As you were : oil, the dollar, inflation

by toni solo

Almost all reality-based economists in the US, whatever their ideology, agree that the US Treasury and the Federal Reserve are wrong in their policies to bail out insolvent US banks. They argue that the US Treasury and the Federal Reserve have made a hugely damaging mistake not forcing insolvent Wall Street quasi-non-governmental entities (quangos) like Goldman Sachs, Citigroup, Bank of America and J.P.Morgan into receivership. Instead the Federal Reserve has bailed out the quango-banks in an apparent effort to return things to how they were before the crash-.

Those quango outfits have benefited from trillions of dollars of government support from the Term Auction Facility opened at the end of 2007 through the Term Securities Lending Facility early in 2008 right up to the Troubled Assets Relief Program in the fall of that year. The sales pitch for all the trillions was that the banks needed such massive support so as to be able to lend in the real economy again.

Given the complete absence of meaningful conditionalities, that was a deliberately disingenuous forlorn hope. Those banks are still not lending liberally in their country's real economy. In addition the whole process definitely means that the Federal Reserve's balance sheet categorically does not give a true and fair view of that body's finances. It cannot do so, because no one knows the value of the securitised derivative junk accepted as collateral from the quango banks.

Those banks are hoarding partly because they still face massive potential losses as they continue trying to return to secure levels of capitalisation against their securities derivatives gambling losses and as they brace to absorb very significant off-balance sheet losses. They are also hoarding so as to retain capital for their next round of currency and commodity market gambling. The Federal Reserve and the Treasury seem to want it that way. Foreign Central Banks - the Bank of England, the European Central Bank, the Swiss National Bank, the Bank of Japan - all collaborate.

The US authorities' Plan A seems to be to gamble that it is easier to resurrect a bubble economy than to undertake the much harder and, for the banks, much less profitable grind necessary to rebuild the real US economy. The Federal Reserve has agreed to buy US$300 billion of Treasury debt this year by printing money. For obvious reasons, Ben Bernanke, Timothy Geithner and their colleagues do not insist on conditionalities like a reduction in military spending or tax increases for the plutocrat ruling class they work for and of which they are part.

The Federal Reserve is buying Treasury debt because no one else wants it. If one goes to the Swiss National Bank web site and looks at that bank's dollar auctions for the last two months the grand total is - zero. For the previous two months the total was about US$5.5 billion. And for the two months prior to that, over US$15bn. So, now that it is harder to sell US Treasury debt, another plank of US monetary policy is likely to be a return to the kind of managed devaluation of the US dollar that characterized the period from 2006 to 2008.

The US authorities would probably like to see the US dollar at around US$1.45 against the Euro and at about Yen90 to Yen95. That would help the US trade deficit, wouldn't be too disadvantageous to European and Asian allies nor be unreasonably inflationary in the current domestic deflationary climate in the US. But there lies the rub. A dollar decline may well provoke a spike in commodities prices, especially oil.

Past experience shows that dollar movements mean corresponding movements of between US$2-3 in the oil price. Should that correlation hold good, if the US dollar falls to 1.45 or so against the Euro, it would take the oil price up into the US$70-75 range. Oddly enough, recently OPEC countries have argued for a US$75 price for oil despite analysts reckoning that prices will stay around US$55. Those analysts probably focus too exclusively on reduced demand.

The supply of oil, too, has fallen dramatically since oil prices dropped to levels that made certain kinds of oil production uneconomic. If, in addition, OPEC cuts production again, then a dollar devaluation to around US$1.45 or more will almost certainly take oil prices to around US$75 or US$80 very quickly. Such a sequence of events might well bring stagflation back to the US and Europe with a vengeance, with all kinds of uncertain outcomes. The dollar might even tank down to US$1.60 against the Euro once more like it did in March 2008.

That threat of economically paralysing stagflation is probably the reason US Treasury Secretary Timothy Geithner recently remarked that the US authorities were quite open to the suggestion, by China, among other countries, of using IMF Special Drawing Rights to substitute the dollar as an international reserve currency. The reflex response of the markets to Geithner's remarks was to drop sharply. But too much can be made of such a potential shift.

The US and its Western Bloc European and Pacific allies dominate the IMF. They have been colluding for decades to try and consolidate permanent Western Bloc domination of global markets and trade through that outfit, along with the World Bank and the World Trade Organization. Depending on how any new arrangements might be put into place, the most likely outcome would be imperialist business pretty much as usual.

The advantage to the US and its allies of such an arrangement would be to dismantle the direct relationship of commodity prices to the dollar. That would probably go some way to mitigating sharp inflation provoked by spiking commodity prices caused by dollar devaluation. In the meantime, another round of speculative market volatility and increased commodity prices is almost certain to follow any further fall in the dollar of more than 3% or 4%, with the US quango banks gambling hard with US taxpayers' money to try and make themselves whole again.

toni writes for tortillaconsal.com