The world has officially entered what we believe will be the final chapter of the U.S. dollar's reign as the world's reserve currency. The dollars in your wallet now not only back bankrupt U.S. money center banks and subprime home "owners"... they are also officially backing all of the economies of Europe. The world's monetary system has evolved into a new kind of global socialism. We don't think that can be bullish for long.
Here are the facts we've been told so far... The European Central Bank (the ECB) will spend $1 trillion (750 billion euro) bailing out Europe's sovereign borrowers (like Greece, Spain, and Portugal). It will also purchase billions of troubled assets from Europe's largest banks – like UniCredit. The mechanisms for these purchases will likely be convoluted. The EU treaties contain a no-bailout clause, forbidding any member to "be liable for or assume the commitments of" another EU country. And the European Central Bank cannot lend to countries or buy their debt directly. To get around the technicalities, the EU created an off-balance-sheet entity that will "borrow" the money and lend it to countries in trouble. Whether this matters to the EU's creditors or not, we can't say... but we certainly wouldn't lend to an off-balance-sheet entity of a central bank that's not represente d by any country. Buying euros used to be a game of "who owes me nothing." Now, it will be a game of "whose off-sheet entity owes me nothing." We doubt that will make Europe more creditworthy in the long term.
What does any of this have to do with the U.S. dollar? More than you'll ever hear anywhere else. On paper, the money is supposed to come from Europe's biggest governments and the IMF. But in reality, most of the money will be borrowed from the U.S. Federal Reserve, which just happened to re-open its trillion-dollar swap account with the ECB this weekend. Ironically, the Federal Reserve says these loans are risk-free because the counterparty is a central bank (or at least the off-balance-sheet entity of a central bank). But if the ECB is truly creditworthy, why couldn't Greece, Spain, Portugal, Italy, or Ireland raise the money for themselves?
At the beginning of the year, we declared rising interest rates in the U.S. as "the single most important trend in finance." We believe interest rates on long-term U.S. government bonds will rise to compensate investors for the increased risk of owning paper-backed sovereign debt. Our logic is simple: The more money the U.S. prints to bail out banks and other sovereign borrowers, the riskier the U.S. balance sheet becomes. By the first half of 2010, the Fed had already spent $2 trillion to bail out Wall Street's banks and the U.S. mortgage market. And as we reminded subscribers just last Friday, because the world's banking system uses the U.S. dollar as its reserve currency, the Fed would eventually be forced to bail out Europe's economy. Indeed, that's exactly what happened over the weekend. The U.S. Federal Reserve has officially become the world's lender of last resort. We would humbly suggest these policies will likely lead to a permanent loss of value for holders of U.S. dollars.
Why are we so concerned? Printing money to bail out borrowers around the world will not solve the problems of overleveraged governments or debt-ridden economies. It simply shifts the risks from private balance sheets to the U.S. government's. The U.S. dollar has assumed all of these risks. Our currency has become a ticking time bomb.
You can watch the dollar die, one day at a time, by keeping your eye on the growing spread between the value of long-term U.S. bonds and the price of gold. Over the last year – even as the U.S. economy apparently improved – the spread widened by about 35%.
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