The Precarious Gamble

The economy is still in a precarious position. Recently the Federal Reserve resumed the purchase of treasury bonds on a massive scale in an attempt to hold down long term interest rates and keep the massive American debt manageable and able to be serviced. It also an attempt to lower the value of the dollar so as to try to force China to unpeg its currency from the dollar standard it has adhered to. China cannot afford to do this yet because many Chinese banks holdings are denominated in dollars while their liabilities are valued in Yuan the Chinese currency. If the holding are devalued vis a vis the liabilities a collapse of China's entire banking system is possible.

It is unclear whether a Chinese collapse is one of the Fed's ultimate intents. It is hard to imagine how such a collapse would help the US in an economic sense. Although in the geopolitical sphere, to the extent that a collapse of the Chinese banking system lessens China's overall power, this is no doubt beneficial to the relative power of the US.

It is questionable, however, whether a collapse of China's banks would hurt China in the long-term. Its Communist leadership (yes, the CCP still runs almost every aspect of Chinese economic activity) knows the extent of over-leverage in Chinese banks. As Communists, they most likely believe that any banking system is prone to collapse eventually. This is one of the historical givens driven by the historical determinism of Marx. Therefore, they have probably planned for a collapse of their banking system just as a snake can plan on its skin shedding. An event that a nation plans for is rarely catastrophic for it in the long-run. This is especially true of an inherently powerful and great nation like China. Conversely, nation's prone to optimistic fantasy driven by the pop psychology of the "power of positive thinking" (the Americans) are susceptible to catastrophic shocks because their optimism, over time, becomes a disincentive to plan for less than pleasant historical eras.

The danger for the Fed's policy of both simultaneously keeping interest rates artificially low through bond purchases and devaluing the dollar through those same purchases is that this can only work, if at all, in the short run when no other economic inputs come into effect. The laws of economics show that as the dollar declines interest rates rise, or as the dollar increases in value interest rates decline. The Fed's policy wishes and fantasies run directly counter to this reality which will come to fruition over the long run. Somehow, at present, a double disaster is occuring for the Fed. That is, the value of the dollar is rising at the same time interest rates on the 10 years US bond are rising. This is the opposite of the Fed's intent. The problem is that other inputs are coming into play that are having unintended consequences (the bane of all economic "planning). The problem seems to be that the systemic European bank weakness is raising the value of the dollar faster than the Fed can lower it through bond purchases. At the same time, China's central banks are easing their buying of US bonds, but that is not collapsing the dollar yet because of crises elsewhere that are driving people to the dollar as a safe haven. However, the other effect of China's easing off the buying of US bonds IS happening; that is that US interest rates are rising quite rapidly.

This simultaneous strengthening of the dollar and rise in interest rates, if it continues for any significant period, is a witch's brew of disaster and financial collapse for the debt-burdened US economy. The Fed itself, over the long-term, could be in danger of insolvency and collapse.