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SPEAKING FREELY
Crisis towers over the dollar

By W Joseph Stroupe

Speaking Freely is an Asia Times Online feature that allows guest writers to have their say. Please click here if you are interested in contributing.

When analyzing such matters as the vulnerability of the US economy and the chances of its collapse, it is vital to avoid the two extremes of "calamity howling" on one hand and investing blind faith in the status quo on the other. Unforeseen and unexpected attack-induced collapses of grand proportions can and do occur. The sudden collapse of both towers of New York's World Trade Center, for example, took everyone by surprise - who could have foreseen that the two towers, which survived the massive lateral impact of two huge planes, would, only minutes later, collapse vertically upon themselves, their own massive weight ensuring their demise?

Structurally, the two towers were impressive indeed. They had actually been designed to take a lateral and direct impact of a Boeing 747 jumbo jet and survive without collapsing. Nonetheless, certain fundamental structural vulnerabilities did exist in the towers. These were not entirely evident before September 11, 2001, but were hidden beneath their massive and stable outward appearance. When those vulnerabilities were carefully targeted and exploited, down the massive towers came within mere minutes of the attack.

Do similar deep structural vulnerabilities exist within the US economy? Are these currently being exploited by the al-Qaeda and others to cause a US economic collapse? Are the apparent strength, stability and imposing size of the US economy deceptively masking an imminent collapse, as the Twin Towers did? Have the initial stages of an attack on the towering US economy, which might bring about a vertical collapse, already begun?

Faulty Towers
The collapse of the Twin Towers was a harsh lesson in the realities of the vulnerability of US infrastructure. In the case of the attack on the towers, the planes struck near the top of the structures. Had they struck nearer to the street level, there might have been a chance to extinguish the resulting fires before the primary steel structural beams weakened. Had they struck the top, the vertical collapses that ensued would have been highly unlikely as the primary steel structural beams wouldn't have been possible.

Fundamental vulnerabilities exist in the US economy too. But there also exists a widespread consensus that there is little real chance of a collapse, no matter what the attack might be. Even most contrarian experts dismiss the possibility of an actual collapse. They generally speak only of a prolonged "bear" period for the economy, not a collapse. The towers also enjoyed such widespread confidence before September 11. The previous targeting of the towers in 1993 and their survival only reinforced this misplaced confidence.

Vertical collapse
Just before September 11, 2001, the US economy was also extremely unlikely to be susceptible to a sideways hit. It did show its resilience in the immediate aftermath of the attacks on its economic infrastructure. But the key to the success of the attacks, from al-Qaeda's perspective, was the igniting of the jet fuel and its impact on the primary steel support girders. Hence it was not the immediate result of the impact itself, but rather the delayed result of the fire that counted. The steel girders were the actual framework of the towers, around which the structures were constructed. When the flames softened the framework, the whole structure caved in.

The US economy is also constructed around a fundamental framework - its currency, the almighty dollar, and the apparently firm and virtually unbreakable international support it enjoys. Similar to the framework of the Twin Towers that supported their massive weight, the dollar supports a massive load of debt, now totaling well over US$7 trillion in the public sector alone. Much of this debt load is, in effect, tenuously suspended at the upper portions of the US economic structure, where it places an undue load upon the lower, traditionally more stable part of the economic framework. This is true for a number of reasons.

Federal Reserve Board and government policies over the past 20 years or so have been extremely shortsighted, leveraging the economy's future stability and strength by means of large and perpetual deficit spending. The US government, and its citizens as well, have acted as if there would never come a day of accounting for the immense debt being amassed, that somehow the amassing of such debt didn't matter. Nothing could be further from the truth. And since the economic slowdown of 2000, Fed and administrative policies have caused a pointed and massive ballooning of very risky forms of public and private debt, all built upon the structural framework we call the dollar. One such form of debt is the massive selling of treasury notes to foreign central banks - most notably to the big Asian economies. Another is the Fed policy of "prolonged monetary accommodation", meaning keeping interest rates at artificially low levels, printing new money at the rate of nearly $1.5 trillion per year and the massive creation of easy credit.

In the past three to four years, debt encouraged by such policies has mushroomed almost beyond imagination. So, in effect, there now exists a mountainous load of debt concentrated within the upper sections of the US economy, where it cannot easily be neutralized to the ground level in an orderly fashion. How much of such massive weight can the framework, the dollar, carry and support before the structure caves in?

Is there already a fire in the immediate vicinity of that framework and are the steel girders already beginning to soften? The traditional international support for the dollar and the US government's foreign and economic policies is beginning to waver. Why? Because al-Qaeda has lighted a fire of sorts in the vicinity of the dollar framework. It has succeeded in instigating the US to take economic and foreign policy measures that have resulted in a loosening of the firm "girders" of international support for dollar and US policies. Al-Qaeda has indirectly lit the fires of controversy over the rightfulness and permanence, and even the desirability, of continued US global dominance in the diplomatic, economic and military spheres.

Now that fire is raging, and ferociously eating into the girders. Controversial and ill-advised unilateral US economic and foreign policies since September 11 are only fueling that fire. In the immediate aftermath of the re-election of President George W Bush, international support for the dollar and for related US economic and foreign policies is noticeably weakening, at a time when it is most needed to support an unprecedented and mushrooming mountain load of debt. Recently, voices from within the government of Norway have called for a switch from the dollar toward the euro for international petro-transactions. The governor of the Bank of Japan has recently stated that having the dollar as the sole global currency is a marked disadvantage and danger, and recommended moving toward adopting the euro as a global currency alongside the dollar. The appetite of the big Asian economies to continue buying dollar assets is waning - last month the US barely achieved the $60 billion of foreign cash inflow required each month to keep it afloat. Hence the possibility of a Twin Towers-like vertical collapse of the US economy is becoming greater, not lesser.

The following highlight the extent of the mounting debt and the risk involved:
  • The total US public national debt now exceeds $7 trillion.
  • When Social Security, Medicare, Medicaid, military and government pensions are added in, the total national debt exceeds $51 trillion, according to Fortune magazine - that's nearly five times the gross domestic product (GDP) .
  • The current year's deficit alone approaches $1 trillion when you add the off-budget items.
  • Derivatives (highly leveraged and enormously risky instruments such as interest-rate futures, options and swaps) now total $180 trillion, 17 times the GDP. Warren Buffet calls derivatives "instruments of mass destruction". Many financial institutions have become highly invested in derivatives. Government-sponsored enterprises such as Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corp) use derivatives heavily. Because of the inherent nature of derivatives, these instruments and those using them are extremely sensitive even to small and moderate interest-rate increases.
  • The total US consumer debt is more than $8 trillion.

    The Japan Times recently stated, "Stephen Roach, Morgan Stanley's perceptive economist, drew attention to the fact that some of the numbers are nothing short of frightening. The US currently has $38 trillion in debts, and there is a $54 trillion federal funding gap - the difference between what the government is committed to pay out and what it will receive in tax revenues."

    The Fed has kept interest rates artificially low for long, thereby creating enormous amounts of cheap and easy money and has also pursued a policy of "monetary inflation" (declining the value of the dollar) by printing nearly $1.5 trillion a year. These prolonged policies have artificially created huge and growing (1) credit, (2) real-estate and other asset and (3) stock-market bubbles. However, with interest rates rising, the bubbles are about to burst.

    The price:earnings ratio is at historic highs - a sure sign of a general stock market bubble. "Smart Money" Warren Buffet has mostly pulled out of the US stock market because stocks are so greatly overpriced. What goes up must come down, and the US stock market is way up, far higher than can be justified by reason and facts.

    The troubled dollar
    Is international support for the dollar and for US policies eroding? Yes, it most certainly is. A powerful case can be made that it has been US policies and actions since September 11 that have resulted in a powerful upswing in terrorism worldwide along with an equally powerful elevation in Middle East instability resulting in sustained crude oil price hike and a resulting dollar decline, both of which are threatening to render serious damage to the big Asian economies. Firm international support for the dollar is certainly flagging. The largest Asian central banks have gone on record that they are curbing their purchases of US debt. And they are also diversifying their huge reserves, steadily moving away from the dollar. The risks have simply become too many and too serious.

    International fears of a disorderly, or possibly even a catastrophic, decline in the dollar have been pointedly heightened. Asian central banks are being forced by the varied and serious risks to hedge their bets, not wanting to be ill-prepared in the event of a disorderly decline in the dollar. Russia is also steadily decreasing the percentage of its reserves denominated in dollars, moving toward a level of 50:50 split between dollars and euros. Russia is the key player here, the one the entire world is intently watching. It alone can play the key role in either restoring the flagging international support for the dollar, or completely undermine its remaining support, precipitating a vertical collapse.

    President Vladimir Putin has stated both publicly and privately that invoicing Russia's crude-oil and gas exports to the European Union in euros instead of in dollars makes very good sense for both Russia and the EU. Putin is known to have very close relations with "old Europe", primarily Germany and France. His statements and those of German and French leaders have even on occasion drawn attention to the fact that US global dominance fundamentally rests on the fact that the dollar is the international currency, and that if an exit from the dollar were to occur in the sphere of global petro-transactions, the effect would be seriously to undermine that global dominance. Furthermore, a number of oil-exporting countries have already gone on public record as to their preference to make an exit from petro-dollars in favor of petro-euros. They have indicated that if Russia begins such a move to petro-euros, they will rapidly follow Russia's lead. The net effect would be a rapid international abandonment of the dollar as the international currency, which would in turn "bring down the towers" of the heavily debt-ridden US economy.

    Al-Qaeda has recently mounted a second attack on the fundamental framework of the US economy. Its clear strategy of attacking oil-exporting infrastructure around the globe to tighten global supply and drive up crude-oil prices is a further act of instigating a raging fire in the immediate vicinity of the US economic girders. Al-Qaeda knows crude oil is the economic lifeblood of industrialized economies. And it also knows the fundamental fragility and deep imbalances that exist in the US economy in particular. It fully understands that international support for the dollar is weakening and that a sustained elevated crude-oil price is the key to producing a set of circumstances in which persistent inflation returns, requiring a set of interest-rate hikes, which in turn will act like a needle to burst the credit, real-estate and stock-market bubbles. The resulting decline of the dollar will be steep and persistent, undermining what is left of international support for dollar.

    However, one huge problem that has been noted on the subject of executing an exit from the dollar is the current enormous reserves held by the big Asian economies - those reserves are largely denominated in the US dollar. How can any of these Asian central banks or Russia, which still holds a percentage of its $112 billion in total reserves in dollar-denominated assets, execute an exit from the dollar without simultaneously wiping out the immense value of their own dollar reserves? On the surface, that problem seems virtually insurmountable. But is it really?

    If we look at Russia as an example, we learn that its central bank has been moving rapidly over the past 15 months from a 75% holding of dollars in its reserves to a 50% holding, significantly decreasing the proportion of its reserves denominated in dollar. Significantly, it is also well along in an effort to de-dollarize itself domestically in favor of the euro, buying up its domestic dollars with windfalls coming as a result of the elevated price of crude oil, and by that means it is progressing steadily toward its stated goal of "diversification" of its reserves away from the dollar. The rest of the world is forced to watch what Russia does in that regard.

    If Russia is perhaps positioning itself to make even a partial exit from the dollar in the pricing of its petro-transactions, then the Asian and other economies don't want to risk being left out in the cold, unprepared, seeing the value of their own huge dollar reserves undermined by a steep or chaotic decline in the value of the dollar. They cannot afford to ignore Russia's moves. Hence as Russia moves to decrease the percentage of its own holdings of dollars, so are the big Asian economies, as well as many other economies around the globe. No one wants to get burned in the event Russia moves to the euro. Additionally, as the dollar continues to weaken and crude oil continues to rise in price, having the dollar as the preferred international currency for petro-transactions will become more of a liability, especially for the big Asian economies, which are heavy importers of crude oil. This fact will tend to further undermine Asian, as well as the rest of international support for the dollar.

    W Joseph Stroupe is editor in chief of Global Events Magazine, an online geopolitical magazine specializing in strategic analysis and forecasting.

    (Copyright 2004 W Joseph Stroupe.)

    Speaking Freely is an Asia Times Online feature that allows guest writers to have their say. Please click here if you are interested in contributing.
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    Nov 25, 2004
    Asia Times Online Community



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