US Policymakers Are Hammering on a Land Mine — guest column by John Williams

US Policymakers Are Hammering a Land Mine

Statistician John Williams of is an expert on government economic statistics. If you have a need or desire to know what the real unemployment, inflation, and GDP growth rates are, whether real median income and retail sales are rising or falling, and whether the housing recovery is real of hyped, subscribe to his service.

With John’s permission I am reproducing here an excerpt from his latest report. John says that US policymakers are banging on a land mine with hammers.

October 4, 2013. Secretaries of the U.S. Treasury, chairmen of the Federal Reserve and presidents of the United States typically do their best not to roil the financial markets.  Presuming some innocent misjudgments, those efforts have not always worked out well.  For example, amidst an extraordinary confluence of negative factors, then-Treasury Secretary James A. Baker provided the proximal trigger for the 1987 stock-market crash of October 19th.  During the weekend preceding the panic, he announced that the United States no longer would support the U.S. dollar against the Deutschemark.  That started a panicked-run against the dollar (all dollar references here are to the U.S. dollar, unless otherwise indicated).

In September 2008, then-Treasury Secretary Henry M. Paulson and current-Federal Reserve Chairman Ben S. Bernanke allowed the failure of Lehman Brothers, with the purported assumption that a run on the banking system would not follow.  An otherwise foreseeable run on the banks and the U.S. dollar, however, followed, immediately, in the great panic of 2008.  The system has been reverberating ever since.  The U.S. fiscal crisis was exacerbated severely, as a result, and much of the ongoing, current economic and systemic-liquidity stresses can be tied to what were non-resolutions of the 2008 crisis (see Hyperinflation 2012).  Five years later, the federal government has shut down, and the U.S. debt ceiling problem has reached crisis level.  As noted in No. 527: Special Commentary of May 29, 2013:

Tap Dancing on Land Mines, Bernanke and Lew Are Not Necessarily Candidates for Dancing with the Stars.  With due deference to the song lyrics of rock group Aerosmith, Federal Reserve Chairman Ben S. Bernanke has been tap dancing on a land mine since 2008.  He has avoided detonating an intensified banking-system crisis, so far, but the cost has been that of locking the Fed into near-perpetual quantitative easing and monetization of U.S. Treasury debt, with horrendous implications for future domestic inflation and U.S. dollar debasement.  Crises in the economy, financial markets and systemic-solvency continue, with the post-2008 panic environment little moved towards sustainable and renewed normal activity, despite the fancy footwork.  Again, the Fed has locked itself into quantitative easing for some time to come, irrespective of any jawboning to the contrary.

“Mr. Bernanke’s new counterpart in the federal government, U.S. Treasury Secretary Jacob J. Lew, is just beginning his carefully orchestrated tap-dancing routine, trying to avoid hitting the new statutory debt limit on Treasury borrowings, along with the risk of detonating a new credit-market Armageddon and/or collapse in the foreign-exchange value of U.S. Dollar.  Secretary Lew is reasonably confident that he can keep his fancy footwork going through Labor Day (September 2nd) [now estimated at October 17th].  Despite any interim negotiating turmoil, with its potential impact on the credit rating of the United States and U.S. dollar selling, the Congress will have to take eventual corrective action. 

“Negotiations surrounding efforts to bring U.S. fiscal conditions into balance appear doomed to contentious political failure, at best, or to a compromised, smoke-and-mirrors balanced-federal-budget package at worst.  In the latter case, some among the U.S. public and in the U.S. markets might be misled into thinking that the fiscal issues had been resolved or the crisis contained, losing what limited time still might be left to address the actual fiscal disaster.  The longer-term U.S. sovereign solvency issues are the bane of the U.S. dollar and the global financial markets.  Unless these problems can be brought under credible control, those same global markets—soon and massively—will revolt against the U.S. dollar.”

Signal to the Markets: Long-Term Solvency Issues of the United States Will Not Be Addressed.  Instead of trying to promote orderly and stable markets, the Administration appears to have been playing an extraordinarily dangerous game, in recent days, trying to talk down the stock market, while counterbalancing some financial-market moves with intervention activity through the efforts of the President’s Working Group on the Markets (a.k.a. the “Plunge Protection Team”).  Created in the wake of the 1987 crash, it certainly was used in 2008, along with other extraordinary machinations by the Fed and Treasury.  It also clearly was used during the mini-panic in August 2011 to “stabilize” (boost) stocks.

Beginning to play with hammers around a land mine, the President recently suggested that the financial markets should be concerned about the shutdown/debt-ceiling crisis.  Related comments from the Treasury Secretary suggest looming economic and financial Armageddon, in the event of a default on U.S. Treasury securities.  The push appears to be to frighten the markets enough, so as to pressure a resolution of the government shutdown and debt-ceiling issues, without those controlling the government having to address federal fiscal-policy issues, meaningfully.  Such market-negative jawboning, however, also runs the risk of triggering an unintended panic or other unfortunate circumstance.

While a U.S. default indeed would be extremely damaging, it remains highly unlikely.  Separately, though, intensifying talk of pending default is the stuff of which rating downgrades are made.  The signal to the markets from the Administration’s current posturing is not that the U.S. government debt is at imminent risk of defaulting on its debt.  Instead, the increasingly clear message to the global markets is that the Administration will not take any meaningful action to address the long-term solvency issues of the United States. 

Sovereign states that issue debt in the same currency they print rarely default, except by deliberate political action.  Instead, they simply print the money needed to cover financial obligations that could not be covered otherwise with tax revenues, asset confiscations, etc.  The effect usually is full debasement of the currency, or hyperinflation.  Creditors get paid off, but with what has become a worthless currency.

Indeed, ahead is currency debasement, eventually complete debasement of the U.S. dollar.  As the global markets increasingly absorb that reality, selling of the dollar against the currencies of major U.S. trading partners should become intense, with pressure for removal of the dollar as the global reserve currency becoming unstoppable.  Oil and other dollar-denominated commodity prices would rise sharply in dollar terms, fueling domestic U.S. inflation, despite a moribund economy.  In like manner, the dollar prices of precious metals—particularly gold and silver—would move on to ever-increasing historic highs, despite any efforts by central banks and related plunge-protection teams to contain those prices with jawboning and covert or overt physical intervention, in the markets.

Developments of the last week have begun to take a toll on the dollar and the domestic equity markets.  The relative weakness in precious metals prices has been counterintuitive and almost certainly reflects direct market intervention aimed at depressing the price of gold, in particular.  Underlying fundamentals, however, will win out here, with the precious metals soaring in response to their role as a store of wealth, an asset class that preserves the purchasing power of wealth and assets.  Circumstances here will be addressed as necessary.

Walter J. “John” Williams
American Business Analytics & Research LLC
The Hearst Building
5 Third Street, Suite 1301
San Francisco, CA 94103 

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