[NYTr] Booming Economy: Plummeting Dollar, Credit Crunch

[All the News That Doesn't Fit]

Counterpunch - Sep 15, 2007
http://www.counterpunch.org/whitney09152007.html

Plummeting Dollar, Credit Crunch...

Final Stop: Soup Kitchen U.S.A.

By MIKE WHITNEY

The days of the dollar as the world’s “reserve currency” may be drawing
to a close. In August, foreign central banks and governments dumped a
whopping 3.8 per cent of their holdings of US debt. Rising unemployment
and the ongoing housing slump have triggered fears of a recession
sending wary foreign investors running for the exits. China, Japan and
Taiwan have been leading the sell off which has caused the steepest
decline since 1992.  

To some extent, the losses have been concealed by the up-tick in
Treasuries sales to US investors who’ve been fleeing the money markets
in droves. Investors have been trying to avoid the fallout from money
funds that have been contaminated by mortgage-backed assets. Naturally,
they bought US government bonds which are considered a safe bet. But
that doesn’t change the fact that the dollar’s foundation is steadily
eroding and that foreign support for the dollar is vanishing.  US bonds
are no longer regarded as a “safe haven”.

The dollar slumped to a 15 year low against 6 of its most actively
traded peers and set the stage for an early morning market rout on Wall
Street.

Foreign investment and currency deregulation has been a real boon for
the stock market which thrives of a steady flow of cheap capital. It’s
also been good for ravenous consumers who like to borrow boatloads of
low interest cash for their toys, SUVs and McMansions.

Of course, when things seem too good to last---they usually don’t. The
economy is contracting; credit is getting tighter, and the stock market
is flailing about aimlessly. As capital flight accelerates; interest
rates in the US will rise, unemployment will mushroom, and the dollar
will fall. It can’t be avoided. American markets and consumers will be
compelled to curb their appetite for cheap foreign credit. Overseas
investors own more than $4.4 trillion in US debt in the form of bonds
and securities.  Even if they sell only 25 per cent of that sum, the US
would feel the pinch of hyper-inflation. For the last decade foreigners
have been eager to by our Treasuries and equities---gobbling up
America’s enormous $800 billion current account deficit and keeping
demand for the dollar artificially high. But just like the subprime
mortgage holder whose “teaser rate” has suddenly expired; the US now
faces the painful adjustment of higher payments and less discretionary
income for indulgences. Maybe the charade could have carried on a bit
longer if not for the belligerent Bush foreign policy that has
alienated friends and foes alike. But, then, maybe not. After all, the
Fed’s loose monetary policies added to Bush’s extravagant spending---$3
trillion added to the National Debt in just 6 years--- doomed the
country from the beginning. Deficit spending has been the central
organizing principle from day

1. Now comes the hangover.

Federal Reserve chairman Bernanke is expected to drop the Fed funds
rate on September 18. The move will provide more “easy credit-crack”
for the addicts on Wall Street but it could also trigger a run on the
dollar. That’s what keeps the Fed chief up at night.  

The Bush Team was warned repeatedly by the Bank of International
Settlements, the World Bank, the IMF and the European Central Bank that
its policies were “unsustainable” and would end in an economic
meltdown. But they brushed aside the warnings with the same casual
indifference as they did the critics of the war in Iraq.

Why would they care if the country suffered? Their friends would still
get their unfunded tax cuts. Their private armies and “no bid”
contractors would still get their payola. The Democrats would still
cave in on the enormous “off budget” war spending. And, they’d still be
able to print as much counterfeit money as they chose until every last
copper farthing was drained from the public till.

No worries. Besides the media would mop up the mess they’d made with
their usual “happy talk”. As the economic calamity unfolds, we can
expect to see the usual parade of lacquer-haired phonies on the
Business Channel singing the praises of “free markets”.  The problems
we’re now facing should have been easy to spot for anyone willing to
look beyond the empty rhetoric of the TV Pollyannas or their
cheerleading co-conspirators at the White House.

It was a hoax. And the seven years of sleepwalking has cost us dearly.
Unemployment is up, consumer spending is down, the housing market has
slipped into recession, and the stock market is lurching back and forth
like an overloaded washing machine. All of this could have been
foreseen by anyone with minimal critical thinking skills and a healthy
dose of skepticism of government.

Consider this: US GDP is 70 per cent consumer spending. That means that
wages have to increase beyond the rate of inflation OR THE ECONOMY
CAN’T GROW. It’s just that simple. So how is it that 50 per cent of the
American people still believe Bush’s supply side baloney that cutting
taxes for the uber-rich strengthens the economy? How does that increase
wages or build a healthy middle class. If we want a strong economy
wages have to keep pace with productivity so that workers can buy the
goods they produce.

Greenspan knows that. So does Bush. But they chose to hide it behind an
“easy credit” smokescreen so they could weaken the dollar, off-shore
thousands of industries, out-source 3 million manufacturing jobs, fund
an illegal war, and maintain the lethal flow of the $800 billion
current account deficit into American equities and Treasuries. In
truth, there hasn’t been any growth in the economy since Bush took
office in 2000. What we’ve seen is an ever-expanding bubble of personal
and corporate debt amplified by a “structured finance” system that
magically transforms liabilities (subprime loans) into securities and
increases their value through leveraging.

That’s it. No growth---just a galaxy of debt-instruments with
odd-sounding names (CDOs, MBSs, CDSs, etc)  stacked precariously on top
of each other. That’s what we call "wealth" in America.

It’s all smoke and mirrors. The financial system has decoupled from the
productive elements of the economy and is now beginning to show
disturbing signs of instability. That’s why there’s the big blow-off in
the bond market. The halcyon days of supplying our armies, funding our
markets and building our subprime “ownership society” empire on the
backs of foreign creditors is over.  The stock market is headed for the
landfill and housing is leading the way. Economic fundamentals can only
be ignored for so long. 

The problems began when Greenspan dropped interest rates to 1 per cent
in 2003 for more than a year pumping trillions of low interest credit
into the economy. This created the appearance of prosperity but it also
inflated a massive equity bubble in housing which is now in its death
throes. The Fed “rubber stamped” many of the “creative financing” scams
which lowered lending standards and turned the subprime fiasco into a
$1.5 trillion doomsday machine. Greenspan said this week that he hadn’t
anticipated the real estate disaster.

The devastation in real estate is almost too vast to comprehend. The
mortgage bubble is roughly $5.5 trillion, and yet, prices have just
begun to fall. It’s a long way to the bottom and there’s bound to be
plenty of bloodshed ahead. Two million homeowners will lose their
homes. 151 mortgage lenders have already gone belly up. Many of the
hedge funds—which are loaded with billions of dollars in
“mortgage-backed” securities are struggling to stay alive. Perhaps the
most shocking projection was made by Yale University Professor, Robert
Schiller, who believes that home prices could decline as much as 50 per
cent in some of the “hotter markets”. (Schiller’s book “Irrational
Exuberance” predicted the dot.com bust before it took place.) The
effects on the US economy would be considerable. If other factors come
into play---like a stock market crash and a subsequent period of
deflation---we could see housing prices descend 90 per cent as they did
between 1928 and 1933.

It’s possible.

Typically, housing bubbles deflate very slowly, over a period of 5 to
10 years. Not this time. Credit problems in the broader market are
speeding up the pace of the decline. The subprime sarcoma has spread to
all loan categories and filtered into the banking system. This is
forcing the banks to hoard reserves to cover their potential losses
(from CDOs and mortgage-backed bonds “gone bad”). Now, even credit
worthy applicants are being turned away on new mortgages. At the same
time, “nearly half of borrowers with adjustable rate mortgages were not
able to refinance their loans. That’s a major concern for policymakers
as an estimated 2.5 million mortgages given to borrowers with weak
credit will reset at higher rates by the end of next year.” (Associated
Press)

Think about that. It’s no longer just a matter of 40 per cent of
loan-types disappearing overnight (Subprime, Alt-A, piggyback, negative
amortization, interest only etc). Even people with good credit are
being rejected because the banks are hoarding capital. That suggests
the banks are in dire straights and hiding losses that are kept off
their balance sheets (more on this later). 

So, it’s harder to get a mortgage. And, if you already have one you may
not be able to roll it over. This will greatly accelerate the rate of
the housing crash. (In fact, the LA Business Journal reported on Sunday
that home sales plunged 50 per cent in one month. We can expect to see
similar numbers in all the hot spots.) 

Dollar Woes

The troubles facing the dollar are as grave as those in housing. The
stock market and the teetering hedge funds are counting on an interest
rate cut, but they’ve ignored the effects it will have on the
greenback. If Bernanke lowers rates, as everyone expects, the bottom
could drop out of the dollar. We’re already seeing gold soar to new
highs (above $700 per Ounce) That’s an indication of dollar-weakness
and a potential sell-off of US Treasuries.  If Bernanke lowers rates,
the greenback will nosedive. 

Author Gary Dorsch explains the potential hazards in his recent
article, “Hopes for an Easier Fed Policy Boost the Euro and Copper”:

     “Interest rate differentials have played a key role in determining
exchange rates. Since the ECB (European Central Bank) began its rate
hike campaign in December 2005, the US dollar’s interest rate advantage
over the Euro has narrowed from 240 basis points to as low as 70 basis
points today. Thus, the Fed can only afford a small rate cut to bail
out Wall Street bankers who hold toxic sub-prime debt and avoid tipping
the dollar into a free-fall. But that might not be enough to prevent a
housing led recession in the months ahead.”

After years of abuse under Greenspan--an $800 billion current account
deficit, a $9 billion per month war, and a 13 per cent yearly increase
in the money supply---the poor dollar has run out of wiggle-room. If
the Fed slashes rates, the mighty greenback will be a dead duck.

Commercial Paper: What You Don’t Know Can Hurt You

Commercial paper is something that is rarely understood outside of the
investor class. It is, however, a critical factor in keeping the
markets operating smoothly.  “Commercial paper is highly-rated
short-term notes that offer investors a safe haven investment with a
yield slightly above certificates of deposit or government debt. Banks
use the money to purchase longer-term investments such as corporate
receivables, auto loans credit card debt, or mortgagees.” (Wall Street
Journal 9-5-07)

Commercial paper has been vanishing at an alarming rate in the last
month. $240 billion has been drained in just the last 3 weeks. (There
is $2.2 trillion of commercial paper in circulation in the US) Because
CP is “short term”, hundreds of billions of dollars need to roll over
(be refinanced) regularly. CP is at the very heart of the credit crisis
which has spread through the financial markets and it could result in a
massive catastrophe. The large investment banks are in a panic---and
that is probably an understatement. Consider this article in the UK
Telegraph which provides an eye-popping summary of what is going on
behind the scenes. 

U.K. Telegraph, “Banks Face 10-Day Debt Time Bomb”: “Britain's biggest
banks could be forced to cough up as much as £70bn over the next 10
days, as the credit crisis that has seized the global financial system
sparks a fresh wave of chaos.

“Almost 20 per cent of the short-term money market loans issued by
European banks are due to mature between September 11 and September 19.
Senior bankers fear that they will have to refinance almost all of
these debts with funds from their own coffers, putting a further strain
on bank balance sheets.

“Tens of billions of pounds of these commercial paper loans have
already built up in the financial system, because fear-ridden investors
no longer want to buy them. Roughly £23bn of these loans expire on
September 17 alone.

“Fears of this impending call on bank credit lines are the true reason
that lending between banks has ground to a halt, according to senior
money market sources.

“Banks have been stockpiling cash in preparation for this ‘double
rollover’ week, which sees quarterly loans expire alongside shorter
term debts - exacerbating a problem that lies at the heart of the
credit crisis.” (UK Telegraph) 


Fortunately, the British still have a few newspapers—like the
Telegraph-- that still report the news. That is not the case in the US.

There’s roughly $1.3 trillion in “asset-backed” commercial paper
filtering through American markets. These are the notes that are
connected to mortgage-backed securities (MBSs) that no one wants and
which have NO MARKET VALUE. They are referred to as “toxic waste”. (No
one is buying anything remotely connected to real estate CDOs) 

Hundreds of billions of dollars of CP has been issued through SIVs
(structured investment vehicles) and “conduits” which are affiliates
(subsidiaries) of the large banks. The banks have kept these operations
hidden from the public, but now they are in the spotlight because they
cannot meet their obligations and are stuck with billions of CP that
they cannot refinance. (The reader may recall that Enron kept similar
“off balance sheets” operations secret from the public before they
declared bankruptcy) 

The banks are now forced to assume responsibility for the commercial
paper held by their affiliates, which means that they need sufficient
capitalization to cover the losses. 

Sound confusing? Don’t give up, yet!

The bottom line is this: The banks are responsible for hundreds of
billions of dollars in commercial paper that probably won’t be
refinanced. It is beginning to look like they don’t have the reserves
to cover their losses.

That’s why we continue to believe that the banks are in trouble.

According to the Wall Street Journal:

    So do the banks and their shareholders have nothing to worry about?
Not quite….Negligible losses in August were enough to force the banks
to run to the authorities for help. Regulators may decide that the best
way to prevent a recurrence is to require banks to hold more capital.
They might even limit some types of transactions. Such moves might be
good for the economy, but would reduce the bank’s returns on equity.
(“Banks Seem Fine—For Now”, WSJ, 9-8-07) 

Read carefully and I think you will agree with me that the WSJ is
“tipping its hand” and suggesting that the banks needed “more capital”
even after “negligible losses.” The predicament is much more serious
now.

Bank troubles are never minor. That’s why there has been so much effort
put into covering up the real source of the problem. When people lose
their confidence in the banks, they lose their confidence in the
system. That ends up inciting social turmoil. Don’t think they’re not
aware of that at the White House.

The Likelihood of a Hard Landing

Notwithstanding the imminent shakeup at the major investment banks, the
path ahead is poorly lit and full of potholes. The reckless policies of
the last 7 years have edged us ever-closer to the inevitable day of
reckoning. Professor Nouriel Roubini summed it up best in a recent
blog-entry, “The Coming US Hard Landing”:
     
    "The forthcoming easing of monetary policy by the Fed will not
rescue the economy and financial markets from a hard landing as it will
be too little too late. The Fed underestimated the severity of the
housing recession, its spillovers to other sectors, and the contagion
of the sub-prime carnage to other mortgage markets and to the overall
financial markets. Fed easing will not work for several reasons: the
Fed will cut rate too slowly as it is still worried about inflation and
about the moral hazard of perceptions of rescuing reckless investors
and lenders; we have a glut of housing, autos and consumer durables and
the demand for these goods becomes relatively interest rate insensitive
once you have a glut that requires years to work out; serious credit
problems and insolvencies cannot be resolved by monetary policy alone;
and the liquidity injections by the Fed are being stashed in excess
reserves by the banks, not re-lent to the parts of the financial
markets where the liquidity crunch is most severe and worsening. The
Fed provided liquidity to banking institutions but it cannot provide
direct liquidity to hedge funds, investment banks, other highly
leveraged institutions and parts of the credit markets – such as asset
backed commercial paper – where the crunch is severe. Thus, the
liquidity crunch in most credit markets remains severe, even in the
usually most liquid interbank markets." (Nouriel Roubini's Blog)

There are no quick-fixes or “silver bullets” as Bush likes to say.
It’ll take years to dig our way out of this mess. In the meantime,
there’s little to look forward to except the steady weakening of the
dollar, the persistent decline in housing and the looming police-state
apparatus that’s supposed to keep us in line while the soup kitchens
open.

[Mike Whitney lives in Washington state. He can be reached at:
fergiewhitney at msn.com ]