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US Government Facing Fiscal Armageddon- US Dollar in Deep Trouble

Economics / US Dollar May 06, 2008 - 02:23 PM GMT

By: Money_and_Markets


Best Financial Markets Analysis ArticleWhen a president tells you the economy's OK and wannabe presidents tell you it's a disaster ... or when Wall Street pundits change their story almost daily ... I can understand how it may be tough to know what to believe ... and even tougher to decide what to do.

But when three respected government agencies put out reports and data that unanimously lead to the same conclusion about the most important factor in your financial future, there's no room for disbelief, no excuse for inaction.

That's precisely the situation we have today:

Three non-political, fact-based government reports point to a single outcome: A long-term decline in the U.S. dollar.

This is not to say the dollar will fall in a straight line. Quite the contrary, as Jack Crooks has correctly pointed out, dollar rallies are inevitable and some may not be trivial. But the big picture for the dollar is clear: Down.

My Two Committments

I'm committed to doing everything in my power to help support the U.S. dollar. And in the interim, I'm equally committed to helping you protect yourself from the consequences of its decline.

That's why I'm Chairman of the Sound Dollar Committee, a nonprofit, non-partisan organization that was instrumental in helping President Dwight D. Eisenhower balance the federal budget in 1959, the last truly balanced budget in American history.

That's why I've been warning you so persistently about the fundamental threats to the U.S. dollar today.

And that's why, right now, I want to lead you on a step-by-step tour of the three government reports. They unlock the key to our future as a nation. Plus, they provide some revealing secrets for your success as an investor.

Saving Our Future requires Tough Choices Today

Report #1
GAO Predicts U.S. Government Faces Fiscal Armageddon

The U.S. Government Accountability Office (GAO) — the auditing arm of the U.S. Congress — warns that the nation's deficits and debts are now so overwhelming, America may face fiscal Armageddon.

Unfortunately, the warning has fallen on deaf ears — so much so that long-time GAO head David M. Walker has recently resigned, hoping he can get his message out more effectively on his own. His main points:

1. The federal deficit is not something that comes and goes. It's built in. It's very large. And its growth trajectory takes America on a veritable collision course with bankruptcy! According to the GAO, unless radical fiscal reform is instituted quickly, the U.S. federal deficit could reach 20% of GDP , or five times greater than the worst level of this century.

2. State and local deficits are on a similar path. Thus, any efforts to shift some of the fiscal burden from federal to local governments will be futile.

3. This astronomical — and potentially devastating — growth in our debt has little to do with the ups and downs in the economy and has everything to do with locked-in, predictable aging of our population.

For years, we've heard warnings about baby boomers retiring, collecting benefits and becoming a drain on the economy. And for years, no one seemed to care; it was too distant in time. But now the day of reckoning is here as the first baby boomers started collecting Social Security benefits late last year.

So from this point onward, the bill is starting to come due: Nearly 80 million Americans becoming eligible for Social Security retirement benefits over the next two decades — an average of more than 10,000 per day. But ...

4. The burden of the government's future obligations for Social Security pales in comparison to the burden for Medicare. In fact, the government's future obligations for Medicare Part D alone exceed all of the unfunded obligations for Social Security.

5. Even if the economy could somehow grow much faster, it would not be enough to solve the problem. For that, you'd have to see our GDP expand at 10% or more every year for the next 75 years!

6. If corrective action is not taken now, then later, when deficits get out of hand, the only way to close the gap will be to cut federal spending by 60% or double all taxes — fiscal shocks that would crush the U.S. economy and depress it for decades.

7. Overall, the federal government's fiscal burden — including expected Social Security, Medicare and other liabilities — totals $50.5 trillion, or $400,000 for every full-time worker in America.

For The U.S. Dollar, These Huge and Growing Burdens Are a Perpetual Deadweight

The deficits and debts help explain ...

  • Why the U.S. economy lags behind the economies of Europe, Asia and Latin America when it's expanding ... and is likely to sink faster when it's contracting ...
  • Why the Fed is forced to continually inject more devalued money into the economy, and ...
  • How — recession or no recession, Fed or no Fed — the obvious absence of fiscal discipline translates into long-term deterioration in the U.S. dollar.
Flow of Funds Accounts of the United States

Report #2
$48.8 Trillion in Credit Market Debts

Most people think that, with such large federal deficits year after year, the U.S. Treasury would have accumulated the largest debt of any sector.

Yes, they are big. But they're not the largest.

According to the Fed's latest Flow of Funds report tabulating all U.S. credit market debts at year-end 2007 ...

  • Corporate debts are more than double the size of the Treasury's ($10.7 trillion vs. $5.1 trillion).
  • Mortgage debts are even larger — $14.6 trillion.
    Private-Sector Debts Far Exceed U.S. Treasury Debts
  • And the grand total, including all debt categories, is $48.8 trillion — or more than triple America's entire GDP.

As a whole, these debts are also a huge, long-term burden on the dollar for three fundamental reasons:

1. These $48.8 trillion in credit market debts are a continuing drag on the U.S. economy, especially when many of them start to go bad, as they are doing now ...

2. These debts are another major excuse for the Fed to pump in cheap money to ease the burden, and ...

3. These debts are also a strong incentive for politicians to simply let the dollar fall in value, helping the government and other debtors repay their debts with cheaper money.

But the $48.8 trillion debt reported in the Federal Reserve's Flow of Funds report is merely the tip of the iceberg. It does not include the contingent obligations of the U.S. government, which I told you about under Report #1. Nor does it include the massive amounts tied up in derivatives, the subject of the next government report ...

OCC's Quarterly Report

Report #3
OCC: The Notional Value of U.S. Derivatives is Now $164.2 Trillion!

Derivatives are, in essence, another form of debt.

But based on the conclusions of the Office of the Comptroller of the Currency (OCC), it's safe to say that they are far riskier than ordinary debts. Here's why:

1. The OCC's data makes it abundantly clear that the amounts involved are excessive and that they've mushroomed at an alarming pace in recent years.

Just 12 years ago, the total notional value of derivatives held by U.S. commercial banks was $16.8 trillion, and we thought that was a lot. At year-end 2007, it was $164.2 trillion, nearly ten times larger.

2. The credit risks associated with derivatives have also grown by leaps and bounds. In the last year alone, they're up by a whopping 67%.

3. Nearly all of the derivatives are traded "over the counter" — outside the purview of established exchanges. For the most part, it's a regulatory no-man's land.

4. For the longest time, we have warned that big losses in derivatives could strike U.S. banks. And sure enough, for the first time in history, that's precisely what has happened: In the fourth quarter of 2007, U.S. banks lost a whopping $9.97 billion in derivatives, proving how risky they really are.

5. These risks are heavily concentrated among just five major banks that account for 97% of all derivatives held in the U.S. banking system, and 87% of the credit exposure.

Total Credit Exposure of Derivatives

6. Among four of these five banks, the credit exposure from derivatives is greater than their capital. And among two of the five — JPMorgan Chase and HSBC — the exposure is over four times their capital (see table).

And again, we see a negative long-term impact on the dollar:

The derivatives crisis is aggravating the housing bust and the recession.

The recession, in turn, is bound to depress the dollar.

And as the Fed fights back with more injections of cheap money into the banking system, the long-term impact on the dollar is to drive it still lower.

My Recommendations

First, look to use a strong dollar rally as your window to diversify out of the dollar into the world's strongest currencies.

They're not risk free. So we don't recommend rushing out and buying them in large amounts immediately. Nor do we advocate selling all your dollars or dollar investments. But if the dollar rallies, it will be a good time to buy some protection — using ETFs dedicated to currencies like FXA (Australian dollar) and FXY (Japanese yen).

Second, the next rally in the dollar will be your opportunity to add to other contra-dollar assets like gold (using ETFs like GLD) as well as key commodities.

Above all, stick with the strategies we recommended in our issues. Despite any ups and downs, no matter how sharp, the big-picture direction of the markets is clearer than ever.

Good luck and God bless!


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