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Special Report: End of the Road for a Ship of Fools (a two-part series)
Part I, The End of the Road for a Ship of Fools
OL News Briefs
Sunday, April 24, 2011
Ed DeShields

According to the Federal Reserve Bank, federal insolvency is now just around the corner.  And, just when clear heads should prevail our leaders have proven themselves a ship of fools without a pilot.

The context, therefore, is no longer mere paralysis but an all-out confrontation between two failing visions of the country’s future.  Regrettably, either strategy will present the same inevitable economic collapse and the subsequent social turmoil that will follow as early as October of this year. 

It’s now every man for himself. 

On one side, the view is to slash spending immediately or we’ll end up just like Greece, unable to borrow except at unspeakable interest rates. We’re not to worry about the impact of spending cuts on jobs because fiscal austerity could create jobs by raising confidence.  Really?

On the other side, an almost illogical view of printing and spending is beginning to seem sinister – as if a secret strategy is being held from Joe Public or other political fools who aren’t listening; or from those who may be now implementing their own schemes of self-interest to escape the Four Horsemen.

The closer we get to the next presidential election (November 2012), the greater the confrontation between the two sides will intensify regardless of any hope of good behavior, including protecting the country’s common good: "Whom the gods would destroy they first make mad", says the line from the ancient Greek play Medea.

In October 2012 comes the traditional annual budget vote and with it will be the ideal moment for this Greek tragedy that will not end well.  This isn’t Hollywood.  It will be the rest of the world, which will write this sequel for the United States of Austerity.

The entire world’s economy is dependent on the economy or trade with the United States; central banks, the global banking system, pension funds, multinationals, commodities, the U.S. population, dollar-zone economies, etc. 

If the U.S. doesn’t substantially reduce government spending on a scale that it isn't even being whispered about in the halls of power - the Fed will be powerless to control the fate of the economy.  Likewise, it will be damned if it dials back its printing presses with its potential for rising interest rates, or if it doesn't it dooms the dollar, and in time, triggers unprecedented higher interest rates anyway.

Everyone is also structurally dependent on the U.S. economy.  Assets denominated in dollars or commercial dollar transactions will suffer a head-on shock of $20 trillion in ghost assets purely and simply disappearing from their balance sheets and from their investments causing a major decline in real incomes across the planet.

Pilotless in their ship of fools, the budgetary politicos of the United States will plunge willingly, or by force, into this unprecedented austerity and take whole swathes of the global economy and finance with it.   There are three concurrent outcomes in the short term:

  1. Whatever accounting sleight of hand is chosen, a crisis emerges in U.S. Treasury bond markets putting the Fed at its "end of the road" which began in 1913 and must now face up to its consequences of bankruptcy.  
  2. A U.S. Dollar crisis threatens and jolts the world’s currency markets
  3. The end of Fed printing (QE2) planned for the second quarter of 2011 triggers a massive devaluation of the Dollar (around 30% in a few weeks)

Whatever the case, closing down the federal government or by irresistible outside pressure from other government’s hard dealing, it will be in the autumn of 2011 that the U.S. federal budget will massively shrink for the first time.  The end of the Fed’s spending spree (QE2) will cause interest rates to rise and thus significantly increase federal debt servicing costs, against a backdrop of falling tax revenues causing a relapse into a deep recession.   It will be a shock not just felt at home, but around the world.

Parenthetically speaking, the bizarre notion that the Chinese would be crazy to get rid of U.S. assets therefore only hastening their fall in value is purely a Western folly.  Our politicians haven’t yet understood that it’s Washington and its political mistakes that have put the Chinese, and the rest of the world, into to a one-course solution. 

This week, as Standard & Poors modified their view to a negative outlook for the U.S.'s AAA standing.  It should have everyone worried. In fact, it's so obvious that the market's reaction to the news almost doesn't make sense.

Why is everyone so surprised?  Many market participants have disregarded all the warnings signs and when the reality of U.S. debt finally comes knocking, the majority will be caught unaware.

The Chinese are not idly standing by.  The Russians, eager for a counter-act of economic revenge after having had its super-power status destroyed by President Reagan, are looking to China with hopes to renew its status in a post-crisis "world after 1945". 

The world is tired of watching the U.S. play the role of Atlas and will not, therefore, be ingratiated to it by the many shocks and aftershocks in the quarters which follow.

Why is the Fed, at the direction of the Executive branch, whistling past the graveyard when it comes to the management of the Federal budget.   Could it be because the government secretly plans an overnight devaluation of the dollar?  You decide, but in any case here’s what we could experience in the days ahead. 

The devaluation of the U.S. dollar means a decline in the purchasing power of the dollar, which leads to a decline in your living standard; unless you are rich and are holding a lot of non-cash assets. 

For example, if the US dollar declines 30% and you had a million US dollars, the million dollars will only buy $700,000 worth of goods and services. You would have lost $300,000 in purchasing power.  Any type of investment in dollars, such as saving accounts, saving bonds, annuities, pensions, etc., will suffer from this decline.  

The coming decline of the dollar will impoverish almost 50% of the middle class and the other 40% will barely survive.  Ten percent of Americans will prosper from this decline of the dollar because they have the knowledge of how to protect their assets. 

The U.S. dollar is the world’s trading currency, which means the majority of goods and services are priced in U.S. dollars whether in Dallas, or Mexico City.  With a U.S. dollar devaluation, the impact on international trade is global.  Any countries trading with the U.S. will instantly raise their prices in anticipation of this devaluation.

All commodities, such as oil, coffee, copper, iron, etc., are setting record prices due to the dollar decline and anticipation of the U.S. dollar devaluation.  This is one reason why oil is now over $112 per barrel.  Oil producers know that the dollars they are receiving for their oil is declining in purchasing power, so they raise their prices to protect their investment. No one wants to hold a currency that is declining in value.

However, if you have managed to accumulate some real assets, with the devaluation of the dollar, those asset prices will re-inflate.  Real estate will again be worth more than the underlying mortgages.  Everything from your Buick to gold and stocks will rise in value relative to the dollar, but debt remains the same.  If the dollar devalues by 30%, it takes $1.43 of those (70 cent) dollars to buy the same amount of any asset. For example, if a homeowner with a $250,000 mortgage on a home that is only worth $200,000 and the dollar drops by 30%, the resulting 43% inflation on asset prices means that home will sell for $286,000 but still have its same $250,000 mortgage.  Now, that homeowner has a new incentive to make payments and keep the home, or sell it for a profit. 

Politically speaking about 10 million homeowners would once again be encouraged from simply walking away from their homes – saving millions of foreclosures.  But, buying one would be tough. 

The weaker dollar will make U.S. manufacturers more competitive overseas, bringing more money to more American families.  At the same time, it means stronger consumers for foreign goods.  Interest rates will rise, giving fixed-income investors a better return.

However, millions of people don’t own anything of value.  All they will have is their paycheck.  You just cannot be 100% cash in this environment.  It is not a safe investment, and it is not diversified.

The Fed’s aggressive money-printing program (QE1, QE2) is exactly this devaluing strategy.  The Nobel Prize-winning economist, Dr. Milton Friedman, wrote of exactly this solution for the type of problems we are encountering.  Fed Chairman Ben Bernanke has also tipped his hand as an option on how the Fed and Treasury might print our way out of a deflationary economy.

One side wants inflation, and I think we are about to get it.  When we get it, you will see gold, stocks, real estate and other assets re-inflate.   But the side that always talks about breaking the backs of the little guy is about to do just that.  And the billions of little people around the globe won’t stand idly by. 

Next week:  Part II
The breakdown of the dollar and the collapse of America’s economy will trigger a worldwide realignment, the felling of the Arab wall and a kickoff to new superpowers of the post collapse era.

About Ed DeShields

Last article: Is the FDA setting us up for the Superbug?

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