, the economy kept sputtering along while Greenspan concealed the long-range effects of massive deficits behind a mountain of cheap money. Now, the well is running dry, and Americans will be facing rising interest rates, a stagnant economy, and a falling dollar.
Chinas action signals that we are entering a period of economic instability, where Americas future is largely in the hands of its creditors. Economic policy in China will now determine the interest rates on mortgages in America.
Welcome to the new world order, comrade.
The Fed believes it can finesse the problem by manipulating the money supply beyond the public view.
The last time Greenspan tried that trick he ended up dropping rates 12 times in a year and a half as the steam whooshed from the stock market bubble leaving the economy on life support.
Greenspan knows that low interest rates (cheap money) cannot always forestall disaster. If China starts a sell-off, its doomsday for the greenback. Japan would be forced to sell, with Germany close behind. The smaller nations would join the feeding frenzy, followed by the hedge and pension funds. It would be like a stroll through the Weimar Republic in the early 1930s.
So, whats next?
On Monday, the Fed will preemptively sluice zillions into the system to increase liquidity and stave off a possible run on the dollar. That way they can maintain the appearance of normalcy while what little is left of American middle class wealth is shifted into the flannel pockets of the central bankers via inflation. This will put the American economy on a long downward trajectory to third-world penury.
America is on the road towards hyperinflation; designed to savage the middle class, undermine popular social programs, crush organized labor, privatize all areas of the federal government, and flatten the workplace (to use the language of globalization guru, Tom Friedman) so that Americans will be forced to compete with the poorest paid workers in the world.
The effects of massive deficits are entirely understood. Eventually, the chickens come home to roost and the poor and middle class suffer horribly. It wont be any different this time.