Guest Post: The Fed's Most Dangerous Game: Checkmate

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

The Fed's Most Dangerous Game: Checkmate

The Fed can only choose the least-worst option now: either destroy the real economy by sinking the dollar below support and unleashing the Inflation Monster, or abandon the "risk trade" stock market rally.

The Fed's game plan--sink the U.S. dollar to goose corporate profits, reinflate asset prices and create "modest inflation"--is now the most dangerous game on Earth. As overleveraged assets from real estate to stocks imploded in 2008 and early 2009, the Federal Reserve rushed to flood the global economy with zero-interest dollars. This did a number of things the Fed reckoned were necessary:

1. It gave U.S. banks and other insolvent financial institutions an unlimited pool of money to borrow at zero interest and leave on deposit at the Fed, where it earned risk-free interest.

2. It enabled a vast global "carry trade" in dollars: speculators could borrow unlimited dollars at no cost, and then deploy the cash around the world to chase higher yields in stocks, commodities, etc.

3. It allowed banks to lend profitably in the U.S., as their cost of money was reduced to essentially zero, and to pour "hot money" into U.S. stocks, creating a virtuous cycle of ever-rising equity prices.

4. With the bulk of U.S. corporations' growth and earnings coming from overseas sales, then a plummeting dollar boosted their profits effortlessly, further goosing U.S. stocks.

5. With savings earning nothing, U.S. investors were driven into the "risk trades" of the stock market and commodities, a flow of funds which reinflated asset bubbles. This reinflation was critical to foster the appearance of widespread "recovery" via the "wealth effect" of rising asset prices.

6. A rising stock market not only offered an illusion of "growth" but it bailed out pension funds and set the stage for Wall Street to reap billions of dollars from the resurgence of mergers and acquisitions, IPOs and derivatives.

The basic idea was to extend the game plan which had worked in the last banking crisis in the early 1980s: don't force the banks to declare their losses, but "extend and pretend" while offering them risk-free ways to bank billions in profits. The goal was to enable the banks to recapitalize "painlessly" on the backs of consumers and taxpayers.

The other goal of the plan was to create some modest inflation by brute-force depreciation of the nation's currency. This inflation would be "good" because it would enable debtors to pay off their debts with cheaper dollars, and it would also serve to reinvigorate the "animal spirits" of borrowing and spending the Fed views as the bedrock of the "permanent growth" economy.

If you're confident that your cash will be worth less next year, you're highly incentivized to spend it now rather than see its purchasing power decline.

But in choosing to depreciate the dollar, the Fed engaged in a high-stakes game with potentially devastating consequences. By pushing the dollar down to near-historic lows, the Fed now risks a destabilizing criticality: if the dollar breaks key support levels, then traders and holders everywhere will have great uncertainties about how low it might drop. That will encourage them to sell their dollars immediately rather than hold on to find out how low it might fall.

As we can see in this chart, the dollar's decline has not occurred in a vaccum: when the dollar declines, oil and gasoline shoot up. The dollar and oil (and other essential commodities) are on a see-saw, for oil exporters simply raise prices to compensate for the loss of purchasing power as the dollar declines. (Chart courtesy of

The Fed is now trapped: if it crushes the dollar any lower, then oil will jump toward its 2008 highs around $140/barrel--a level that triggers recession in the "real" U.S. economy. A recession will disembowel the "recovery" and all the rest of the Fed's carefully nurtured props of "prosperity."

The unintended consequences of the Fed's inflationary plan to depreciate the dollar is evident everywhere in skyrocketing food and energy costs. Destroying the dollar has sparked destabilizing global inflation which threatens to spin out of control.

But if they let the dollar rise, then their precious stock market rally implodes. And what's left of the mirage of "recovery" if the "wealth effect" evaporates? Zip, zero, nada.

Here is a long-term chart of the dollar, courtesy of Harun I. I have added a few notes.

Note the long-term downtrend. No wonder 97% of the pundits and punters are bearish. The "line in the sand" is not far below current levels: if the Fed pushes the dollar below this level, technically there is no visible support, and oil will be on its way to $200/barrel, far past the point it pushes the economy into recession.

Many technicians have noted the wedge/flag pattern in the dollar's recent action. Price usually breaks out of a flag in a major move either up or down.

Also of interest is the extended period of indecision traced out between 1988-1994. In a macro perspective, this mirrored the trends and counter-trends in the U.S. and global economy.

The dollar has again traced out a similar period of indecision since 2004--roughly seven years. That suggests the possibility that a key inflection point is close at hand--the same conclusion drawn from the flag-pennant-wedge formation.

The Fed now has to choose between two bad options: either keep pushing down the dollar and let oil's inevitable rise trigger a recession, or let the dollar recover and watch stocks crater as the "risk trades" reverse.

If the dollar Bears have to cover their short bets, the ensuing rally in the dollar might well be explosive and self-reinforcing. I addressed this possibility in A Contrarian Take on the Dollar's Demise (March 25, 2011).

If the Fed lets the dollar depreciate in an uncontrolled fashion, then we may well end up with the hyper-inflation (loss of faith) that many expect. My question remains: what course of action will benefit those issuing the whispered orders to their lackeys and toadies on the Fed and in Congress? Will a disorderly and disruptive collapse of the dollar serve the Financial Power Elites' best interests? I don't see how it would. Rather, I see it wreaking great damage on their holdings.

Thus it wouldn't surprise me in the least were the Fed to shock the markets with a "surprise" rate increase within the next few weeks or months. Destroying the real economy to maintain the "risk trades" is a foolhardy way to close down a lose-lose position.

Harun sheds additional light on the broader contexts in his commentary:

Have you ever played chess against someone who refuses to resign even though he or she is down so many pieces chances of winning are zero. All they do is keep moving out of check until there is no more room and they are finally checkmated?

What happens if rates rise? At the time of a loan the principle is created, the interest is not, therefore, everyone who needs to borrow tremendous amounts of money to service existing debt (most of western Europe and the US) will not be able to, therefore there will be cascading defaults of unprecedented amounts. Governments would collapse seemingly overnight. If the game is to continue, there must be enough credit expansion create enough "money" to make interest payments and create so called "growth". Which brings us to...

Inflating the currency: As with the chess player above, it merely holds off the inevitable. Why is it "different" this time? Why has the system become so intolerant to the smallest adverse moves? Answer: Leverage. At 1:1 leverage 100 percent has to be lost to achieve ruin. At 1:2 50 percent must be lost. Jump to 1:40 leverage and only a 2 percent loss brings about ruin.

So what is our leverage? First, we must stop this version of off balance sheet accounting. This version of private household accounting keeps off the liability side of its balance sheet the federal deficit. It is also further skewed by dispersing the federal deficit amongst every person in the US. When is the last time a person bought a house and turned to their infant in the stroller happily using its toes as a pacifier and said, "your portion of this mortgage is $25,000.00?"

If total debt, private and public were carried on household balance sheets and divided only among the productive, i.e. employed, the reality of it would change the conversation dramatically. What would be realized is that the US and most of Western Europe is hopelessly over-leveraged and it is only a matter of time before the structural instability created by this leverage manifests in some unpleasant way.

And no, the answer does not lie in a one world currency. Without getting rid of current levels of debt we would run into Dr. Bartlett's analogy of microbes doubling every minute in a bottle. How much time would it take to fill three more bottles. Well, in the first minute the first new bottle would be full, and in the next minute the two remaining bottles would be full (remember, they are doubling). So if debt levels remain the same debt must double in order to service existing debt and providing growth.

This is why California and other states keep running into problems they thought they fixed. While they make minimalist cuts to spending those cuts are outstripped by the exponential growth of the interest on existing debt. This is also why the current deal in congress is an insult to every intelligent adult in America. Interest on the debt will consume that $33 billion spending cut in no time at all.

BTW, this is the same reason why discovering a brand new super-giant oil field will not matter if demand growth continues at a constant rate. Any and all growth is exponential and therefore will continuously double at some point.

The DXY yearly chart (not shown) shows that bulls have not been able to force a test of the previous three year highs. The quarterly chart shows bears have been able to push price down breaking quarterly lows to important support. What happens next depends. If historical support is broken then the probability increases that price will continue down and things get really interesting. If support holds or if price dips below support enough to get those stops and then move back up through support turned resistance the probability increases there will be a sharp rally as bears cover. But this tells only a portion of the story.

Look at what has happened while the DXY has been range bound. In the case of energy (and just about all other commodities) the DXY has underperformed dramatically. More specifically if you stayed in cash, the cost of gasoline has gone up four fold since the bottom in 2009.

Do this exercise across the commodity spectrum and the results will be roughly the same. So the question is, how long can can the current course be maintained?

Thank you, Harun. As I wrote Harun, it's Fed Chairman Ben Bernanke's move, but he faces a cruel dilemma: if he moves his king out of check, he will lose his queen.

There are only bad choices left, Mr. Bernanke. That's the consequence of playing the world's most dangerous game with the dollar, grain and oil.

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NOTW777's picture

logical place for a bounce 74.22

Fish Gone Bad's picture

There is a time lag between when excess money is printed, and prices rise.  To keep that "false prosperity" going, more inflation needs to be created.  I am going to have to go with keep pushing the dollar down.  The US will follow Germany's path and eventually default on its debts, AND then create a new dollar.  Everybody not wiped out by debt will be able to buy their debt back for practically nothing.

redpill's picture

That is down the road a bit, I think Bernank will find a way to extend until he can finish his term.  At some point it must have become apparent to him that he's trapped, so now the only way out is to stretch things out and hope it is someone else that has to pick up the pieces.

Imminent Crucible's picture

The best that Bernanke can hope for is to buy a little time with a "surprise" 25 bp increase, or two.  He cannot raise interest rates significantly, because it will force a ballooning of federal debt service costs, wrecking the already exploding budget.

This is silliness: "Destroying the real economy to maintain the "risk trades" is a foolhardy way to close down a lose-lose position."  Yes, except that Bernanke has already destroyed the real economy.  He did it by allowing the banks to create trillions of dollars in derivative losses, and then transferring the bill to workers/taxpayers.

What happened in Sept 2008 was just the blasting cap. The real detonation is only beginning, as more and more debt of all kinds (mortgages, second mortgages, HELOCs, credit card, auto loans) melts down and becomes an unrecoverable loss, and THEN we discover that it was written into a collateralized debt obligation held off-balance sheet by some bank or fund.

66Sexy's picture

It amuses me when articles refer to Bernake "being in trouble..."

The Federal Reserve is a private institution; the term "federal" is a deceptive term.

So, it is really the US government that is in trouble... and the borrowers from the fed.

Not Bernake.

It should be clear that the FED is NOT our friend, and whatever they are doing, the endgame is destruction.

Tulli's picture


Here are some sobering numbers out of Portugal this morning:

  1. Over the last 5 exercises, the debt of the Portuguese state went rom 58% GDP to 97% GDP.

  2. The "great deed" of the next government will be to achieve only 3% deficit in 2010. (laugh allowed here).

  3. To reach the goal, the government needs to find 12 Bn EUR.


  4. How much is 12 Bn in portuguese terms?         A) 12 Bn EUR is half of all annual salaries of portuguese state workers          or     B) 12 Bn EUR is 120% of the personal income taxes collected lat year by the government     or    C) 12 Bn EUR is 300% of the income taxes over corporations and businesses collected last year by the government.   It's all good - it will surely happen.


55mph's picture



"But if they let the dollar rise, then their precious stock market rally implodes. And what's left of the mirage of "recovery" if the "wealth effect" evaporates? Zip, zero, nada."

what will the politicians have to hang their hats on?  it's a very dangerous alternative that could advance wholesale social unrest.   

lookma's picture

If the Fed ends ZIRP/otherwise halts its massive support of the $ credit market, then we will well end up with the hyper-inflation (loss of faith) that many expect.

AG BCN's picture

tedious football club.

anynonmous's picture

posted earlier

this is worth listening to, from Bloomberg radio very early this morning where Gallo suggests that last week could well have been

"The official beginning of America's Sovereign Debt Crisis"

hedgeless_horseman's picture

As we can see in this chart, the dollar's decline has not occurred in a vaccum: when the dollar declines, oil and gasoline shoot up.

Let's try to remember, what do we do with a well-defined long-term trading range?

gordengeko's picture

"The Fed can only choose the least-worst option now: either destroy the real economy by sinking the dollar below support and unleashing the Inflation Monster, or abandon the "risk trade" stock market rally."  To keep the majority asleep while prepping for the primaries he can't abandon the risk trade.  Removing the nipple would raise too many questions and infuriate the herd since MSM have been screaming bull market.  Therefore QE3 and illusionary corporate profits are my guess.

spiral_eyes's picture

there will be no end to delusion economics 'til the shit hits the fan. they will not give up the ghost. qe3 is a foregone conclusion, and qe infinity 'til china and the arabs stop accepting greenbacks.

LibertyIn2010's picture's as if the FED is purposefully trying to crash the dollar in a ditch so that it could bring our economy into such a terrible crisis that we would be willing to listen to just about anyone claiming to have a "solution" to this crisis.  Of course, that would mean giving up the US $ as the world's reserve currency in exchange for a one world currency.  Hmmm...a solution they will claim will solve our money problems as well as those in the EU.  However, this will be just another thinly veiled effort to consolidate more power and money in the hands of the elite who control the world.

I believe I read this story in a book once.

Bob Sponge's picture

....and further enslave the masses.

Blotsky's picture

I wish it were just a story in just another "book". But if anyone has read "that Book", they will come to see exactly how this story plays out.

None of what is happening, or is to come, surprises me, but I cant say that it isnt without it's woe.

EscapeKey's picture

Delusion economics?

Mervyn King has stated UK above-target inflation has been "temporary"... for 4 years running!

gordengeko's picture

Seems they are grasping at straws now.  You can bet there are major talks going on right now behind the curtain.  I'm betting silver is a nice little thorn in their side right now fucking up their plans a little.

Arthor Bearing's picture

Central banking has become a game of Jenga, a house of cards. It'll either fall one way, or the other, but it definitely won't continue to stand long.

Snidley Whipsnae's picture

GG, lest we not forget; Bill Gross has already made a major move to divest long dated bonds at PIMCO. I doubt Bill made this move without some inside info about near/mid term Fed moves.

masterinchancery's picture

Which could happen almost any time.

RealitiveMind's picture

"Keep the majority asleep", a fine sleep it is.

I found myself getting sucked in to the Ponzai for a moment yesterday while looking at the retirement accounts.  Well sure, they are in all physical gold and silver but still, you have a simulated emotional moment where you think, hey everything is doing OK, we are going to be fine.  Mandy is on the TV showing you all the green squares and you feel good, back to sleeeep.

But in reality, it would be like me telling my son to go out back and practice catching falling knives, his hands get all cut up, I take him to the hospital and they say it's child abuse.  When in fact, that is what Ben is doing to all the kids, or is he throwing knives at them?


I remember shopping for my first home in 1979 with interest rates around 18.5% and listening to all the wise elders telling me that real estate never goes down in value, blah, blah, blah.  Ironically, I went and bought a 45 ft sailboat to live on which everyone told me will go down in value.  Even though I sold it years ago, the same boat sells for about the same price now.  Gee this is fun.

B9K9's picture

All the "wise elders" don't know jack-shit. Even in 1979, a 70 year old (born in 1909) would know absolutely nothing about why population & output had miraculously been climbing for the prior 100 years. All they could do would be to project their own experiences forward assuming the same set of circumstances.

That goes double for 70 year olds today (born 1941). They know nothing from experience other than that America stood alone (1945-1973) during the precise period of peak oil production. No one, nowhere, understands the role of fossil fuels, population, production & banking (ie interest covered by output).

Being part of the ZH crowd and knowing these things also doesn't get you jack-shit unless you're willing to act on it. PMs are only a start, not a windfall trading opportunity.

tawdzilla's picture

"The Fed can only choose the least-worst option now: either destroy the real economy by sinking the dollar below support and unleashing the Inflation Monster, or abandon the "risk trade" stock market rally." To keep the majority asleep while prepping for the primaries he can't abandon the risk trade.  Removing the nipple would raise too many questions and infuriate the herd since MSM have been screaming bull market.  Therefore QE3 and illusionary corporate profits are my guess.

True, but in all actuality the Fed is triple screwed, because even if they choose to continue propping up the "fake plastic tree" stock market, high commodity prices will eventually destroy demand and corporate earnings...which will destroy the stock market.  Stock market gets destoyed either way.  

The only thing QE does is delay the inevitable, and gives TPTB time to prepare for a global reset, which means we still have 1 or 2 pump n dump rallies in the que, before the final mass exodus is upon us.

I'm not sure who is smarter... those who are preparing for the post collapse, or those still making hay while the sunshines in the soon to be defunct economy.  I tend to think playing both sides is the best available option right now.    

Commander Cody's picture

Agreed, except that the Fed is not triple screwed.  Most Americans are being triple screwed.  The lackeys at the Fed will be told what to do and when so that their controllers can place their bets accordingly and beat the system.  This will continue to occur until the system is no longer able to sustain the wealth transfer.  At that point, it is meaningless to the recipients as they will be long gone from the game and all the rest of us will be holding the bag looking at each other in amazement that such a formerly great country could fall so far so fast.  Who could have foreseen?

CAPTCHA:  33 times one equals?  I don't need my calculator anymore.

tawdzilla's picture

Thanks for the correction...The Fed is the screwer, not the screwee.

falak pema's picture

Good analogy with chess. Better analogy with "green knight" in Monty Python Holy Grail.

He was cut to small pieces all the while saying "I won't yield"...

Ben Bernanke is really in a Monte Python film. But somehow, its not hilarious...

zaknick's picture

Yes it is!


The only complaint to watching this great comeuppance is tgat it's taking too long. I want to see the real Great Crash, bond market collapse with screaming yields, defaults squealed everywhere and food stamps and all entitlements cut so that the Mad Max conclusion can begin.

You reap what you sow, imperialists! Choke on it now, bitchez!

Reap the whirlwind!

spiral_eyes's picture

it's only funny if you're living in the woods, have guns, ammo, food, water filtration, solar, backup gen, bullion, seeds, etc. i figure less than 1% of zero hedgers fall into that bracket, one in ten-thousand in the general population. i have most (but not all) of the above. as great as it feels when i see silver going >41 when i bought it <10, <15 and <20 when the shit actually hits the fan, i'm gonna be pretty sad. civilization was great while it lasted. 

mach777's picture

qft. mad max won't be so funny after the first few days....


SweetStevie's picture

But the whirlwind is indiscriminate.

tek77blu's picture

great radio interview with peter grandich on the collision course the u.s., fed is heading down, and implications for gold, silver, the markets, and social turmoil:

Glasgow Gary's picture

My question remains: what course of action will benefit those issuing the whispered orders to their lackeys and toadies on the Fed and in Congress? Will a disorderly and disruptive collapse of the dollar serve the Financial Power Elites' best interests? I don't see how it would. Rather, I see it wreaking great damage on their holdings.

Charles still doesn't get it. These are not competent people working in their own interests. They are incompetent people working in their own interests. In other words, they have already sunk their own insitutions--the banks and the FED--and its just a waiting game now to the resolution. Charles doesn't seem to understand that the credit bubble itself is the thing that spells the end of the FED.

Or, put another way, all the "powers" that Charles imagines have just as much to lose from deflation. In deflation, the banks crater again and the FED has to monetize Treasuries anyway because international trade stops.

Overall, it really doesn't matter what they do. The USD either breaks because of "weakness" against other assets. Or, the USD breaks because the US is going down the tubes. Nothing can save the USD now, or the treasury market.

Oh regional Indian's picture

GlasgowG, it might be an over-simplification to consider those at the helm incompetent.

They are hand-picked players to bring a long running game to its illogical but pre-determined conclusion. They may be psychopathic, sociopathic, insensitive, selfish, but these are not incompetent people.

In fact, I'd go as far as to say, they are the best at their game. if they were incompetent, they would have lost control a long time ago.


Underestimating your opponent is the single biggest mistake you can make in battle.


Gunther's picture

The way I see TPTB operating they are excellent at keeping the game going aka kicking the can down the road.
Changing the game to make the economy viable in the long term is something I could not observe at all.
So, they are competent in a limited sense.

The explanation for this behaviour might be that they believe their own propaganda and/ or think very short-term or they care only about their own profit similar to a third-world-cleptocrat.

PierreLegrand's picture

Perhaps you don't understand the results the Bernank is striving for?

My money is on he knows exactly what he is doing and this is EXACTLY the result he expected.

Oh regional Indian's picture

My sentiments exactly. These guys know the game. to well.


Hook Line and Sphincter's picture

Many here have not ever really met a true, patient, hustler. There's always a lot of 'losing' to do before the win. Most people do not understand the heart of predation, because they are prey.

ConfusedIdiot's picture

Agreed PL. The USD is like a cat. Regards, CI.

Spastica Rex's picture

I don't buy your argument. The players are just as stupid as you and me, just greedier and meaner. And actually, I don't think they're the "opponents."

"We have met the enemy and he is us"


torabora's picture

Union General McClellan seriously overestimated his opponents early in the war. If he would have not been so timid he could have at least have taken Richmond and destroyed Lee at Antietam. The War would have continued but not for as long as it did. He made a lot of war profiteers rich.

Josh Randall's picture

Dollar only gets saved by return to Gold standard (or basket of backing) - the only question for me is how long before they whip that big stick out. I fear they wait until dollar drops below 50 and China drops it's paper like PIMPCO did. But QE 3 is baked in - stimulus the congress doesnt need to approve so that Soetero can point to the stock market during the re-election campaign

BeerGoggles's picture

the only flaw is that oil has gone up because of the middle east...not the dollar. Fail.

gordengeko's picture

I agree, I always talk with my friends that know nothing about the markets to get a guage.  They realize the same thing happened before back in 2008 with oil which preceded the market crash.  So a lot of them are questioning the market now because of the gas prices.  I think short term crude dips to 105-110ish.

EscapeKey's picture

1. Print money, cause inflation.

2. Revolutions in countries, where food expenditures represent a significant percentage of overall spending.

3. Resources of countries in question will be affected.

Mr Lennon Hendrix's picture

This article is way over simplified. 

What is missing from the philosophy of economics is the fundamental understanding that 1) all resources are finite and 2)  labour is a willing good.  Once these are used as a metric for input costs, neo Keynesian rhetoric falls to the way side.  Neo Keynesianism relies on free labour and thinks of all resources as abundant.  Nothing is further from the truth.