That 70's Show Revisited

Sometime in the next couple of years we are going to see the virtual death of the dollar and its death is going to be perpetuated by the very recovery the administration is now engineering.

The death I speak of may not necessarily come in the form of terrible exchange rates, but it will definitely manifest itself in the form of very high interest rates and likely inflation as well (through commodities again).

Right now, we are all enjoying a period of historically low interest rates (the 3-month treasuries have almost no yield) due primarily to a flight to safety in the form of dollars following the worst market crash since "the great crash" and a collapse in virtually every other investment (except bonds obviously). This flight to safety means that there are hundreds of billions of dollars sitting on the sidelines earning almost no yield waiting for the gloom to pass so they can be reallocated in a more favorable manner (ie a potentially higher return). This will almost assuredly happen as the economy (and stock market) begin to recover at some point late this/early next year. The velocity of the recovery is going to be very important to how the return to equities unfolds.

The Obama administration has put out its budget (of which I have been very critical of their GDP forecasts), which will grow the debt by roughly 50% over the next 5 years in an effort to continue with efforts to stimulate the economy going forward. This budget is being coupled with an already high level of federal debt and consistent deficits that were racked up during the last administration (and before of course). All of this debt rolls over at regular intervals as determined by the term of the bonds sold when it was issued (and the interest rates vary with each auction), thus right now our debt service (and any new/rolled over debt) is quite low (in interest rate terms). The problem I see us about to run into could potentially destroy any recovery and really create even worse problems for years to come, as when the flight to safety ends, there will be no buyers at low rates for our debt. This potential lack of buyers in the near future means that rates will have to rise, which means a greater percentage of revenues will have to go to service payments (as opposed to things like health care/etc.) and it will also mean that a recovery in housing may get killed by rising mortgage rates.

The velocity of the recovery is very important here, as a fast recovery (like the administration is gambling on in its budget with 4% growth rates as soon as 2010) actually may be worse for the economy than a slow recovery due to the expected rapid rise in interest rates/inflation that a fast recovery will almost assuredly bring. Inflation is also a key worry here (obviously inflation isn't present now) because demand for commodities will increase during any recovery and a flight from treasuries will flood the market with dollars that will likely lose value and most commodities happen to be priced in dollars. Thus we may be simply jumping from the pot into the fire.

The reason I am against Obama's budget is not because I don't believe in the programs it supports (I do), but because the vastness of the deficit it creates may lead to worse economic conditions than we are facing now.

Cross posted at Daily Kos:
http://www.dailykos.com/storyonly/2009/3/31/715049/-The-Death-of-the-Dollar

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Comments

Welcome to EP SilverOz

My issue with "Stimulus" and deficit spending is it not following real Keynesian theory. The problem is they will not tie the jobs to U.S. citizens, perm residents.

Hence we have billions upon billions of contracts going to companies like IBM, who will assuredly offshore outsource the actual work. We also have GE, who also will offshore the work, same with Caterpillar.

So, by the equation, temporary deficit spending must increase domestic income in order to actually work.

So that's just the project spending, we haven't even gotten to the "tax cuts".

The Fed printing press is also a major concern and it's quite clear not only are other nation's wanting to decouple from the U.S. dollar, they literally want to get rid of the U.S. dollar as an international currency.

You might format your links. EP is different from DK in that there are a host of tools to help you format your posts. Check out the user guide on the upper left and there is also an admin forum. There is also an email system, so if someone is really stuck with formatting, they can email me for help (or post in the admin forum for help).

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I have a tendency to agree

And I've said so before- Keynes aside, there's a gigantic possibility that this method of spending will overshoot and crash the dollar.

At best, we'll hit it exactly on the mark (or within a billion or two), avoid major deflation, and reset the regulations to have this problem all over again in about 70 years.

As Robert Oak says above, the lack of tying the stimulus to *local* *domestic* production, and local self-sufficiency is the problem. The age of Manifest Destiny is over. We live on a finite world. We can't handle an eternally growing global economy. Time to figure out something else.
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Maximum jobs, not maximum profits.