classical economics
for analysis,  forecasting
and policy design

Dollar Nears Carrion
As Wall Street Vultures Eye Dying Economy
By Wayne Jett © October 14, 2009
    No one should be surprised when Wall Street’s organs on the Left and the Right get it wrong as they attempt to mold public thought on what should be done about the U. S. dollar.
    Keynes espoused manipulation of domestic interest rates to subsidize employment and exports, but he did not expressly promote currency devaluation in The General Theory because the world witnessed destructive devaluation in Weimar Germany. Yet New York Times economics columnist Paul Krugman heralds “the falling dollar [a]s good news” because it signals “subsiding … fear” and puts dollars in exporters pockets. Krugman fails to mention those dollars and more come from living standards of other Americans.
    The Wall Street Journal, for its part, rightly deplores the falling dollar, but sees it as a vote of no confidence in U. S. economic policy.  The dollar’s value problem does not flow from public opinion of policy, but from policy itself – much as an arithmetic result flows from the factors input. As Krugman intimates, U. S. policy intends and produces dollar devaluation.
Prying Open the Enigma
    If a stronger, stable dollar is its aim, the Journal should support real reform of U. S. monetary policy. Running bank credit rates up the ladder again would shut off credit to small and medium-sized business, as occurred in 2004-2006, while doing nothing to improve or stabilize dollar value. Despite its high interest rates, the Fed added liquidity in each of those years, finally cutting off new liquidity in 2007. By then, big banks and hedge funds were over-leveraged with liquidity which should have gone to level-headed small business.
    In ordinary times, these monetary concerns could be resolved, as often prescribed here previously, by allowing markets to set domestic interest rates (“float the Fed funds rate”) and by managing (draining) monetary base liquidity to achieve a target price of gold in the markets. But the second prong of this prescription (liquidity management) is complicated now by two important factors: (1) rampant criminal fraud in U. S. financial markets, and (2) degraded marketability of assets owned by the Federal Reserve.
The Fed’s Dilemma
    In order to drain monetary liquidity from the economy and thereby strengthen the dollar’s value, the Fed must have assets readily saleable for dollars. Until 2008, the Fed owned only U. S. Treasury securities, the most easily traded securities in the world. Now, however, the Fed instead owns $700 billion of Treasuries plus $692 billion of mortgage-backed securities, $133 billion of federal agency debt, $178 billion in term auction debt, $110 billion of other debt, $41 billion of corporate commercial paper, and other items totaling $2.18 trillion.  
    Having added about $1.2 trillion to the monetary base during the past year, the Fed has $700 billion of marketable Treasuries for use in draining excess liquidity. If the Fed sells all its Treasuries, its balance sheet would decline in quality and in amount to about $1.4 trillion, still 40% higher than in early 2008.
    What else could the Fed sell to drain dollar liquidity? All other of its assets were purchased by the Fed when their prices were sharply undercut by criminal fraud and manipulation in U. S. financial markets. Little or nothing has been done to remedy the fraud and manipulation. If the Fed were to attempt sales of those assets, market prices for MBS, agency debt and commercial paper almost certainly would collapse again. “Great Depression II” chairman Ben Bernanke wished to avoid could then proceed apace.
Where Congress Must Act
    The “little” done to remedy fraud and manipulation consists primarily of FASB clarifications of accounting rule 157 governing mark-to-market accounting of certain financial assets. This was done only under intense pressure from Congress, and it allowed banks to recover somewhat. Under similar pressure, the SEC repealed the “Madoff exemption” which allowed options market makers to counterfeit securities by selling shares short without delivering them. But Congress has not taken away the SEC’s unbridled discretion to ignore financial fraud whenever it wishes, as the SEC did throughout the 2008-2009 debacle.
    Neither Congress nor the “new” Obama SEC has restored the uptick rule repealed in 2007, which permitted Goldman Sachs and its customers to resume driving down share prices. Neither Congress nor the SEC has stopped Goldman Sachs from exploiting its high-frequency-trading secret software manipulative codes to take billions in profits from financial markets, first disclosed on July 4, 2009.
    These market conditions drove private capital from private investments into Treasuries and gold, and shut down bank lending to the private economy. This led the Fed to expand its balance sheet as described and, in addition, to engage in off-balance-sheet transactions rumored to be in the $10 trillion range. In addition, federal budget deficits soared near $2 trillion in 2009 and are projected well above $1 trillion annually for the next ten years. The Fed will be hard pressed to create more dollars to buy much of that debt.
    Nothing has been done to prevent or to punish manipulation of crude oil prices in dark, unmonitored markets for futures and swaps contracts. Crude oil prices manipulated to three times market destroyed global economic growth in 2008, and prices remain nearly twice what lawful markets would provide.
Reality Economics: Markets Require Justice
    Lawless financial markets serve the interests of the same dominant elite who control the Federal Reserve. If justice is to be brought to financial markets, it will be done only by overcoming the will and influence of those dominant elite who exploit the middle class through the markets. And, if this can be accomplished, why not take control of the Fed and end its service of their ends? These are worthy and difficult goals on which the nation’s destiny depends.
    Why is financial fraud, manipulation and crime the business of classical economic theory? Classical economics is reality economics. It targets real conditions in the economy which determine business risk outcomes of individuals and firms. Financial fraud is the central, driving element of reality economics in the U. S. today. As shown by the analysis above, monetary policy is closely related to and intertwined with financial fraud. Likewise, multi-trillion dollar federal budget deficits annually may be eliminated, but only through resolution of the market and monetary issues as described.
    Fiscal and monetary policy malfeasance is as much the design of Wall Street’s dominant elite as is criminal fraud in financial markets. Resolving one or all three of these great challenges will require the middle class to rise and defeat the dominant elite politically. ~