Ambrose Evans-Pritchard: Does U.S. face a run on its currency?

By Ambrose Evans-Pritchard
The Telegraph, London
Tuesday, September 23, 2008

http://blogs.telegraph.co.uk/ambrose_evans-pritchard/blog/2008/09/23/fin...

This just arrived in my e-mail from Alex Patelis, global strategist at Merrill Lynch.

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AS THE US PRINTING PRESS STARTS

Taking Stock

* Treasury buying mortgage-related assets: $700 billion.

* Potential supplementary stimulus package favoured by Democrats: $100 billion.

* Insuring money market funds: $50 billion.

* Treasury fortifying the Fed's balance sheet: $100 billion.

* Expansion of temporary swap lines with central banks: $180 billion.

* Loan to AIG: $85 billion.

* Fed purchase of agency discount notes abd ABCP: amount not specified.

* Fed loans through the Primary Dealer Credit Facility: $20 billion through Sept. 17.

* Fed's discount window: $33 billion balance.

* Treasury purchase of GSE MBS this month: $10 billion.

* Potential cost of Fannie/Freddie bailout: $200-$300 billion.

* Financing the current account deficit: priceless.

Investment implications: Sell the U.S. dollar.

"The fiscal cost to the United States is likely to be enormous. Speculation will intensify on a possible US government paper downgrade. US policy-making and credibility have been put into question. The safety of US assets has been put into question. We remain concerned with the repercussions that this crisis will have on the financial flows into the United States against the context of a still large current account deficit."

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Ouch!

Mr. Patelis has come within a whisker of warning that the US now faces a full-scale run on its currency and debt markets. There is certainly a risk that this could happen.

By my tally, the serial bailouts add $1.6 trillion to total US debt, or 12 percent of GDP (at least on paper). This is worse than the Swedish banking collapse in the early 1990s.

An entire generation of American policy-makers -- Clinton, Bush, Rubin, Greenspan, and the congressional leadership of both parties -- has come perilously close to ruining a great nation. The creation of the credit bubble was one of the most disgraceful episodes of economic government in western history.

Nothing can justify it. There is no parallel to the Spain of Phillip II, who ruined his empire to pursue the religious cause of counter-Reformation, or to the bankruptcy of the British Empire combating fascism. It occurred because America abandoned all restraint and gave licence to consumer hedonism.

Having said that, I still believe that the US has the cultural vitality to pull itself out of this debacle.

While I endorse Mr. Patelis' indictment, I do not entirely share his conclusions. The debt added is backed by collateral, mostly housing, and is therefore nothing like normal government debt.

Even if it were, the US general government debt (owed to the public, under IMF measures) would rise from 48 percent to 60 percent of GDP. Yes, I know the US "national debt" is higher, but that is not the relevant benchmark for worldwide comparisons.

This extra debt is a tax on the future. It is unconscionable, but it is not a catastrophe. It would still leave US debt at French or German levels, and well below those of Japan and Italy -- assuming that you believe the official figures.

I do not think it will come to this. The RTC made a profit in the early 1990s as the savings-and-loan crisis slowly abated. Paulson's "TARP" may do likewise. The ABX index used to price subprime debt almost certainly overstates the likely default rate.

Stephen Jen, currency chief at Morgan Stanley, says bank crises are bloody for currencies, but nationalizations of the banking system (which is what we have here, in disguised form) typically mark the bottom.

I do not share the widespread view that the dollar will collapse. This has prompted a volley of hostile comment, as if I was somehow turning traitor to the cause of bears, or had become an optimist overnight.

The reason why it will not collapse -- at least for now -- is that the euro is facing an even deeper and more intractable crisis, Britain is mangled, Sweden frozen, most of Eastern Europe is facing a swing from property boom to bust, Brazil is about to slow dramatically, Japan is in full recession, and China's banking system is buckling, as Fitch warned today.

What I envisage as this credit crisis goes turns into a full-fledged global economic slump is that half the world resorts to currency devaluation in a beggar-thy-neighbour scramble to stave off recession and cling to market share.

This will be very good for gold, though only once the EMU smash-up becomes more evident, perhaps with the onset of street protests in Spain. You won't have to wait very long.

To those GATA loyalists asking me why I never report on their claim that the gold price is manipulated by central banks, I can say only that it would be a full-time job to attempt to verify such assertions. I cannot judge whether China, Japan, Russia, emerging Asia, or the Mideast petro-powers are colluding in such practices, or ascertain why they would do so. And unless they collude, any unilateral efforts by the US to suppress gold would prove futile -- would it not?

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