Stable dollar rests on sand

By F. Willam Engdahl (*)

I have written several times in recent months in these pages about the danger of an imminent dollar collapse and, with it, a danger of the collapse of the largest bubble in financial history-the US real estate bubble. Yet the dollar has been remarkably stable, this, despite the incredible devastation of hurricane Katrina and Hurricane Rita and the huge cost in lives and materiel of the Iraq war. Why has this been so?

Today, to make matters more precarious, the US has a de facto 'lame-duck' President. It is undergoing a wave of major corporate Chapter 11 bankruptcy filings from United Air to Delphi, the US' largest auto parts supplier. The US economy has not been able to create new jobs of any significance. The average disposable income is stagnating, and personal debt levels are going through the stratosphere, as people desperately borrow money at very low interest rates to buy vastly over-valued houses. The Federal budget deficit again recorded a near record size of over $318 billion.

Why would anyone in their right mind want to own dollars? That's a very good question.

Recent Federal Reserve Flow of Funds data just released, is worth noting. Alan Greenspan prefers to focus his soothing comments on the fact that total Household Net Worth has risen faster than ever before in US history. That is due to the effects of the housing bubble, of course. Net Worth, which includes market value of homes, has risen from $42 trillion in 2000 to $50 trillion today. That is about 20% over 5 years. Not bad were it normal times. But these are no normal times.

In the same time period, Total Credit Market Debt (Z-1) has gone to $38 trillion by September 2005, a rise of 51% since the beginning of 2000. That means that while asset prices of homes and Household Net Worth has risen by 20% in the past five years, total debt of the economy has risen more than twice as fast. And, not surprisingly, home mortgage debt has gone from $7 trillion in 2000 to $11 trillion today, an increase of 57%. By any measure including Net Worth of Households, the US economy in aggregate is worsening and sinking into an unprecedented debt trap of Texas-size dimension.  

Add to this picture the fact that the Bush priority, a domestic Social Security privatization law, which Wall Street was desperately hioping would provide new juice for the stagnant US stock market and financial markets, that legislation is completely 'dead in the water' as the Washington expression goes.

The Dow Jones Industrial stocks have been more than stagnant this entire year largely as a result of the lack of major new capital inflows from private savers. After disasters like the Enron collapse and the catastrophic fall of the NASDAQ IT stock bubble in 2001, Americans, who had invested their income in stock plans for their retirement only to see the retirement go up in flames with the stock market fall, have turned to investing every penny they can borrow in buying a new home, sometimes two or even three, all on credit, in hopes of using the income from renting the home to provide for their retirement security.

The grim reality however, is that the prices of US homes, which are going through the roof as home-buying turns into a Tulip-speculation mania, are just as vulnerable to collapse as the IT stocks of WorldCom or Enron. The only thing preventing collapse that has been the stability of the US dollar which prevents foreign central banks and foreign banks and pension funds from fleeing their hundreds of billions invested in US government and corporate bonds and stocks. Why is the dollar so important? Because the US is the world's greatest not only in military power projection. It is the world's greatest net debtor-some $3.7 trillion is owed to foreign creditors. If they were to demand payment suddenly, the dollar would collapse as money left. That would force the US central bank to raise interest rates far higher than today. That high interest rate process in turn would not only kill the real estate and home buying mania. It would collapse the bubble of inflated real estate prices, lead to millions of Americans defaulting on their home mortgage payments and likely cause a wave of bank failures worse than the early 1930's.  

One myth which is being used to keep foreign interest in US bonds and other assets is the lie that despite record high $63 a barrel oil prices, inflation is 'no worry.' The latest Consumer Price Inflation number was the biggest rise since 1980. But because markets have accepted the fraudulent hoax of 'core inflation,' CPI stripped of energy and food, the reaction was subdued, as 'core' rose only .1%. Weak Industrial Production and Capacity Utilization, and a Michigan Sentiment survey that was the lowest since March 1992 all showed a struggling economy.  The Treasury Budget closed out the government's fiscal year with a 2005 federal deficit (after subtracting the Social Security Trust Fund income), up to $318.6 billion.  The deficit falls short of 2004's record high mark of $412.9 billion, but it is still the third largest deficit on record. The huge costs of hurricanes Katrina and Rita, which hit in August and September, will largely come in the next fiscal year.

Why then would major foreign capital flows be attracted to the dollar in coming months?

The 'Dollar Stabilization Act'

One major reason the dollar has not gone into free fall this year is the little-discussed 'USA Jobs Creation Act of 2004,' which might more accurately be labelled 'The Dollar Stabilization Act.' It was quietly passed in 2004 amid election year distractions and signed into law by Bush. The Jobs Creation Act included a little-mentioned proviso giving US corporations a one-year period in which they can take advantage of a major tax break if they repatriate offshore profits from foreign subsidiaries. Instead of the 35% tax rate for such profits, for the next 12 months, companies need only pay 5.25%. The tax amnesty was reportedly worked out in coordination with Cheney's office, and one aim of the tax break was to make the US dollar less dependent on the wishes of Japanese and especially Chinese central bankers.

Since the revaluation of the Yuan this summer and the announcement that the Bank of China was diversifying from a dollar peg to a basket of currencies including Euro, China purchases of US dollars has been dramatically lower this year. But the dollar has remained remarkably stable despite the loss of Chinese and even Japanese, purchases this year. Those two central banks own more than $1.5 trillion in dollar bonds alone. No other country even comes close. Why?  

The explanation to dollar strength is the Jobs Creation Act dollar repatriations.

A new report by a Wall Street strategy firm, International Strategy & Investment Group is that in the first 9 months of 2005, US major corporations have repatriated a huge sum of  $210 billion under the Act.

ISI estimates are based on a survey of 91 major corporations. Based on that they project that the total dollar inflows from US offshore accounts will exceed $350 billions by the expiration of the tax benefit on December 31. That is a staggering sum and more than explains the bizarre counter-logic behaviour of the dollar this year. The tax benefit expires December 31.

It would be comforting to think that this massive flow of private capital into the US was simply a product of rapidly rising investment opportunities in the United States, that the investment opportunities in the United States have risen more rapidly than have the domestic savings available to finance those investment opportunities. It isn't.

According to the US Commerce Department Bureau of Economic Analysis, the net sum of foreign direct investment has run close to zero the past several years, implying that almost all of the net flow of investment has been short-term speculative financial flows. As noted above, the overwhelming share of that inflow for 2005 comes from the one-time 12-month window of tax abatement for repatriation of foreign profits to the tune of a likely $350 billion this year.

Even allowing for the evident flaws of the euro zone, its long term problems are comparatively small in relation to those of the dollar and the American economy.  Even if there is no further depreciation in the dollar, the deficit in the balance of trade is likely to reach 7.5% of GDP, a record, by the end of the decade.

The question now, with such a bleak perspective for dollar assets, is what will Cheney & Co. come up with in the next year to keep the house of cards of the dollar system from cratering? Or will the Bush Administration find itself too busy with the growing Watergate II scandals warming around Cheney and Karl Rove to notice? Apres moi les deluge…

(*)  F. William Engdahl is author of 'A Century of War: Anglo-American Oil Politics and the New World Order, Pluto Press and the soon-to-be released book, 'Seeds of Destruction: The Geopolitics of Gene-ocide'. He can be contacted through his website, www.engdahl.oilgeopolitics.net.