Collapse At Hand

Federal Reserve
The Marriner S. Eccles Federal Reserve Board Building

Ever since the beginning of the financial crisis and Quantitative Easing, the question has been before us:  How can the Federal Reserve maintain zero interest rates for banks and negative real interest rates for savers and bond holders when the US government is adding $1.5 trillion to the national debt every year via its budget deficits?  Not long ago, the Fed announced that it was going to continue this policy for another 2 or 3 years. Indeed, the Fed is locked into the policy. Without the artificially low interest rates, the debt service on the national debt would be so large that it would raise questions about the US Treasury’s credit rating and the viability of the dollar, and the trillions of dollars in Interest Rate Swaps and other derivatives would come unglued.

In other words, financial deregulation leading to Wall Street’s gambles, the US government’s decision to bail out the banks and to keep them afloat, and the Federal Reserve’s zero interest rate policy have put the economic future of the US and its currency in an untenable and dangerous position.  It will not be possible to continue to flood the bond markets with $1.5 trillion in new issues each year when the interest rate on the bonds is less than the rate of inflation. Everyone who purchases a Treasury bond is purchasing a depreciating asset. Moreover, the capital risk of investing in Treasuries is very high. The low interest rate means that the price paid for the bond is very high. A rise in interest rates, which must come sooner or later, will collapse the price of the bonds and inflict capital losses on bond holders, both domestic and foreign.

The question is: when is sooner or later?  The purpose of this article is to examine that question.

Let us begin by answering the question: how has such an untenable policy managed to last this long?

A number of factors are contributing to the stability of the dollar and the bond market. A very important factor is the situation in Europe.  There are real problems there as well, and the financial press keeps our focus on Greece, Europe, and the euro. Will Greece exit the European Union or be kicked out?  Will the sovereign debt problem spread to Spain, Italy, and essentially everywhere except for Germany and the Netherlands?

Will it be the end of the EU and the euro?  These are all very dramatic questions that keep focus off the American situation, which is probably even worse.

The Treasury bond market is also helped by the fear individual investors have of the equity market, which has been turned into a gambling casino by high-frequency trading.

High-frequency trading is electronic trading based on mathematical models that make the decisions. Investment firms compete on the basis of speed, capturing gains on a fraction of a penny, and perhaps holding positions for only a few seconds.  These are not long-term investors. Content with their daily earnings, they close out all positions at the end of each day.

High-frequency trades now account for 70-80% of all equity trades. The result is major heartburn for traditional investors, who are leaving the equity market. They end up in Treasuries, because they are unsure of the solvency of banks who pay next to nothing for deposits, whereas 10-year Treasuries will pay about 2% nominal, which means, using the official Consumer Price Index, that they are losing 1% of their capital each year.  Using John Williams’ correct measure of inflation, they are losing far more.  Still, the loss is about 2 percentage points less than being in a bank, and unlike banks, the Treasury can have the Federal Reserve print the money to pay off its bonds.  Therefore, bond investment at least returns the nominal amount of the investment, even if its real value is much lower.

The presstitute financial media tells us that flight from European sovereign debt, from the doomed euro, and from the continuing real estate disaster into US Treasuries provides funding for Washington’s $1.5 trillion annual deficits. Investors influenced by the financial press might be responding in this way.  Another explanation for the stability of the Fed’s untenable policy is collusion between Washington, the Fed, and Wall Street. We will be looking at this as we progress.

Unlike Japan, whose national debt is the largest of all, Americans do not own their own public debt.  Much of US debt is owned abroad, especially by China, Japan, and OPEC, the oil exporting countries. This places the US economy in foreign hands.  If China, for example, were to find itself unduly provoked by Washington, China could dump up to $2 trillion in US dollar-dominated assets on world markets. All sorts of prices would collapse, and the Fed would have to rapidly create the money to buy up the Chinese dumping of dollar-denominated financial instruments.

The dollars printed to purchase the dumped Chinese holdings of US dollar assets would expand the supply of dollars in currency markets and drive down the dollar exchange rate. The Fed, lacking foreign currencies with which to buy up the dollars would have to appeal for currency swaps to sovereign debt troubled Europe for euros, to Russia, surrounded by the US missile system, for rubles, to Japan, a country over its head in American commitment, for yen, in order to buy up the dollars with euros, rubles, and yen.

These currency swaps would be on the books, unredeemable and making additional use of such swaps problematical.  In other words, even if the US government can pressure its allies and puppets to swap their harder currencies for a depreciating US currency, it would not be a repeatable process.  The components of the American Empire don’t want to be in dollars any more than do the BRICS.

However, for China, for example, to dump its dollar holdings all at once would be costly as the value of the dollar-denominated assets would decline as they dumped them. Unless China is faced with US military attack and needs to defang the aggressor, China as a rational economic actor would prefer to slowly exit the US dollar.  Neither do Japan, Europe, nor OPEC wish to destroy their own accumulated wealth from America’s trade deficits by dumping dollars, but the indications are that they all wish to exit their dollar holdings.

Unlike the US financial press, the foreigners who hold dollar assets look at the annual US budget and trade deficits, look at the sinking US economy, look at Wall Street’s uncovered gambling bets, look at the war plans of the delusional hegemon and conclude: “I’ve got to carefully get out of this.”

US banks also have a strong interest in preserving the status quo. They are holders of US Treasuries and potentially even larger holders. They can borrow from the Federal Reserve at zero interest rates and purchase 10-year Treasuries at 2%, thus earning a nominal profit of 2% to offset derivative losses. The banks can borrow dollars from the Fed for free and leverage them in derivative transactions. As Nomi Prins puts it, the US banks don’t want to trade against themselves and their free source of funding by selling their bond holdings.  Moreover, in the event of foreign flight from dollars, the Fed could boost the foreign demand for dollars by requiring foreign banks that want to operate in the US to increase their reserve amounts, which are dollar based.

I could go on, but I believe this is enough to show that even actors in the process who could terminate it have themselves a big stake in not rocking the boat and prefer to quietly and slowly sneak out of dollars before the crisis hits.  This is not possible indefinitely as the process of gradual withdrawal from the dollar would result in continuous small declines in dollar values that would end in a rush to exit, but Americans are not the only delusional people.

The very process of slowly getting out can bring the American house down. The BRICS—Brazil, the largest economy in South America; Russia, the nuclear armed and  energy independent economy on which Western Europe (Washington’s NATO puppets) are dependent for energy; India, nuclear armed and one of Asia’s two rising giants; and China, nuclear armed, Washington’s largest creditor (except for the Fed), supplier of America’s manufactured and advanced technology products, and the new bogyman for the military-security complex’s next profitable cold war, and South Africa, the largest economy in Africa—are in the process of forming a new bank. The new bank will permit the five large economies to conduct their trade without use of the US dollar.

In addition, Japan, an American puppet state since WWII, is on the verge of entering into an agreement with China in which the Japanese yen and the Chinese yuan will be directly exchanged.  The trade between the two Asian countries would be conducted in their own currencies without the use of the US dollar. This reduces the cost of foreign trade between the two countries, because it eliminates payments for foreign exchange commissions to convert from yen and yuan into dollars and back into yen and yuan.

Moreover, this official explanation for the new direct relationship avoiding the US dollar is simply diplomacy speaking. The Japanese are hoping, like the Chinese, to get out of the practice of accumulating ever more dollars by having to park their trade surpluses in US Treasuries. The Japanese US puppet government hopes that the Washington hegemon does not require the Japanese government to nix the deal with China.

Now we have arrived at the nitty and gritty.  The small percentage of Americans who are aware and informed are puzzled why the banksters have escaped with their financial crimes without prosecution. The answer might be that the banks “too big to fail” are adjuncts of Washington and the Federal Reserve in maintaining the stability of the dollar and Treasury bond markets in the face of an untenable Fed policy.

Read the 1st chapter of Obstacle to Peace for free!

Paul Craig Roberts

Dr. Paul Craig Roberts attended four of the finest universities, studied under two Nobel Prize-winners in economics, authored 20 peer-reviewed articles in journals of scholarship, and published four academic press peer-reviewed books, including Harvard and Oxford Universities, and seven commercially published books. His most recent book is The Neoconservative Threat to World Order: Washington's Perilous War for Hegemony

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  • Louise

    Good to see someone in the US is watching because the rest of the world is very aware of the situation that the US is in.

    The Euro will survive but it will take a decade to sort out. This means very slow growth for the US for the next decade because up until 2008 about 20% of America’s exports went to the EU. And you can forget about the EU buying military weapons from the US or getting involved in more US led wars.

    US financial commentators fail to realise how comfortable China’s neighbours are with China. Within five years the whole of East Asia including Japan, South Korea, the ASEAN countries and Australia and New Zealand will be doing trade using the Yuan and Yen.

    The members of the Shanghai Cooperation Organisations which is likely to include India, Afghansitan, Pakistan and Iran within a decade are all going to be doing trade suing the Yuan as well.

    The US dollar is on the nose to say the least and internationally it is no secret. I would put the downfall/collapse of the US at around year 2020 and by then internationally it will not matter nearly as much because much of the world will have already moved away from trade using the US dollar. Both China, India and the EU will have strong economies by 2020 and will be able to weather the storm.

  • Thanks for the excellent article.

    We’ve seen many predictions of doom over the years but they tend to be accompanied by little or no rational discussion about the root causes.

    Here Roberts provides detailed explanation of the current U.S. financial problems in accessible terms. And he even offers a solution!

  • Edward

    An apt title “Collapse at Hand”. Looking at the news tonight, if America is about to collipse it is intent on bringing the world down with it.
    The dogs of war are a hair’s breath from being unleashed.
    Pray that I am not right.

  • Great article. I can imagine most people won’t be able to stomach it but I completely agree and am glad to see some sanity in descriptions of the current situation and future situation.

  • Jon Harrison

    Very interesting article. The analysis is fascinating and, as far as this non-economist can tell, on the money (no pun). The one area where I would disagree with Roberts concerns the state of the world in 2020. The U.S. may very well be in desperate straits by then, but I doubt China and the EU (if it still exists) will have strong economies. Indeed, I think the internal problems in both places are actually worse than the challenges the U.S. faces. And if the U.S. market is gone (or largely so), where will China in particular export to?

    The author is also to be complimented for reining in his rhetoric — his arguments are so much more convincing as a result.

  • J

    -If you are on a dinghy, floating along with a slight leak in the lining of your craft and you only begin to realize this as you enter into the grand ocean currents globally and do not have a sufficient pump, nor supports to fix the apparent and obvious leakage of what supports your water craft….Then you will be S_ O_ L_, if, indeed you think ‘joe-blow’ is going to come to your rescue. Better: You PRAY that you make it to a shore with some miraculous speed…before you become -what is known as- “Shark Bait De Facto.”

  • Beverage Bob

    So does this mean that even the Gold and Silver markets are being manipulated before the collapse that it is still a good idea to buy Silver and Gold?

  • Beverage Bob

    Should have read:

    So does this mean that even though the Gold and Silver markets are being manipulated before the collapse that it is still a good idea to buy Silver and Gold?

    • Well, as Dr. Roberts notes, the markets are being manipulated in an an effort to suppress the price. So I’m not gonna give anyone any financial advise, but take from that what you will.