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Power Mad Obama Offers Two Choices: Unconditional Surrender Or Default

Barack Obama is warning that if he does not get everything that he wants that he will force the U.S. government into a devastating debt default which will cripple the entire global economy.

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Barack Obama is warning that if he does not get everything that he wants that he will force the U.S. government into a devastating debt default which will cripple the entire global economy.  In essence, Obama has become so power mad that he is actually willing to take the entire planet hostage in order to achieve his goals.  A lot of people are blaming the government shutdown on the Republicans, but they have already voted to fund the entire government except for Obamacare.  The U.S. Constitution requires that all spending bills originate in the House of Representatives, and the House did their duty by passing a spending bill.  If the Senate or the President do not like the bill that the House has passed, then negotiations need to take place.  That is how our system works.  And the weak-kneed Republicans have already indicated that they are willing to give up virtually all of their prior demands.  In fact, if Obama offered all of them 20 dollar gift certificates to Denny’s to end this crisis they would probably jump at that deal.  But that is not good enough for Obama.  He has made it clear that he will settle for nothing less than the complete and unconditional surrender of the Republican Party.

Why is Obama doing this?  Why is Obama willing to bring the country to the brink of financial disaster?

It isn’t hard to figure out.  Just check out what one senior Obama administration official said last week

“We are winning…. It doesn’t really matter to us” how long the shutdown lasts “because what matters is the end result,” a senior Obama Administration official told the Wall Street Journal last week.

This is all about a political victory and crushing the Republicans.  Obama doesn’t really care how long this crisis lasts because he believes that he is getting the end result that he wants.

According to Obama, the Republican Party is just supposed to roll over and give him the exact spending bill that he wants and also give him another trillion dollar increase in the debt limit.

If the Republicans do not give him that, he is willing to plunge us into financial oblivion.

The funny thing is that most Americans do not want the debt limit increased.  According to one new poll, 58 percent of all Americans do not even want the debt ceiling to be increased by a single penny.

And recent polls show that Americans are against Obamacare by an average margin of about 10 percent.

But the pathetic Republican Party is actually willing to hand Obama a trillion dollar debt ceiling increase and fully fund Obamacare if Obama will at least give them something.

Unfortunately, Obama won’t even give them the time of day.

So don’t blame the Republicans for what is happening.  The Republicans have already compromised themselves to the point of utter disgrace.  If Obama had been willing to even compromise a couple of inches this entire crisis would already be over.

And nobody should be claiming that the Republicans won’t vote to end this shutdown.  They have already voted to end it.  The following is from a recent article by Thomas Sowell

There is really nothing complicated about the facts. The Republican-controlled House of Representatives voted all the money required to keep all government activities going — except for ObamaCare.

This is not a matter of opinion. You can check the Congressional Record.

As for the House of Representatives’ right to grant or withhold money, that is not a matter of opinion either. You can check the Constitution of the United States. All spending bills must originate in the House of Representatives, which means that Congressmen there have a right to decide whether or not they want to spend money on a particular government activity.

Whether ObamaCare is good, bad or indifferent is a matter of opinion. But it is a matter of fact that members of the House of Representatives have a right to make spending decisions based on their opinion.

Once again, the Republicans have already indicated that they are willing to fund Obamacare.  They just want Obama to throw them a bone.

And Obama will not do it.

So either the Republicans are going to cave in completely (a very real possibility) or we are going to pass the “debt ceiling deadline”.

What happens then?

Well, we would have more of a “real government shutdown” than thefake shutdown that we are having right now.

Once the federal government cannot borrow any more money, it will only be able to spend what it actually has on hand.  That means that a lot more government functions will have to shut down.

Money will still be coming in to the government, but it won’t be enough to fund everything.  According to the Wall Street Journal, the federal government will still have enough money to pay interest on the debt, make Social Security payments, make Medicare payments, make Medicaid payments, provide food stamp benefits and pay the military if they cut almost everything else out.

The other day, I suggested that the federal government could potentially start defaulting on interest payments on the debt as early as November.  But that would only happen if the federal government manages their money foolishly.

If the federal government managed their money smartly and saved cash for the interest payments as they came due, they would not have to miss any.

But when was the last time the federal government ever did anything “smartly”?

For the sake of argument, however, let’s assume that the federal government can manage money wisely and can save up enough cash ahead of time for large interest payments as they come due.

If that could somehow be managed, then according to Paul Mampillythe government would never need to actually default…

The U.S. Treasury always has money coming into its accounts. So its always got some amount of cash that it can use to pay interest on bonds. That’s especially true right now because the government is partially shutdown and there’s no cash going out from its accounts.

In fact, when you look at it the U.S. Treasury should simply have no trouble making interest payments on bonds that it has issued.

And there’s no restriction on the U.S. Treasury prioritizing interest payments. Why?

The obligation to pay interest is set by the 1917 Second Liberty Bond Act and laws that commanded the Treasury to pay interest on the debt. You can look this up in section 3123 of Title 31 of the U.S. Code and section 4 of the 14th Amendment of the Constitution and in Supreme Court precedent (Perry v. United States). It’s all there in black and white.

So the only possible way the U.S. defaults on its debt is if Barack Obama, President of the United States, instructs his Treasury secretary Jack Lew to default on the debt.

And according to the Washington Post, Moody’s has just issued a memo that also indicates that the federal government should be able to make all interest payments even if the debt limit is not increased…

In a memo being circulated on Capitol Hill Wednesday, Moody’s Investors Service offers “answers to frequently asked questions” about the government shutdown, now in its second week, and the federal debt limit. President Obama has said that, unless Congress acts to raise the $16.7 trillion limit by next Thursday, the nation will be at risk of default.

Not so, Moody’s says in the memo dated Oct. 7.

“We believe the government would continue to pay interest and principal on its debt even in the event that the debt limit is not raised, leaving its creditworthiness intact,” the memo says. “The debt limit restricts government expenditures to the amount of its incoming revenues; it does not prohibit the government from servicing its debt. There is no direct connection between the debt limit (actually the exhaustion of the Treasury’s extraordinary measures to raise funds) and a default.”

Of course the federal government would have to stop throwing money around like a drunk gambler at a casino in Las Vegas in order for this to work.

On the very first day of the government shutdown, the feds gave $445 million to the Corporation for Public Broadcasting.  Apparently Elmo is considered to be “essential personnel” by the Obama administration.

And according to CNS News, the U.S. Army has committed more than $47,000 to buy a mechanical bull during this “shutdown”…

The government shutdown may be keeping furloughed federal workers at home, but on Monday the U.S. Army contracted to buy a mechanical bull.

The $47,174 contract was awarded on Oct. 7 to Mechanical Bull Sales Inc. of State College, Penn.

So needless to say, there is some serious doubt about whether the federal government would be able to manage their money effectively in the event that the debt ceiling deadline passes.

And if the U.S. did start defaulting on debt payments, it would be absolutely disastrous for the global economy as I discussed in aprevious article

“A U.S. debt default would cause stocks to crash, would cause bonds to crash, would cause interest rates to soar wildly out of control, would cause a massive credit crunch, and would cause a derivatives panic that would be absolutely unprecedented.  And that would just be for starters.”

Other nations that we depend upon to lend us money would stop lending to us and would start dumping U.S. debt instead.

Could you imagine what would happen if China started dumping a large portion of the 1.3 trillion dollars in U.S. debt that they are holding?

It would be a total nightmare.  The collapse of Lehman Brothers would pale in comparison.

And already some banks are stuffing their ATM machines with extra cash just in case the general public starts to panic.

But none of this has to happen.

If Obama decides to negotiate with the Republicans, this crisis will likely end very rapidly.

If not, and we pass the “debt ceiling deadline”, the federal government will still have enough money to make interest payments on the debt as long as they manage their money correctly.

Unfortunately, Obama seems far more interested in playing political games than he is in solving our problems.

In fact, Park Service rangers have been ordered to “make life as difficult for people as we can” during this government shutdown.  Obama has apparently decided to punish the American people in order to get leverage on the Republicans.  Just check out the following example from a new Weekly Standard article

There’s a cute little historic site just outside of the capital in McLean, Virginia, called the Claude Moore Colonial Farm. They do historical reenactments, and once upon a time the National Park Service helped run the place. But in 1980, the NPS cut the farm out of its budget. A group of private citizens set up an endowment to take care of the farm’s expenses. Ever since, the site has operated independently through a combination of private donations and volunteer workers.

The Park Service told Claude Moore Colonial Farm to shut down.

The farm’s administrators appealed this directive​—​they explained that the Park Service doesn’t actuallydo anything for the historic site. The folks at the NPS were unmoved. And so, last week, the National Park Service found the scratch to send officers to the park to forcibly remove both volunteer workers and visitors.

Think about that for a minute. The Park Service, which is supposed to serve the public by administering parks, is now in the business of forcing parks they don’t administer to close. As Homer Simpson famously asked, did we lose a war?

The hypocrisy that Obama has demonstrated during this “government shutdown” has been astounding.

He has barricaded open air war memorials to keep military veterans from visiting them, but he temporarily reopened the National Mall so that a huge pro-immigration rally that would benefit him politically could be held.

He has continued to fund al-Qaeda rebels in Syria that are trying to overthrow the Syrian government, but he has been withholding death benefits from families of fallen U.S. soldiers.

The conduct of the Obama administration during this shutdown has been so egregious that is hard to put into words.  Obama has chosen topurposely harm the American people in order to score political points.

But this is how our politicians view us these days.  As Monty Pelerinrecently explained, most of our politicians have absolutely no problem with exploiting us for their own purposes…

The concept of political service has been replaced by that of masked exploitation. The public is no longer viewed as clients or constituents to be served. Instead they have become political prey. Politicians see the public as a collection of wallets and votes, fair game to be hunted as the means to expand power and wealth. Constituents are now the Soylent Green of the political food chain.

The political class assumes the public exists to serve them, not the other way around. Public participation beyond the lightening of wallets or the provision of votes is unwelcome. It is considered “interference” that must be deterred by the ruling class.

The political class is now a huge, voracious parasite. Like the plant in the Little Shop of Horrors, its needs have grown to the point where it threatens anything productive. Its needs now exceed the willingness for continued sacrifice on the part of the productive. The parasite threatens the very existence of the host.

The political Ponzi scheme of tax, borrow and spend has reached its limit. Either it will die when citizens turn on it or it will kill the productive, ensuring its own destruction.

It perishes in the end. Whether it takes civilization with it is the bigger question.

Is there anyone out there that still does not believe that our system is broken?

Hopefully cooler heads will prevail and power mad Obama will decide to toss the Republicans a few crumbs and this crisis will be resolved.

Because if this crisis is not resolved soon, it could have consequences that are far beyond what any of us could possibly imagine.

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Economy

Facebook Thinks You Are A Moron – Here Is The Chart Proving It

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Last week we jokingly wrote about a Facebook press release that was apparently an honest effort by the social media giant intended to summarize Russian efforts to undermine the 2016 election using their social media platform. That said, at least to us, it seemed as though Facebook unwittingly proved what a farce the entire ‘Russian collusion’ narrative had become as, after digging through advertising data for the better part of full year, Facebook reported that they found a ‘staggering’ $50,000 worth of ad buys that MAY have been purchased by Russian-linked accounts to run ‘potentially politically related’ ads.

Not surprisingly, after being attacked by the mainstream media and even Hillary for “assisting” the Russians, Zuckerberg is once again in the press today fanning the flames of the ‘Russian collusion’ narrative by saying that Facebook will release to Congress the details of the 3,000 ads that MAY have been purchased by Russian-linked accounts.

And while it seems obvious, please allow us to once again demonstrate why this entire process is so utterly bizarre… 

The chart below demonstrates how the $50,000 worth of ad buys that MAY have been purchased by Russian-linked accounts to run ‘potentially politically related’ ads compares to the $26.8 billion in ad revenue that Facebook generated in the U.S. over the same time period between 3Q 2015 and 2Q 2017….If $50,000 can swing an entire presidential election can you imagine what $26.8 billion can do?

Of course, not all of that $26.8 billion was spent on political advertising so we took a shot at breaking it down further.  While Facebook doesn’t disclose political spending as a percent of their overall advertising revenue, we did a little digging and found that political advertising represented ~5% of the overall ad market in the U.S. in 2016.  We further assumed that political share of the overall ad market is roughly half of that amount in non-election years, or 2.5%.

Using that data, we figure that Facebook may get ~3.5% of their annual revenue from political advertising in an average year, or nearly $1 billion per year…give or take a few million.  Unfortunately, as the chart below once again demonstrates, this still does little to support Zuckerberg’s thesis that the $50,000 he keeps talking about is in any way relevant to the 2016 election.

 

Of course, the pursuit of this ridiculous narrative proves that Zuckerberg has no interest in spreading the truth about how his company impacted (and by “impacted,” we mean “had no impact at all”) the 2016 election, but rather is only interested in shoving his political agenda down the throats of an American public that he presumes is too stupid to question his propaganda. 

That said, if Zuckerberg is really just on a mission for truth, as he says he is, perhaps he can stop patronizing the American public and disclose the full facts surrounding political advertising on Facebook.  We suspect a simple financial disclosure detailing how much political advertising was sold on Facebook from 3Q 2015 – 2Q 2017, broken down by political affiliation, would go a long way toward proving just how meaningless $50,000 is in the grand scheme of things. 

That said, somehow we suspect ‘truth’ is not really Zuckerberg’s end goal, now is it?

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Economy

Today’s Market Looks Like It Did At The Peaks Before Last 13 Bear Markets

The US stock market today looks a lot like it did at the peak before all 13 previous price collapses. That doesn’t mean that a bear market is imminent, but it does amount to a stark warning against complacency.

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h/t ZeroHedge 

The US stock market today looks a lot like it did at the peak before all 13 previous price collapses. That doesn’t mean that a bear market is imminent, but it does amount to a stark warning against complacency.

The U.S. stock market today is characterized by a seemingly unusual combination of very high valuations, following a period of strong earnings growth, and very low volatility.

What do these ostensibly conflicting messages imply about the likelihood that the United States is headed toward a bear market in stocks?

To answer that question, we must look to past bear markets. And that requires us to define precisely what a bear market entails. The media nowadays delineate a “classic” or “traditional” bear market as a 20% decline in stock prices.

That definition does not appear in any media outlet before the 1990s, and there has been no indication of who established it. It may be rooted in the experience of Oct. 19, 1987, when the stock market dropped by just over 20% in a single day. Attempts to tie the term to the “Black Monday” story may have resulted in the 20% definition, which journalists and editors probably simply copied from one another.

Origin of the ‘20%’ figure

In any case, that 20% figure is now widely accepted as an indicator of a bear market. Where there seems to be less overt consensus is on the time period for that decline. Indeed, those past newspaper reports often didn’t mention any time period at all in their definitions of a bear market. Journalists writing on the subject apparently did not think it necessary to be precise.

In assessing America’s past experience with bear markets, I used that traditional 20% figure, and added my own timing rubric. The peak before a bear market, per my definition, was the most recent 12-month high, and there should be some month in the subsequent year that is 20% lower. Whenever there was a contiguous sequence of peak months, I took the last one.

Referring to my compilation of monthly S&P Composite and related data, I found that there have been just 13 bear markets in the U.S. since 1871. The peak months before the bear markets occurred in 1892, 1895, 1902, 1906, 1916, 1929, 1934, 1937, 1946, 1961, 1987, 2000 and 2007. A couple of notorious stock-market collapses — in 1968-70 and in 1973-74 — are not on the list, because they were more protracted and gradual.

CAPE ratio

Once the past bear markets were identified, it was time to assess stock valuations prior to them, using an indicator that my Harvard colleague John Y. Campbell and I developed in 1988 to predict long-term stock-market returns. The cyclically adjusted price-to-earnings (CAPE) ratio is found by dividing the real (inflation-adjusted) stock index by the average of 10 years of earnings, with higher-than-average ratios implying lower-than-average returns. Our research showed that the CAPE ratio is somewhat effective at predicting real returns over a 10-year period, though we did not report how well that ratio predicts bear markets.

This month, the CAPE ratio in the U.S. is just above 30. That is a high ratio. Indeed, between 1881 and today, the average CAPE ratio has stood at just 16.8. Moreover, it has exceeded 30 only twice during that period: in 1929 and in 1997-2002.

But that does not mean that high CAPE ratios aren’t associated with bear markets. On the contrary, in the peak months before past bear markets, the average CAPE ratio was higher than average, at 22.1, suggesting that the CAPE does tend to rise before a bear market.

Moreover, the three times when there was a bear market with a below-average CAPE ratio were after 1916 (during World War I), 1934 (during the Great Depression) and 1946 (during the post-World War II recession). A high CAPE ratio thus implies potential vulnerability to a bear market, though it is by no means a perfect predictor.

Earnings to the rescue?

To be sure, there does seem to be some promising news. According to my data, real S&P Composite stock earnings have grown 1.8% per year, on average, since 1881. From the second quarter of 2016 to the second quarter of 2017, by contrast, real earnings growth was 13.2%, well above the historical annual rate.

But this high growth does not reduce the likelihood of a bear market. In fact, peak months before past bear markets also tended to show high real earnings growth: 13.3% per year, on average, for all 13 episodes. Moreover, at the market peak just before the biggest ever stock-market drop, in 1929-32, 12-month real earnings growth stood at 18.3%.

Another piece of ostensibly good news is that average stock-price volatility — measured by finding the standard deviation of monthly percentage changes in real stock prices for the preceding year — is an extremely low 1.2%. Between 1872 and 2017, volatility was nearly three times as high, at 3.5%.

Low volatility

Yet, again, this does not mean that a bear market isn’t approaching. In fact, stock-price volatility was lower than average in the year leading up to the peak month preceding the 13 previous U.S. bear markets, though today’s level is lower than the 3.1% average for those periods. At the peak month for the stock market before the 1929 crash, volatility was only 2.8%.

In short, the U.S. stock market today looks a lot like it did at the peaks before most of the country’s 13 previous bear markets. This is not to say that a bear market is guaranteed: Such episodes are difficult to anticipate, and the next one may still be a long way off. And even if a bear market does arrive, for anyone who does not buy at the market’s peak and sell at the trough, losses tend to be less than 20%.

But my analysis should serve as a warning against complacency. Investors who allow faulty impressions of history to lead them to assume too much stock-market risk today may be inviting considerable losses.

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Economy

The Demise Of The Dollar?

If you think the US dollar is on the way out, let’s look at currency flows, reserves and debt.

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So let’s look at currency flows, reserves, and debt.

The demise of the U.S. dollar has been a staple of the financial media for decades. The latest buzzword making the rounds is de-dollarization, which describes the move away from USD in global payments.

De-dollarization is often equated with the demise of the dollar, but this reflects a fundamental misunderstanding of the currency markets.




Look, I get it: the U.S. dollar arouses emotions because it’s widely seen as one of the more potent tools of U.S. hegemony. Lots of people are hoping for the demise of the dollar, for all sorts of reasons that have nothing to do with the actual flow of currencies or the role of currencies in the global economy and foreign exchange (FX) markets.

So there is a large built-in audience for any claim that the dollar is on its deathbed.

I understand the emotional appeal of this, but investors and traders can’t afford to make decisions on the emotional appeal of superficial claims–not just in the FX markets, but in any markets.

So let’s ground the discussion of the demise of the USD in some basic fundamentals. Now would be a good time to refill your beverage/drip-bag because we’re going to cover some dynamics that require both emotional detachment and focus.

First, forget what currency we’re talking about. If the USD raises your hackles, then substitute quatloos for USD.

There are three basic uses for currency:

1. International payments. This can be thought of as flow: if I buy a load of bat guano and the seller demands payment in quatloos, I convert my USD to quatloos–a process that is essentially real-time–render payment, and I’m done with the FX part of the transaction.

It doesn’t matter what currency I start with or what currency I convert my payment into to satisfy the seller–I only hold that currency long enough to complete the transaction: a matter of seconds.

If sellers demand I use quatloos, pesos, rubles or RMB for those few moments, the only thing that matters is the availability of the currency and the exchange rate in those few moments.

2. Foreign reserves. Nation-states keep reserves for a variety of reasons, one being to support their own currency if imbalances occur that push their currency in unwanted directions.

The only nations that don’t need to hold much in the way of currency reserves are those that issue a reserve currency–a so-called “hard currency” that is stable enough and issued in sufficient size to be worth holding in reserve.

3. Debt. Everybody loves to borrow money. We know this because global debt keeps rising at a phenomenal rate, in every sector: government (public), corporate and household (private sectors).(see chart below)

Every form of credit/debt is denominated in a currency. A Japanese bond is denominated in yen, for example. The bond is purchased with yen, the interest is paid in yen, and the coupon paid at maturity is in yen.

What gets tricky is debt denominated in some other currency. Let’s say I take out a loan denominated in quatloos. The current exchange rates between USD and quatloos is 1 to 1: parity. So far so good. I convert 100 USD to 100 quatloos every month to make the principal and interest payment of 100 quatloos.

Then some sort of kerfuffle occurs in the FX markets, and suddenly it takes 2 USD to buy 1 quatloo. Oops: my loan payments just doubled. Where it once only cost 100 USD to service my loan denominated in quatloos, now it takes $200 to make my payment in quatloos. Ouch.

Notice the difference between payments, reserves and debt: payments/flows are transitory, reserves and debt are not. What happens in flows is transitory: supply and demand for currencies in this moment fluctuate, but flows are so enormous–trillions of units of currency every day–that flows don’t affect the value or any currency much.

FX markets typically move in increments of 1/100 of a percentage point. So flows don’t matter much. De-dollarization of flows is pretty much a non-issue.

What matters is demand for currencies that is enduring: reserves and debt. The same 100 quatloos can be used hundreds of times daily in payment flows; buyers and sellers only need the quatloos for a few seconds to complete the conversion and payment.

But those needing quatloos for reserves or to pay long-term debts need quatloos to hold. The 100 quatloos held in reserve essentially disappear from the available supply of quatloos.

Another source of confusion is trade flows. If the U.S. buys more stuff from China than China buys from the U.S., goods flow from China to the U.S. and U.S. dollars flow to China.

As China’s trade surplus continues, the USD just keep piling up. What to do with all these billions of USD? One option is to buy U.S. Treasury bonds (debt denominated in dollars), as that is a vast, liquid market with plenty of demand and supply. Another is to buy some other USD-denominated assets, such as apartment buildings in Seattle.

This is the source of the petro-dollar trade. All the oil/gas that’s imported into the U.S. is matched by a flow of USD to the oil-exporting nations, who then have to do something with the steadily increasing pile of USD.

Note what happens to countries using gold as their currency when they run large, sustained trade deficits. All their gold is soon transferred overseas to pay for their imports. So any nation using gold as a currency can’t run trade deficits, lest their gold drain away.

Nations aspiring to issue a reserve currency have the opposite problem. They need enough fresh currency to inject into the global FX markets to supply those wanting to hold their currency in reserve.

This means any nation running structural trade surpluses will have difficulty issuing a reserve currency. Nations shipping goods and services overseas in surplus end up with a bunch of foreign currencies–whatever currencies their trading partners issue. This is opposite of the global markets need, i.e. a surplus (supply) of the reserve currency.

Any nation that wants to issue a reserve currency has to emit enough currency into the global economy to supply the demand for reserves. One way to get that currency into the global system is run trade deficits, as the world effectively trades its goods and services in exchange for the currency.

A reserve currency cannot be pegged; it must float freely on the global FX exchange. China’s currency, the RMB, is informally pegged to the USD; it doesn’t float freely according to supply and demand on global FX markets.

Nobody wants to hold a currency that can be devalued overnight by some central authority. The only security in the realm of currencies is the transparent FX market, which is large enough that it’s difficult to manipulate for long.

(Global FX markets trade trillions of dollars, yen, RMB and euros daily.)

This is why China isn’t keen on allowing its currency to float. Once you let your currency float, you lose control of its exchange rate/value. The value of every floating currency is set by supply and demand, period. No pegs, no “official” rate, just supply and demand.

If traders lose faith in your economy, your ability to service debt, etc., your currency crashes.

So let’s look at currency flows, reserves and debt. In terms of currencies used for payments, the euro and USD are in rough parity. Note the tiny slice of payments made in RMB/yuan. This suggests 1) low demand for RMB and/or 2) limited supply of RMB in FX markets.

The USD is still the dominant reserve currency, despite decades of diversification. Global reserves (allocated and unallocated) are over $12 trillion. Note that China’s RMB doesn’t even show up in allocated reserves–it’s a non-player because it’s pegged to the USD. Why hold RMB when the peg can be changed at will? It’s lower risk to just hold USD.

While total global debt denominated in USD is about $50 trillion, the majority of this is domestic, i.e. within the U.S. economy. $11 trillion has been issued to non-banks outside the U.S., including developed and emerging market debt:

According to the BIS, if we include off-balance sheet debt instruments, this external debt is more like $22 trillion. FX swaps and forwards: missing global debt?




Every day, trillions of dollars are borrowed and lent in various currencies. Many deals take place in the cash market, through loans and securities. But foreign exchange (FX) derivatives, mainly FX swaps, currency swaps and the closely related forwards, also create debt-like obligations. For the US dollar alone, contracts worth tens of trillions of dollars stand open and trillions change hands daily. And yet one cannot find these amounts on balance sheets. This debt is, in effect, missing.

The debt remains obscured from view. Accounting conventions leave it mostly off-balance sheet, as a derivative, even though it is in effect a secured loan with principal to be repaid in full at maturity. Only footnotes to the accounts report it.

Focusing on the dominant dollar segment, we estimate that non-bank borrowers outside the United States have very large off-balance sheet dollar obligations in FX forwards and currency swaps. They are of a size similar to, and probably exceeding, the $10.7 trillion of on-balance sheet debt.

So let’s wrap this up. To understand any of this, we have to start with Triffin’s Paradox, a topic I’ve addressed numerous times here. The idea is straightforward: every currency serves two different audiences, the domestic economy and the FX/global economy. The needs and priorities of each are worlds apart, so no currency can meet the conflicting demands of domestic and global users.

Understanding the “Exorbitant Privilege” of the U.S. Dollar (November 19, 2012)

So if a nation refuses to float its currency for domestic reasons, it can’t issue a reserve currency. Period.

If a nation runs trade surpluses, it has few means to emit enough currency into the FX market to fulfill all three needs: payment, reserves and debt.

As for replacing the USD with a currency convertible to gold: first, the issuer would need to emit trillions for the use of its domestic economy and global trade (let’s say $7 trillion as an estimate). Then it would need to issue roughly $6 trillion for reserves held by other nations, and then another $11 trillion (or maybe $22 trillion) for those who wish to replace their USD-denominated debt with debt denominated in the new gold-backed currency.

source

So that’s at least $24 trillion required to replace the USD in global markets, roughly three times the current value of all the gold in existence. Given the difficulty in acquiring more than a small percentage of available gold to back the new currency, this seems like a bridge too far, even if gold went to $10,000 per ounce.

Personally, I would like to see a free-floating completely convertible-to-gold currency. Such a currency need not be issued by a nation-state; a private gold fund could issue such a currency. Such a currency would fill a strong demand for a truly “hard” currency. The point here is that such a currency would have difficulty becoming a reserve currency and replacing the USD in the global credit market.

Issuing a reserve currency makes heavy demands on the issuing nation. Many observers feel the benefits are outweighed by the costs. Be that as it may, the problem of replacing the USD in all its roles is that no other issuer has a large enough economy and is willing to shoulder the risks and burdens of issuing a free-floating currency in sufficient size to meet global demands.

Of related interest:

How Dangerous Is Emerging Markets Dollar Debt?

$10.5 trillion in dollar-denominated debt

The Fed’s Global Dollar Problem Borrowers around the world have gone on a dollar binge. This makes them vulnerable when interest rates rise.




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