The Consequence of America’s Path

pathlongDear Readers,  

President Obama just authorized airstrikes in Iraq, which means America has officially entered a new war in the Middle East.

From Syria to Ukraine, from Israel to Iraq, and from Africa to Vietnam, the US continues to intervene in conflicts outside of its borders.

Unfortunately, this will cost America and its citizens – and anyone holding US currency – billions and billions of dollars.

But before you pass judgment on America’s ambitions in other countries, do not forget that the world’s most powerful nation received its status by doing exactly that: intervening in conflicts outside its borders.

If you are unsure of my meaning, go back to my letter, “China and Russia Strike Massive Blow to America” to get a better understanding of how America became the number one power, when the dollar received its world reserve status.

As a result of this world status, the monetary and fiscal actions of the US and the Fed are exported onto everyone around the world.

But why?

Here’s a simplified version:

  • The Fed prints dollars and lends it out to America and its citizens; its citizens then use these dollars to buy foreign goods and services.
  • The sellers of the foreign goods and services receive dollars as payment, but in order to use them at home, they have to exchange it for local currencies
  • The sellers exchange their dollars for local currencies by selling them to their respective central bank
  • The foreign central banks then takes the dollars and reinvests it. But since there’s no “safe” market large enough to soak up the amount of dollars, these foreign central banks invest it right back in the world’s largest “safe” market: US debt.

So the wheels continue to spin. Dollars go out in exchange for goods and services, and come back in the form of debt, or should I say, pieces of paper.

Since this money – or debt – is essentially “free” (see How the Government Borrows Money) it continues to rack up at an astonishing pace.

Just ask China:

china reserves

As I mentioned in my letter, “The Brink of War“, when the Fed prints, other central banks have to print local currencies in order to exchange it for the amount of dollars rushing into their country.

When the US allows for easy money via low interest rates or QE, it leads to an explosion of cheap credit and cash all over the world.

Because the dollar and US debt are widely spread amongst the world, it is also the primary cause of many of the world’s problems.

Rising commodity prices have devastated developing countries such as Egypt and Bangladesh. The media blames these issues on climate shock and global warming but the root is the devaluation of the dollar relative to commodities, and not other currencies.

It’s All Relative

While the dollar remains strong (relative only to other currencies), it has actually weakened substantially over the last thirty years.

Too often we value the strength of the dollar against other currencies, when the real value of the dollar should be based on its purchasing power; what the dollar can actually buy.

It doesn’t take a mathematician to see just how drastically the dollar has been devalued against goods and services since the end of the Bretton Woods System.

In order to keep up with the higher costs of living, society has relied on more debt to survive. This results in poor lending policies that add fuel to inflationary problems.

Such was the housing bubble and the financial crisis in 2008.

Since we also partake in the fractional reserve banking system, the idea of debt leverage compounds the situation into a serious black hole.

Money Printing Death Spiral

Since 2008, US national debt has doubled to over $17 trillion.

The problem is that printed money from the Fed’s unaudited account does not create economic activity; it simply makes the rich, richer and the poor, poorer.

Take a look a this chart from Pavlina R. Tcherneva of the Levy Economics Institute of Bard College in her paper, “Reorienting Fiscal Policy: A Critical Assessment of Fiscal Fine-Tuning“:

Screen Shot 2014-08-10 at 10.17.26 AM

The chart says it all.

Fed policy is supposed to help the economy, yet the biggest monetary stimulus in the history of mankind (QE) has produced the weakest recovery from a major downturn in US history.

That’s not because the money isn’t there; its because it hasn’t gone to the places that need it most.

Americans have blamed American banks for its loose lending policies that caused the housing bubble. In return, regulators have put pressure on banks to reduce lending to riskier customers – which, of course, are smaller businesses who need the money the most.

When you unleash a record-setting amount of money into the market, yet prevent small businesses from accessing those funds (the ones who need it most), the money gets fueled into other areas, such as financial institutions and the richest 1%.

From my letter, “The Subprime Crisis Obama is Allowing But Doesn’t Want You to Know”:

“The government wants banks to lend so people can spend, but people can only borrow so much based on their financial situation.

All of the money sitting at the banks from their sales to the Fed need to be lent out, so that the banks can make money on the interest while fulfilling their obligations to the government and the Fed to lend and stimulate the economy.

Since the average American can only qualify for a small loan, the banks have to resort to other practices.

They lend to those who can afford to borrow lots.

And the only ones with the capacity to borrow trillions of dollars are big funds and traders who collateralize the debt with other assets, such as stocks and financial assets, or hard assets such as gold and real estate.”

Remember, money is a measure of value. Just because you print more money, doesn’t mean you have more money.

Unless, of course, you’re the richest 1% who was able to borrow money for free and use it as leverage to invest in risky assets.

This is why so many nations are fighting back. They are tired of being victims to the monetary and fiscal policies of the US.

Rising Nations Fight Back

The US has enjoyed many years of prosperity and power as a result of the “liquid” abilities of its currency in world transactions.

But what happens when this liquidity runs dry?

Over the past few years, I have talked about how rising nations such as Russia, Brazil, India and China are beginning to work towards bypassing the dollar in trade.

China has already struck agreements with Brazil, India, and Russia to bypass the dollar. These nations are doing the same with each other, most recently with India and Russia, as I mentioned last week.

The BRICS nations have created a bank very similar to the Western-controlled World Bank and IMF and will soon deploy its capital to developing nations.

Beijing and Moscow have recently struck the world’s largest gas deal with details awaiting to be finalized. When it is concluded, the world’s largest energy importer will be trading with the world’s largest energy producer – all outside of the dollar*.

(*One of the main reasons why the US dollar became the world reserve currency is because of the oil agreements struck between the largest consumer of oil, the US, and the largest oil producing organization, OPEC.)

The finalization of the Russia-China deal, along with bilateral trades outside the dollar, will diminish America’s reserve currency status; thus, severely undermine the US Treasury market.

The Consequence of America’s Path

Since the US has no choice but to run major deficits every year, many of its bills are paid through the issuance of more debt.

So what happens when no one else wants to buy US debt? What happens if the US can’t afford to pay its bills and debt obligations as its Treasury market shrinks?

Actually, this has already happened.

QE was essentially unleashed because foreign nations could not afford to buy the amount of debt the US needed to borrow; that’s why the US turned to the lender of last resort, the bank roll of the unaudited Federal Reserve (see How the Government Borrows Money).

So the question is not what happens when other nations no longer want to buy US debt; we already know that: it borrows from the Fed.

The question we should be asking is: “What happens when the value of the dollar begins to diminish against other currencies, and not just goods and services?”

This is when world powers begin to shift. Keep your eyes on foreign exchange rates (as a group) relative to the dollar. Significant swings will mark the beginning of a major power shift.

Not So Fast

This isn’t something that will happen overnight, and no one – including China – wants the dollar to collapse.

China’s growth requires US economic strength. That’s why it will continue to buy US debt and has always been the largest foreign buyer of it.

As such, it has built a massive treasury of US currency. If the dollar collapses, China will suffer.

Unless, of course, it uses those dollars now to buy hard assets such as gold, land, resources, and infrastructure in foreign nations – just as the US has done over the past decades.

China Deploys Dollars

China has been unloading its war chest by buying resources, including gold, all over the world. I mentioned this in many of my past letters

But its also using its dollars to build numerous giant infrastructure projects all around the world.

This includes one of the world’s largest infrastructure projects, the Nicaragua Canal.

When completed, the Canal will be about four times the length of the Panama Canal, and will connect the Atlantic Ocean and the Pacific Ocean.

Via Global Times:

“With a planned capacity to accommodate ships with loaded displacement of 400,000 tons, the proposed 278-kilometer-long canal that will run across the Nicaragua isthmus would probably change the landscape of the world’s maritime trade, Wang, the billionaire behind the project, told the Global Times.
“The project is the largest infrastructure project ever in the history of man in terms of engineering difficulty, investment scale, workload and its global impact,” Wang, chairman and CEO of the HK Nicaragua Canal Development Investment Co (HKND Group), told Global Times reporters in an exclusive interview on Thursday.
…”Our canal lock is 15-meter-thick, hard steel. Imagine its size. [It’ll be] the world’s largest,” the 41-year-old Wang said.”

There are at least five megaprojects that are currently being planned or under construction, including the $32 billion China-Pakistan economic corridor and the $1.7 billion Baltic Pearl Project, according to media reports.

The construction of this canal will open up a new corridor for world trade between the East and West, while giving China the upper hand in trade negotiations. It will also plant one of the world’s largest infrastructures right in America’s backyard – just as the US has done in around China.

In the same Global Times interview with Wang, he was asked:

“Does digging a canal in the “backyard of the US” not bug you?”

His answer?

“No – Free, prosperous maritime trade benefits everybody, including the US.”

A World of Hypocrites

The world is filled with hypocrisy. There are Americans who protest against US involvement in wars overseas, yet vote for presidents whose policies allow the US to intervene. There are Canadians who oppose pipeline projects, yet drive expensive V8 gas guzzling cars and leave the heat on when they leave their house.

No one is innocent, and everyone is a hypocrite; myself included.

I may write about America’s problems, but that doesn’t mean I want America to fail.

The problem is that the truth is often hard to bear for those who choose not to believe it.

“People will generally accept facts as truth only if the facts agree with what they already believe.” – Andy Rooney

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Until next time,
Ivan Lo

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