There are two things that many Americans have long taken for granted: 1) foreigners not only want to hold U.S. dollars and invest in this country, but, in many cases, they have few other options; and, 2) our country's vast economic and military resources mean that we control our own destiny.
In a Monday double-header, The Telegraph's Ambrose Evans-Pritchard -- international business editor of the British daily and one of my regular must-reads -- provides us with two reports that call each of those assumptions into question:
1. "China Warns Federal Reserve Over 'Printing Money'":
China has warned a top member of the US Federal Reserve that it is increasingly disturbed by the Fed's direct purchase of US Treasury bonds.
Richard Fisher, president of the Dallas Federal Reserve Bank, said: "Senior officials of the Chinese government grilled me about whether or not we are going to monetise the actions of our legislature."
"I must have been asked about that a hundred times in China. I was asked at every single meeting about our purchases of Treasuries. That seemed to be the principal preoccupation of those that were invested with their surpluses mostly in the United States," he told the Wall Street Journal.
His recent trip to the Far East appears to have been a stark reminder that Asia's "Confucian" culture of right action does not look kindly on the insouciant policy of printing money by Anglo-Saxons.
Mr Fisher, the Fed's leading hawk, was a fierce opponent of the original decision to buy Treasury debt, fearing that it would lead to a blurring of the line between fiscal and monetary policy – and could all too easily degenerate into Argentine-style financing of uncontrolled spending.
However, he agreed that the Fed was forced to take emergency action after the financial system "literally fell apart".
Nor, he added was there much risk of inflation taking off yet. The Dallas Fed uses a "trim mean" method based on 180 prices that excludes extreme moves and is widely admired for accuracy.
"You've got some mild deflation here," he said.
The Oxford-educated Mr Fisher, an outspoken free-marketer and believer in the Schumpeterian process of "creative destruction", has been running a fervent campaign to alert Americans to the "very big hole" in unfunded pension and health-care liabilities built up by a careless political class over the years.
"We at the Dallas Fed believe the total is over $99 trillion," he said in February.
"This situation is of your own creation. When you berate your representatives or senators or presidents for the mess we are in, you are really berating yourself. You elect them," he said.
His warning comes amid growing fears that America could lose its AAA sovereign rating.
2. "US Bonds Sale Faces Market Resistance":
The US Treasury is facing an ordeal by fire this week as it tries to sell $100bn (£62bn) of bonds to a deeply sceptical market amid growing fears of a sovereign bond crisis in the Anglo-Saxon world.
The interest yield on 10-year US Treasuries – the benchmark price of long-term credit for the global system – jumped 33 basis points last week to 3.45pc week on contagion effects after Standard & Poor's issued a warning on Britain's "AAA" credit rating.
The yield has risen over 90 basis points since March when the US Federal Reserve first announced its controversial plan to buy Treasury bonds directly, a move designed to force down the borrowing costs and help stabilise the housing market.
The yield-spike may be nearing the point where it threatens to short-circuit economic recovery. While lower spreads on mortgage rates have kept a lid on home loan costs so far, mortgage rates have nevertheless crept back up to 5pc.
The Obama administration needs to raise $2 trillion this year to cover the fiscal stimulus plan and the bank bail-outs. It has to fund $900bn by September.
"The dynamic is just getting overwhelming," said RBC Capital Markets.
The US Treasury is selling $40bn of two-year notes on Tuesday, $35bn of five-year bonds on Wednesday, and $25bn of seven-year debt on Thursday. While the US has not yet suffered the indignity of a failed auction – unlike Britain and Germany – traders are watching closely to see what share is being purchased by US government itself in pure "monetisation" of the deficit.
Don Kohn, the Fed's vice-chair, said over the weekend that Fed actions would add $1 trillion of stimulus to the US economy over time and had already prevented "fire sales" of assets.
"The preliminary evidence suggest that our programme has worked," he said.
The US is not alone in facing a deficit crisis. Governments worldwide have to raise some $6 trillion in debt this year, with huge demands in Japan and Europe. Kyle Bass from the US fund Hayman Advisors said the markets were choking on debt.
"There isn't enough capital in the world to buy the new sovereign issuance required to finance the giant fiscal deficits that countries are so intent on running. There is simply not enough money out there," he said. "If the US loses control of long rates, they will not be able to arrest asset price declines. If they print too much money, they will debase the dollar and cause stagflation.
"The bottom line is that there is no global 'get out of jail free' card for anyone", he said.
The US is acutely vulnerable because it relies heavily on foreign goodwill. China and Japan alone hold 23pc of America's $6,369bn federal debt. Suspicions that Washington is trying to engineer a stealth default by letting the dollar slide could cause patience to snap, even if Asian exporters would themselves suffer if they harmed their chief market.
The dollar has fallen 11pc against a basket of currencies since early March. Mutterings of a "dollar crisis" may now constrain the Fed as it tries to shore up the bond market. It has so far bought $116bn of Treasuries as part of its "credit easing" blitz, out of a $300bn pool.
When the Fed first said it was going to buy Treasuries in March the 10-year yield to dropped instantly from 3pc to near 2.5pc, but shock effect has since worn off. Any effort to step up purchases might backfire in the current jittery mood.
In the late 1940s the Fed was able to cap the 10-year yield at around 2pc, but that was a different world. The US commanded half global GDP and had a colossal trade surplus. The Fed could carry out its experiment without worrying about foreign dissent.
Fed chair Ben Bernanke has long argued that central banks can bring down long-term borrowing rates by purchasing bonds "at essentially no cost". His frequent writings rarely ask whether foreigner investors – from a different cultural universe – will tolerate such conduct.
Mr Bernanke is betting that under a floating currency regime there is no risk of repeating the disaster of October 1931, when the Fed had to raise rates twice to stem foreign gold withdrawals, with catastrophic consequences. This assumption may be tested.
It is not clear where the capital will come from to cover global bond issues. Asian central banks and Mid-East oil exporters have cut back on their purchases of US and European bonds as reserve accumulation slows. Russia has slashed its holding by a third to support growth at home. Even Japan's state pension fund has become a net seller of bonds for the first time this year the country's population ages.
Japan's public debt will reach 200pc of GDP next year. Warnings by the Japan's DPJ opposition party that, if elected this autumn, it would not purchase any more US debt unless issued in yen, is a sign that the political mood in Asia is turning hostile to US policy.
There is no evidence yet that foreigners are in the process of dumping US Treasuries. Brad Setser from the US Council on Foreign Relations said global central banks added $60bn to their US holdings in the first three weeks of May.
This is bitter-sweet for Washington. It suggests that private buyers are pulling out, leaving foreign powers as buyer-of-last resort.
We just have to hope that G20 creditors agree to put a clothes peg on their nose and keep buying Western debt until the crisis passes, for the sake of the world.
Wow, do I have STRONG issue with that scoundrel Richard Fisher, "president of the Dallas Federal Reserve Bank".
The Chinese are just verbalizing what many U.S. citizens feel. Why is the Fed debasing the currency?
Let's step back a bit and issue this question:
Why does the Fed even exist. A (non government) cartel originated 100 years ago when a bunch of fat cat bankers met on a holiday South Carolina barrier island in a luxury resort.. and they came up with is ultimate fraudulent scheme (that the ultra wealthy would always be inserted between every transaction, always taking their cut, "making money even in their sleep". I say HELL NO, time to Audit the fed, then end it! That's so important, I'll say it again.
TIME TO AUDIT THE FED, THEN END IT!
Then, Mr Fisher will have to go and get a real job, an honest job ... in this economy ... of his making.
Posted by: Robert | May 26, 2009 at 12:15 AM
"There's not enough capital....": what? You mean that they can't just deem it to exist?
Posted by: dearieme | May 26, 2009 at 02:25 PM