Japan has begun a "race to the bottom" this week, embracing inflation to cheapen their Yen and encourage sales of their export products. Meanwhile, in Virginia, farsighted members of the State House — realizing that the U.S. will have little choice but to follow suit and further devalue the dollar to compete — voted to study the viability of issuing their own more stable metal-backed money. These developments are just a sampling of the many indicators of the decay of fiat currencies, and people's confidence in them. Evidence shows that governments have obviously gone "all in" on the concept of funding their profligate stimulus programs and spending by borrowing and creating more money.
What has become of all the freshly printed money recently injected into the markets and how will it be taken back out of circulation? (shorthand: most of the created dollars aren't physically "printed" but rather are created in the paper trade between the Treasury, the Federal Reserve, and investors). The wondrous upside for government is that they get to spend the new money first, before the ripple of inflation cheapens it for the rest of us increasing the cost of all of the goods and services we buy. But where is this feared inflation? Nominal rates are running at less than 2% if you don't see past the government accounting tricks.
One of the main reasons we haven't yet "felt" the real inflation is that the majority of bailout funds and earnings have been cautiously stowed in corporate cash reserves instead of being invested in growing the economy as planned.
Who can blame Virginia or corporate America for their trepidation? The easy money policies of the Federal Reserve, Britain, and now Japan have been lauded as good medicine for a sluggish economy. Since the 2008 meltdown almost collapsed the world's banking and insurance industries, central banks have dumped an unprecedented volume of cash into the system. In fact by some reckoning the money supply has increased at an average rate of 10% per year every year since then. That means the number of dollars will double in 7.2 years. With twice as many dollars in existence in the year 2015, is there any scenario in which there will not be massive inflation?
Peter Schiff explains in his recent article in The New American how businesses and central banks are already moving out of the USD and repatriating their gold reserves. More importantly, though, we need to be wary of central banks and multi-national corporations ditching their dollar holdings. There are an estimated $16 trillion held in foreign reserves. Trillions more sit in corporate vaults. There can be no doubt that those holding those shaky fiat dollars have noticed the increase in supply and the decrease in demand.
"The most likely direction of instability will be higher inflation. First, the Fed is increasing the supply of money relative to the demand for dollars in an explicit effort to lower interest rates and spur consumption. Too much money relative to the demand for money cheapens the dollar and leads to higher prices.
Second, this process feeds on itself. By increasing the risk of inflation, the Fed's policy has made holding dollars more risky which produces a fall in the demand for dollars — individuals and businesses alike seek to avoid holding any asset whose value is in decline. An, as Forbes' Charles Kadlec, says, "a fall in the demand for dollars in the face of rising supply adds fuel to inflationary pressures."
Meanwhile, Japan and China, whose trade used to be conducted in dollars, have moved to eliminate the USD as their volatile "go-between" and begin trading directly in their own currencies. OPEC, tired of having to do oil business in mercurial dollars, has resumed talk of creating their own more stable "petro dollar." Several smaller countries have dropped the USD altogether.
None of the major banks can claim to have seen the 2008 debacle coming. This "dollar bubble" portends a much larger threat that has slowly been building almost under the radar. Americans have found great pride and solace in the fact that the dollar is the reserve currency of choice for most of the nations in the world. This privileged status led many economists to brush aside concerns about the massive creation of dollars. After all, 60% to 70% of the reserves of foreign nations consist of dollars. The USD can't possibly be devalued since it is so widely relied upon, right?
One has to wonder though, what happens if there is a "bank run" similar to the inflationary Nixon Crash that led to the U.S. fleeing the gold standard? It could begin with a credit downgrade or a regional war, or a small, third world country quietly selling off their dollar reserves to preserve the credibility of their own currency's backing. As the currency markets took notice perhaps others would dump a discrete portion of their own dollar reserves. The dip in dollar exchange rates might catch the attention of other private holders of large dollar caches who would also hedge against the declining greenback.
When pressed, the Fed's only reply is that they can fix sudden inflation by large increases in domestic interest rates. To me, this would appear to investors like a white flag of surrender, further dashing confidence in the U.S. economy. They provide no contingency plan for large scale dollar dumping because mainstream economists consider it unthinkable. The hubris of "too big to fail” has gone global.
The sell-off, along with the steady bleeding created by the pumping printing press ($4.5 billion per day), cannot bode well for the survival of the once mighty dollar. Good thinking, Virginia.