Open Letter to the U.S. Dollar:
Dear Mr. Dollar:
I have for some time expounded your shortfalls and frailties. And now, with your soundness and future status having been elevated to the crucial issue in global markets and economics, it is appropriate that I address my heightened concerns to you directly. There are some critical issues that I want to ensure you are aware of. As much as I have criticized you in the past, I today fear for your future.
First of all, there is great confusion and misinformation as to who you really are and what role you play. Some believe – and many would like to perpetuate the myth - that you are the “currency” created and managed by the Federal Reserve. I think even you would admit that this is an expedient and false impression. Federal Reserve liabilities are but a small and shrinking portion of dollar-denominated claims, and the Fed has quite limited capacity to support you during episodes of faltering confidence and market tumult. The Fed’s previous effort to support you by increasing the attractiveness of U.S. securities is at this point a largely spent force. And while the consensus view holds that the Federal Reserve and Administration have advantageously used your devaluation as a policy tool – the Fed to “fight deflation” and the Bush team to buoy U.S. manufacturers and employment – it is more accurate to recognize that the actual policy mechanism has been to incite the (mindless) creation of additional dollar claims (Credit inflation), thereby stimulating expenditures and asset inflation (real estate, bonds and equities, in particular). The policy has been to perpetuate Bubbles, and only talk as if they were concerned about your strength and welfare. “Strong dollar” blather has similarly lost efficacy.
Many confuse you with dollar “bills” – Federal Reserve Notes - and Treasury debt. Others commonly mistake you for numerous Credit instruments issued by various types of institutions that can be used these days to consummate transactions in the real economy or financial markets. Some erroneously presume that scores of previous gross financial transgressions and policy derelictions – not to mention the consequent deep structural economic maladjustments and endemic inflated asset prices - will somehow be forgiven if only the federal budget is balanced. If it were only that easy, Mr. Dollar. I wish it were true.
Many refer to you as “fiat,” insinuating that you are authorized or sanctioned by the U.S. government. This is inaccurate. The Fed enjoys no dollar “monopoly power,” while Secretary Snow and the Department of the Treasury today possess virtually no power. The issuance of dollar debt is open to virtually all, while the size and nature of the dollar trading market – dominated today by derivative trading, “hot money” speculative flows, and foreign central banks - is massive and unlike anything in history.
There were long periods when you were backed by gold and other precious metals. This provided inherent value for dollar instruments, as well as an effective mechanism to restrict over-issuance. And there were also decades when the Federal Reserve and government authorities thoughtfully regulated the creation of additional dollar financial claims. Indeed, closely-regulated commercial banks were the chief non-federal government entities sanctioned with the capacity to create new dollar-denominated purchasing power. In such a circumstance, the terminology “fiat currency” was generally applicable. But today, in a Fancy-Free Marketable Securities-Based Financial New World Order - with myriad institutions creating liquid dollar-denominated liabilities, and securities playing such an instrumental role in the global system’s payments settlement mechanism - the term “Global Wildcat Finance” is much more legitimate than “fiat currencies.”
Mr. Dollar, it is today more factual and certainly analytically advantageous to think of you in the context of a “unit of account” in the global pricing of U.S. assets. Your value is determined in the marketplace (currency futures trading), and then is used to impute value for a vast array of claims throughout the global “ledger” of financial assets and liabilities. As a unit of account your intrinsic value would generally move inversely with the quantity of financial claims created. However – and we will return to this crucial issue - any chasm that develops between market perceptions and reality creates fragilities and the potential for dislocation. Your market value will always be relative to other units of account (currencies) and, at times, to perceived superior stores of value (gold, precious metals, crude and energy).
Without the traditional anchor of inherent fundamental value and/or constrained issuance, the vagaries of marketplace perceptions play an instrumental role. This role has risen in conjunction with the rising prominence of marketable securities throughout global Credit systems. For years (especially the eighties and nineties), your relative value was supported by fragilities and recurring crises in “competing” currencies or currency blocks. The dollar was increasingly perceived as a universal safe haven (remember gold at $255 and the euro at 85?). For a few (“blow-off”) years your perceived worth was completely overblown by massive speculative (“king dollar”) flows into U.S. securities markets. This inflated demand (fostered by the Fed and the leverage speculating community’s attendant desire to play the Greenspan bond Bubble) accommodated an historic Bubble of non-productive debt and asset inflation – self-reinforcing dynamics that have placed you at extreme risk.
The past two years of massive global central bank buying has only augmented these dysfunctional Monetary Processes and incited acute Monetary Disorder. And while your relative value did decline, the gap between the massive inflation of debt and the underlying limited capacity to create economic wealth remained extraordinarily wide. Remarkably, confidence in you remained high.
Most importantly, you are the “unit of account” for financial claims created by the U.S. Credit system. Regrettably, for some time the “activist” Greenspan Fed has nurtured - and the U.S. financial sector has enthusiastically delivered - an unprecedented inflation of new Credit instruments (financial claims). And the greater the Credit Bubble, the more committed the Fed has been to providing unlimited liquidity to the markets. Unlimited marketplace liquidity? Mr. Dollar, this is where they ensured your downfall. Moreover, a very large percentage of thee new financial claims were created in the process of financing consumption (especially imports and “services”), asset inflation (real and financial), and real investment of dubious long-term economic value. Massive foreign dollar claims have been accumulated that cannot be matched against true economic wealth. And I fear a large amount of this risk has been “hedged” in the derivatives markets, which implies the potential for a catastrophic market dislocation in the event of panic “portfolio insurance”-type forced selling.
A myth has been propagated by no less of an authority than our top central banker that the U.S. economy is both wonderfully productive and resilient, and that the magic of the market mechanism will painlessly rectify U.S. imbalances. But the reality of the situation is so much different: unrelenting inflation of dollar financial claims has fueled unsustainable economic and asset Bubbles and these powerful Bubble dynamics have been mistaken for economic efficiencies and resiliency. And, importantly, the Fed is determined to perpetuate Credit inflation and liqudity excesses in a desperate gamble to avoid asset price and debt collapse. Indeed, Mr. Dollar, it is the pyramid of dubious dollar denominated claims – and the Greenspan Fed’s determination to sustain it – that are at the core of your risk to collapse. You’ve been hung out to dry.
Mr. Dollar, no one knows better than you how present-day notions of monetary and fiscal policies - along with New Age Finance, have left you unguarded and vulnerable. Considering your role as the “world’s reserve currency” and the eminent “unit of account” for global prices, to not assiduously guard your wellbeing is an outrage. The complacent consensus view nonetheless takes comfort from the historical ebb and flow in your relative value to other currencies. I would, instead, suggest that the ongoing saga of contemporary finance and its recurring currency crises and collapses leave zero room for complacency.
And as you know, there is a consensus view that holds that your value is being somewhat sacrificed by the Fed as it sticks with its accommodative monetary policy (“peg” interest rates low and let your value “float”). Few in the U.S. see much risk with this strategy, with most in Washington and Wall Street content to enjoy the seductive “debtors’ blessing” delusion of devaluation and inflation. This is a quagmire. And if I had any hope that low interest rates and the status quo would rectify acute U.S. financial and economic fragilities I would not be writing to you this evening. But I fear the worst: the Fed is immersed in a trap of runaway Credit and asset inflation. Global players – including central banks – are coming to recognize there is no way out. Almost anything non-dollar is viewed as a superior store of value to investors and the massive speculating community. And perhaps others see dollar vulnerability as a potential countervailing force to aggressive U.S. foreign policies. Things don’t look good Mr. Dollar. Confidence is faltering, financial fragilities provide little room for error, and I fear we have passed the point where a dollar crisis is unavoidable.
I wish you the best in what will likely be a difficult and tumultuous period. And I do sincerely hope you can muster all your strength and surprise us with your resiliency. It certainly didn’t have to be this way. I hope the Greenspan Fed (and the “inflationists”) will be held accountable. Too much lunacy has been spoken and written, while the scourge of financial folly worked furtively to destroy you. The world’s preeminent currency was a terrible, terrible thing to waste. There will be huge costs to pay, and I’m saddened and sorry it happened.
Doug Noland |
