U.S. Dollar Attacked by Central Bank Lilliputians Profting From the Carry Trade

Currencies / US Dollar Oct 21, 2009 - 02:40 PM
By: Jim_Willie_CB

The US Federal Reserve continues to talk about their urgent Exit Strategy. My theory is they will be doing mostly talking and almost no doing. The nations that talk the least will be hiking interest rates the most, like Australia. The United States might be dead last in hiking interest rates. The credibility of the USFed will in the process continue to be harmed much more than already, which is rock bottom. The Dollar Carry Trade and the lost Petro-Dollar advantage will work to destroy the USDollar as the global reserve currency. The USFed will have to resort to unusual means to keep the world ‘interested’ and ‘involved’ in the USDollar at all. When they lose interest and involvement, the US$ will descend into the Third World. The USDollar will then be forced to find its true value, based on its own merit.

Outsized federal deficits, widespread insolvency, absent industry, refusal to reform the financial sector, bad bank loans festering on balance sheets, Goldman Sachs still in syndicate control of the USGovt finance ministry, the costly drain of endless wars, these are the new fundamentals for the USDollar. It is certain to descend by 30% to 50% in the coming few years. The word on the street has it that with the new IMF role in establishment of a currency basket, the USDollar is isolated sufficiently for a massive devaluation. The maestros have a tough challenge though, as they must halt the move of gold to $2000 and must avert an outright USDollar collapse.

THE SOPHIE CHOICES

In the last few years, three Sophie Choices have been faced. The first was in 2005 and 2006 to cut the credit supply to the housing & mortgage finance bubble, or to support the USEconomy that was dependent on the bubble. They could not do both. They chose continuity of the bubbles and support of growth, even though sick growth. The second was in 2007 and 2008 to cut interest rates and support the housing recovery if possible, or to support the USDollar by keeping rates high. They could not do both. They chose the fatal 0% interest rate path, even though it is a colossal trap. Besides, Wall Street loves free money. They thus migrate from bond fraud to carry trades on home soil with free money. The third was in 2009, to support the USTreasury Bond with federal fiscal restraint and a withdrawn hand from monetization of debt, or to support the USDollar with an official rate hike and control of monetary growth. Remember the promise that the official 0% rate would be a temporary feature? They could not do both. They chose unspeakable hidden monetization of debt and USTBond survival, with an unpublicized plan to let the USDollar fall significantly.

My forecast was for continued funding until the system broke for choice #1 (true). My forecast was for a move to 0% rates since it aids the bank exploitation for choice #2 (true). My forecast was for continued free money, hefty monetization, and amplified credit derivative control for choice #3 (true). It is actually easy to forecast some USFed decisions, since they do whatever is best for bubbles and Wall Street, the concerns and priorities of the nation secondary. We see that in spades with defiance on USFed challenges for disclosure and audits, conducted by the unwashed plebeians.

The situation has grown complicated. The third choice continues to resurface. The underlying threat behind a hike in interest rates is the risk of credit derivative explosion. Something like $500 to $600 trillion in Interest Rate Swaps has kept the out-of-whack cost of money ultra-low for almost two decades. By means of Interest Rate Swaps, the JPMorgan wizards can use short-term dictated Fed Funds rates to control the long-term USTreasury Bond and thus mortgage rates. So a USFed official rate hike would torpedo the IRSwap complex and cause serious collateral damage like the death of JPMorgan itself. Oops! That is a factor the officialdom wishes not even to discuss. Also, much easier for the unwashed to comprehend, an official rate hike would force mortgage rates to rise.

The housing market is nowhere prepared for a recovery or even a true stability for another two years. The hidden housing inventory maintained by banks, burdened by their foreclosure portfolios, assures constant overhang of supply to pressure prices down. Banks have been compelled to make their own Sophie Choice. They can either flood the market with foreclosed homes, thus pushing down home prices by another 30%, or conceal their hidden inventory like just another off balance sheet game, thus perpetuating the housing bear market. My forecast has been for perpetuation of the hidden inventory, since it is based upon government help and false hope. The bankers expect some meaningful home loan modification, but will not receive it. They expect some stability for a housing market generally based upon vaporous historical precedent.

LILLIPUTIANS JOIN ON DOLLAR CARRY TRADE

A new factor expands the powerful forces to keep the USFed at bay, and continue in perpetuity its highly destructive 0% official rate. This story has many sides. Obviously, financial firms worldwide, even some enlightened Wall Street firms who can manage to keep their game offshore, have joined the Dollar Carry Trade enterprise. They borrow USDollars at 0% and expect the US$ exchange rate to continue its trend down. Their object investment is a strong liquid anti-US$ asset like crude oil, gold, or German long-term bonds. The requirement to profit is usage of a non-US$ asset as the investment. The story of carry trades was told in a September 23rd article entitled “New Deadly Dollar Carry Tradeâ€