Reserve Currency

So what exactly did Reid know and when?

• *UNITED STATES' AAA IDR RATING MAY BE CUT BY FITCH :3352Z US
• FITCH SAYS PUTS U.S. ON RATING WATCH NEGATIVE AS U.S. AUTHORITIES HAVE NOT RAISED FEDERAL DEBT CEILING IN A "TIMELY MANNER
• *FITCH STILL SEES U.S. DEBT CEILING TO BE RAISED SOON :3352Z US
• *FITCH SEES RESOLVING US RWN BY END OF 1Q '14 AT LATEST
• *FITCH STILL SEES U.S. DEBT CEILING TO BE RAISED SOON :3352Z US
• *FITCH SEES U.S. ECONOMIC GROWTH REVERTING TO 2.25% AFTER 2017

Time runs out on Italian and Spanish banks. But the truth is fatal.

There are two characteristics of a currency that make it useful in international trade: one, it is issued by a large trading nation itself, and, two, the currency holds its value vis-à-vis other commodities over time. These two factors create a demand for holding a currency in reserve. Of course, psychological factors entered the demand for dollars, too, since the US was seen as the military protector of all the Western nations against the communist countries for much of the post-war period. Today we are seeing the beginnings of a change. The Fed has been inflating the dollar massively, reducing its purchasing power in relation to other commodities, causing many of the world’s great trading nations to use other monies upon occasion. President Obama’s imminent appointment of career bureaucrat Janet Yellen as Chairman of the Federal Reserve Board is evidence that the US policy of continuing to cheapen the dollar via Quantitative Easing will continue.  As we noted before, nothing lasts forever...  (especially in light of China's earlier comments)

We assume it is a coincidence that on the day in which we demonstrate China's relentless appetite for gold, driven by what we and many others believe is the country's desire to have a call option on a gold-backed reserve currency when the time comes, just posted in China's official press agency, Xinhua, is an op-ed by writer Liu Chang in which he decries the "US fiscal failure which warrants a de-Americanized world" and flatly states that the world should consider a new reserve currency "that is to be created to replace the dominant U.S. dollar, so that the international community could permanently stay away from the spillover of the intensifying domestic political turmoil in the United States." Of course, if China were serious, and if the world were to voluntarily engage in such a (r)evolutionary reserve currency transition, then all Magic Money Tree theories that the only thing better than near infinite debt is beyond infinite debt, would promptly be relegated to the historic dust heap of idiotic theories where they belong.

China has just one thing to say to all those who engage in the now daily slamdowns of gold just around the time of the London fixing, after 8 am Eastern, which lately have gotten so vicious they have resulted in "stop logic" market halts not on one but at least two occasions, keeping the price of gold delightfully low for all those who instead of selling, are looking to buy: "thanks."

The dollar is the world’s go-to currency. But for how much longer? Will the dollar’s status as the only true global currency be irreparably damaged by the battle in the US Congress over raising the federal government’s debt ceiling? Is the dollar’s “exorbitant privilege” as the world’s main reserve currency truly at risk? Sane governments do not default when they have a choice – especially not when they enjoy the “exorbitant privilege” of issuing the only true global currency. We are about to find out whether the US still has a sane government.

While the following may look like a broken scene from "Breaking Bad" (one wonders just how much methylamine was on the train) we couldn't help but see the analogy of an oncoming train (no tunnel, so no warning light this time) of inevitable default, whether in one week or later, and the USA sat square across the tracks as reserve currency status (as we discussed last night) becomes increasingly challenged.

In the midst of a debacle such as the the one under way in Washington currently and the finger-wagging from various foreign entities (that Jack Lew himself warned Congress would be more than happy to replace the USD as world reserve currency), we thought the following simple chart useful for some context as to the rest of the world's "growth."

Three explanations have been provided for this peculiar exhibit of "spilled" cash in the Senate's Hart Building:

i) Step aside "Bernanke chopper"; presenting the "Yellen briefcase"

ii) Debt ceiling compromises don't come cheaply

iii) A Senator just cashed out of their SPX calls

All are equally likely, although perhaps what is saddest is that nobody even wants to pick it the strewn "reserve" currency.

Forget about the headlines, the most concerning statement from the entire circus of Jack Lew's hearing was his comment that the world counts on the US to be responsible. It seems that boat sailed a long time ago. The following succinctly summarizes the key aspects of his testimony and the Q&A. As a reminder, Lew noted "Obama did negotiate," denied the chance of "prioritization," and warned that other nations appear ready (and somewhat excited) for the US to falter.

While there is hope that DC will engage in its favorite, can-kicking activity any minute and if not resolve then at least push back the funding and debt ceiling stalemate by a few weeks, the reality is that without a deal in seven days, there may be no cash to pay down maturing Bills starting with the October 17 issue whose yield soared to nearly 50 bps yesterday. The reason for the capitulation as was revealed yesterday, is that various money market funds such as Fidelity's have been selling all paper around the X-Date. This morning the contagion surrounding the use of Bills as collateral has crossed the Pacific, following news that the "Hong Kong’s futures and options market operator will require traders to put up more collateral when using some Treasury bills to back their positions, citing concern that the U.S. is at risk of a default." In other words, as we forecast on Monday, the debt-ceiling confusion in cash-land has now openly engulfed the repo market, which only makes the states of a debt deal that much higher. Because if the repo, $2.5 trillion money market, and subsequently, the entire $80 or so trillion custodian market freeze up, what happens next will make Lehman seem like a quiet walk in the park.

"...The chaos that one day will ensue from our 35-year experiment with worldwide fiat money will require a return to money of real value.

We will know that day is approaching when oil-producing countries demand gold, or its equivalent, for their oil rather than dollars or euros.

The sooner the better."

- Ron Paul, 2006

Isn’t it wonderful how the US believes (whether that be the citizens or the politicians) that the state will never default on its debt repayments?

We strongly suspect that both government debt growth and money supply inflation will continue unabated – any pause will immediately bring about the kind of short term economic pain these policies have explicitly sought to prevent and will therefore be quickly reversed. It is not unlike the situation the revolutionary assembly of France found itself in during the late 18th century: when it issued new money, industry seemed to revive. As soon as it stopped, industry slumped again. And so it was decided to issue ever more money, until the entire scheme blew up. There can be little doubt that modern-day governments are on the road to a similar date with destiny – and lately the speed at which they travel toward it has increased markedly.

It takes a lot of courage to go against the crowd. Whether in investing, or acknowledging that your country is heading towards an epic fiscal crisis, it isn’t easy to stand alone... especially when everyone else is betting the other way. After more than a decade of positive returns, many investors have abandoned their precious metals positions. The conventional wisdom says that gold is ‘finished’. After all, the dollar price is falling... so it must be a bad ‘investment’. Others, however, are looking at where gold is right now, where it probably will be a few years from now, and thinking that it’s a hell of a bargain.