Printing Money Out of Thin Air Dooms All Fiat Currencies

* Last week I made two statements, which one reader picked up on:


1>  The Fed prints money out of thin air

2>  China’s currency and credit is a large part backed by their holdings of US dollars, which the Fed creates out of thin air.


I summarized with the following: “In other words, China’s money printing operations are legitimately supported by their trade surplus, while the US Fed is creating money out of thin air.”


The reader writes in: “Rick, if it’s true that U.S. dollars are created out of thin air. Isn’t the Chinese Yuan backed by foreign currency reserves actually backed by thin air? I think that’s the problem all around. Mr. Ponzi meet Mr. Ponzi”.


This notion had crossed my mind when I was writing the blog on Friday, which this reader picked up on. I did not want to get too dramatic about this particular way of looking at the global financial system. However, there is an inter-connectedness between the fortunes of many countries which own US dollars and Euros, with the nature of how the US and the Euro-zone are conducting their fiscal and monetary affairs. From a starting point of global dominance, the US and the Euro-zone has been the benchmark which other countries have measured their success by. And so it seemed that accumulating dollars, and more recently euros, was an appropriate way to accumulate ones currency reserves. Up until recently, the US and the Euro-zone had reasonable fiscal discipline and investing in the debt of these entities was deemed safe and risk-free. The response to the financial crisis of 2008 has been to move private company debts onto the government’s balance sheets, and a remarkable explosion of deficit spending, in order to counter-act the deflationary effects of the debt implosion, and wealth destruction.


And here is my gloomy take-away: if the rest of the world is so stupid as to rely on currencies which  are failing, then they deserve the disaster which befalls them, and to their nation’s treasury, when a mad scramble for something other than euros and dollars ensues. What tips the scale in favor of calamity and the ‘mad scramble’? In the book “This time is different” Carmen Reinhart and Ken Rogoff outline centuries of financial folly and default by countries large and small. Their take-away is that debt default is neither a rare event, nor is it un-common. I believe that this book, which was published early this year, helped inspire many hedge funds to purchase long dated, out of the money puts on US debt. (It seemed as if everyone was talking this trade earlier this year). Unfortunately, they would have been better served to wait for the spring seasonals to exert themselves, as rates are now a lot lower, and debt prices are a lot higher.


As the RBS piece outlines, about what a US debt crisis will look like, which I included in my blog a few weeks ago, when US debt goes, everything else denominated in dollars will go with it, since these assets are benchmarked off the US treasury’s rate structure. What Reinhart and Rogoff also point out is that it is difficult to forecast when a country passes the tipping point at which time their debt yields rises dramatically, and a full blown debt crisis occurs. For Greece, it occurred with a debt to GDP ratio of 130%. While the US’s external debt is around $9-10 trillion, this debt level seems far enough away from 130% (which would be $18 trillion) so as not be concerned about. Yet the US is running 10% budget deficits a year, and will quickly be approaching the 130% level in the next few years. If you add in the guarantees of FNMA, FHLMC and the FDIC, as well as the social security and medicare trust funds, which are invested in treasuries, then we are over the 130% level today! My best guess is that sometime between today and a few years from now, will there be a US debt crisis.


As I have stated before, the Fed could continue to print money, and by keeping the supply of treasuries off the open market, it is possible to avoid a debt problem. In turn, the growing supply of dollars will eventually force various asset categories to do well, and quite possibly the stock market too. Because the real estate markets are under such a state of siege, and housing costs comprise 40% of CPI, then it is likely that even if oil is rising dramatically, that CPI will show only modest increases, giving the Fed cover to print money. 


A debt crisis is not necessary, but is a very real possibility. And one should be prepared with strategies to implement if the Fed circumvents a debt crisis by printing money. Readers of this piece will know that the only asset category I have any faith in is gold, and preferably in offshore accounts and away from the long (taxing) arm of the government. Gold should do well if the Fed prints money, or if there is a collapse of the dollar. For some reason, if fiscal discipline prevails, then budget cuts will push the US into an economic depression, which is why I am also keenly on the look-out for a falling stock market. Somehow, I do not think that the spend and pretend, Obama administration, knows what fiscal discipline is all about. The other reason why I am concerned about a falling stock market, has to do with the massive amounts of wealth destruction which has occurred over the last few years, which is deflationary. Regardless of how this plays itself out, we are moving towards an end-game which I do not think can end well. And unfortunately for our trading partners, who are blindly invested in our currency, the situation is not likely to change any time soon. The crisis which will ensue will create consequences of global importance.