Game Plan

by Kevin D. Freeman

  Of course, despite the appearance of economic progress in Germany, a hyperinflationary collapse became inevitable. I have a German bank note labeled “ein Million Mark,” printed in 1923, that came from my grandmother. It is printed on only one side—the currency literally wasn’t worth the paper it was printed on.11 I keep it as a souvenir and reminder of how a government can unwittingly destroy its currency.

  The columnist Doug Hagmann actually theorizes that the Obama administration intends to “kill” the U.S. dollar: “An alliance is being forged between Russia and China to replace the USD as the reserve currency, already severely weakened by the policies of those in power, with a gold backed currency. Russia and China are hoarding gold to levels never before seen, while the U.S. issues worthless paper and digital currency backed by . . . nothing, save for the ‘oil-backed’ scenario.” Whatever Obama’s intentions may be, the fact remains that Hagmann’s take on what our enemies are up to is correct. They are out in force, and we have not even come close to responding correctly.12

  The Federal Reserve, in an attempt to prop up the failing economy, has announced that it will continue to engage in quantitative easing—buying long-term U.S. government securities—until the economy is healed. Which, in effect, may mean forever. “Surprise unconventional policy easing has pushed down the value of the dollar roughly as much as similar surprise downward moves in the federal funds rate did before the crisis,” said Reuven Glick and Sylvain Leduc, vice presidents of research at the San Francisco Federal Reserve.13 There is only one problem: buying up long-term securities means printing money. The only other option is to sell the debt to foreigners. And that means that those who own our debt can harm us if they are determined to do so.

  Welcome to Debt Hell

  In 2012, Terence Jeffrey reported in his book Completely Predictable that “the combined spending of federal, state and local governments per American household [$50,000] actually exceeded the median household income for 2010,” which was just under $50,000. Spending on that scale is utterly unsustainable; the only way to make it work is to borrow piles upon piles of cash. Because we are the reserve currency—because people need U.S. dollars—we can get away with it. But that won’t last forever.14

  As I write, the reported federal debt is about $17 trillion, with the debt held outside the U.S. government totaling almost $12 trillion, amounting to over three-quarters of our annual GDP.15 If we don’t raise taxes and cut spending, we’re in serious trouble—even conservative estimates show national debt rising to a whopping 153 percent of GDP by 2035. Greece’s ratio is currently 153 percent. The unemployment rate here would climb to over 20 percent, as it has done in Greece. Taxing the rich won’t work, whatever President Obama tells you—if the marginal tax rate were to skyrocket 50 percent on the top 1 percent of earners, by the end of the decade the national debt would nevertheless exceed $20 trillion.16

  America’s unfunded liabilities amount to up to $115 trillion by some estimates (and that is before Obamacare kicks in).17 And the situation might be far worse. Laurence J. Kotlikoff, an economics professor at Boston University, estimates that our true debt might be on the order of $211 trillion.18

  So how are we financing that debt? Other than creating it at the Fed, we’re financing it by relying on one of our greatest geopolitical adversaries: China owns over 7 percent of all outstanding federal debt. If China were to sell that debt, it would destroy the market for U.S. debt, undermining our ability to raise money to pay off our short-term debt.19 But our government is not taking that threat seriously. The Defense Department dismissed the threat in July 2012, as reported by Bill Gertz in the Washington Times: “‘Attempting to use U.S. Treasury securities as a coercive tool would have limited effect and likely would do more harm to China than to the United States,’ says the five-page report entitled, ‘Assessment of the National Security Risks Posed to the United States as a Result of the U.S. Federal Debt Owed to China as a Creditor of the U.S. Government.’” The same article mentioned my disagreement with this assessment.20

  This report came out at the same time as a broader Defense Department report about potential weapons of mass destruction, which Gertz covered in the same article:

  A Pentagon-sponsored report warns that the United States faces new threats from mass destruction weapons in the form of cyber, electronic and financial attacks, in addition to more well-known dangers from nuclear, chemical and biological WMD arms.

  “In addition to the prolific conventional [weapons of mass destruction] threats posed by a vast network of state and non-state actors, the U.S. must also contend with emerging threats that are not conventionally recognized as WMD,” said the report produced last month for the office of the Undersecretary of Defense for Intelligence.

  “Very few of America’s adversaries will attempt to challenge the unmatched strength of the U.S. military in a traditional conflict, but they may employ alternative asymmetric approaches.

  “It is therefore necessary to consider emergent, nontraditional threats, such as cyber, electromagnetic pulse (EMP), and economic attacks, in a comprehensive discussion of WMD threats.”

  On financial warfare, the report mentions the 1999 Chinese military book, “Unrestricted Warfare,” which advocates that China’s military utilize stock market crashes, computer viruses and currency manipulations.

  “Essentially, any threat to the U.S. economy is a threat to the country as a whole, and the potential impact of an economic attack is considered increasingly significant,” the report said.21

  Bottom line? We are naively betting our nation’s future on the notion that China would never purposefully harm its own holdings by dumping U.S. debt. But we are assuming that China’s interest is economic growth rather than destruction of the economy of its largest geopolitical foe. That may not be the case.22

  Even without a direct assault on the dollar, we still have huge problems.

  Former Federal Reserve governor Frederic Mishkin, along with David Greenlaw of Morgan Stanley, James Hamilton of the University of California at San Diego, and Peter Hooper of Deutsche Bank, wrote in the Wall Street Journal that the United States’ massive debt could create “a fiscal crunch [that] would force a central bank to pursue inflationary policies, a situation that’s called fiscal dominance.” If the United States did not print money to pay off its debt, interest rates would have to rise, since private lenders are nervous about earning back their money. Those higher rates would make borrowing tougher, and the economy would contract. To enable continued borrowing, the Fed would have to print more cash. And that would lead to “a surge in inflation.” In order to prevent that catastrophe, the four economists wrote, the government would have to start by “gradually reining in spending on entitlement programs such as Medicare, Medicaid and Social Security, while increasing tax revenue by broadening the base.” But the chances of such cutbacks are slim. In fact, some commentators say that the government has already passed the threshold in printing cash. Steve Forbes said, “Like steroids in baseball, it ultimately wrecks the player. The government is making it easier to borrow money for mortgage-backed securities and the like, and small businesses, households have a hard time getting credit.”23

  Former Florida governor Jeb Bush said in March 2013, “No one argues that we can keep doing what we’re doing. So either we have it collapse or we change it to protect it. . . . [We must raise] the retirement age to reflect the life expectancy increase that’s been dramatic, means testing some of the entitlement programs over time. We have to reform healthcare underneath the entitlement system as well so that the cost curve is dealt with, which means we should move toward catastrophic coverage as the form of insurance and reward healthy lifestyle decisions and focus on prevention to lessen cost by improving healthcare outcomes.”24 The chances of that happening: close to zero. With America’s demographic pyramid completely upside down, older voters now dictate how benefits are distributed. They will not vote to cut their own benefits, and any party that suggests
they do will meet electoral defeat.

  Gene Epstein of Barron’s sums up the problem: “Despite media coverage to the contrary, the updated 10-year projections of the Congressional Budget Office . . . confirm that the long-term debt crisis faced by the federal government is as much a threat as ever.”25

  That could spell the end of our way of life as we know it, much sooner than anyone expects.

  The End of the Dollar as Reserve Currency?

  In February 2013, CNBC reported that the dollar was dying: “The U.S. dollar is shrinking as a percentage of the world’s currency supply, raising concerns that the greenback is about to see its long run as the world’s premier denomination come to an end.” Michael Pento, president of Pento Portfolio Strategies, told CNBC, “The No. 1 security issue we have as a nation is the preservation of the U.S. dollar as the world’s reserve currency. It’s a thousand times more important that we keep the dollar as the world’s reserve currency, and yet we are doing everything to abuse that status.” He estimated that the United States could lose reserve currency status as early as 2015.26

  Americans don’t want to believe that the dollar could be overthrown. “But it will be,” Dick Bove of Rafferty Capital Markets wrote in February 2013, “and this defrocking may occur in as short a period as five to ten years.” Bove points out that the U.S. dollar is dropping precipitously as a percentage of the global money supply, down to a fifteen-year low. That’s not because of a shortage of dollars in circulation. It’s because fewer people want to use it.27

  The dollar still represents 62 percent of the foreign exchange holdings by central banks around the globe, but that number is rapidly dropping as more and more nations begin trading in the Chinese yuan, the Swiss franc, and the Japanese yen.28

  Russia announced that it would be avoiding the U.S. dollar by converting its oil revenues into gold bullion—adding 570 metric tons of gold in the past decade, according to the International Monetary Fund. That would weigh more than three Statues of Liberty.29 Of course, Russia has also long predicted a collapse of the dollar that would destroy the United States. Igor Panarin, a former KGB friend of Putin’s and the dean of the Russian foreign ministry’s academy for future diplomats, has predicted the collapse of the U.S.-led monetary system and the consequent fragmentation of the United States into six separate countries. Russia and China, he says, will together assume leadership of the global economy when America disappears. What is startling is that he first made this prediction in 1998, repeating it in 2008.30 Panarin’s prediction, Putin’s repeated calls for the end of the dollar, and the 2008 “disruptive scheme” that Treasury Secretary Paulson revealed, in which Russia tried to have China join in collapsing the American economy, all make it clear that the leadership of Russia not only expects America’s economic demise but is willing to work to make it happen.31

  In March 2013 the Australian government announced that it would not be using the U.S. dollar for its reserve currency in dealings with China. Instead, Australian cash will be swapped for yuan. “The value of such a deal would be substantial for exporters to China, especially those that import a lot from China like mining companies, as it would remove business constraints including exchange-rate risks and transaction costs,” said Geoff Raby, Australia’s former ambassador to China.32

  It’s not just Australia. That same month, Brazil and China agreed to a direct exchange of currencies. The exchange will amount to approximately $30 billion per year. “Our interest is not to establish new relations with China, but to expand relations to be used in the case of turbulence in financial markets,” said the governor of the Brazilian central bank, Alexandre Tombini. Zhou Zhiwei, a researcher with the Chinese Academy of Social Sciences, agreed: “Trade ties between China and Brazil are of great importance to the two countries’ economies amid global woes and the member states’ economic stability is vital for the BRICS mechanism.” (BRICS is a cooperative organization made up of Brazil, Russia, India, China, and South Africa.) India called this development “the new axis of global development,” with Anand Sharma, India’s minister of commerce, industry, and textiles, stating, “The global economic order created several decades ago is now undergoing change and we believe for the better to make it more representative.”33

  By late March the BRICS nations were planning the establishment of a development bank to avoid the American-controlled World Bank and International Monetary Fund. Martyn Davies, chief executive officer of Johannesburg-based Frontier Advisory, told Bloomberg News, “The deepest rationale for the BRICS is almost certainly the creation of new Bretton Woods–type institutions that are inclined toward the developing world. There’s a shift in power from the traditional to the emerging world. There is a lot of geo-political concern about this shift in the western world.” The BRICS nations had a combined foreign currency reserve of $4.4 trillion in 2013. Trade between the BRICS nations could hit $500 billion by 2015.34

  In February 2013 the Bank of England struck a deal with China to set up a yuan-sterling swap for three years. Direct trading of the yuan jumped 400 percent from 2010 to 2013. “In the unlikely event that a generalized shortage of offshore renminbi* liquidity emerges,” said Sir Mervyn King, governor of the bank, “the Bank of England will have the capability to provide renminbi liquidity to eligible institutions in the U.K.” In other words, the British are worried about the stability of the yuan but want to make sure they have enough yuan to trade because they don’t trust the dollar.35

  Turkey has been trading gold for oil with Iran to get around economic sanctions.36 India is reportedly doing so as well, and China is expected to follow suit. The price of gold is therefore expected to rise, and the dollar’s value will therefore be depressed.37

  Other Asian economies, too, are moving away from the American dollar, with a so-called renminbi bloc forming in East Asia. The Peterson Institute for International Economics says that China has now moved closer than ever to the renminbi’s becoming a global reserve currency. Seven of ten regional economies are now more closely tied to the renminbi than to the dollar.38

  China is the greatest threat in the disestablishment of the dollar as the reserve currency. The group that manages China’s currency reserves is diversifying from the U.S. government bonds it had been buying in bulk. In June 2013, “[f]oreign holders dumped a whopping $40.8 billion in long-term Treasuries, the biggest exodus from bonds in the history of the U.S.,” reports the financial researcher Mike Larson. China alone accounted for half of those sales, which followed a string of monthly selling going back to earlier in the year.39 Holding up the bond market is the Fed, buying billions in treasuries each month.40

  So where is China putting its money if not in dollars? We suspect that the Chinese have been quietly adding to their gold holdings. While many American economists would question the wisdom of that approach, leaked cables from the American embassy in Beijing have provided insight into their thinking:

  “China increases its gold reserves in order to kill two birds with one stone.”

  The China Radio International sponsored newspaper World News Journal (Shijie Xinwenbao) (04/28): “According to China’s National Foreign Exchanges Administration China’s gold reserves have recently increased. Currently, the majority of its gold reserves have been located in the U.S. and European countries. The U.S. and Europe have always suppressed the rising price of gold. They intend to weaken gold’s function as an international reserve currency. They don’t want to see other countries turning to gold reserves instead of the U.S. dollar or Euro. Therefore, suppressing the price of gold is very beneficial for the U.S. in maintaining the U.S. dollar’s role as the international reserve currency. China’s increased gold reserves will thus act as a model and lead other countries towards reserving more gold. Large gold reserves are also beneficial in promoting the internationalization of the RMB.”41

  China is moving full speed ahead to substitute its own currency for the United States’ dollar. CNBC reported in September 2011 that the yuan would b
e fully convertible—that is, Chinese businesses and investors could freely convert yuan to other currencies, a step toward becoming a basis currency—within five years.42 It might happen even sooner. In September 2013, Gordon Chang, a well-known China analyst, predicted that full convertibility for China’s currency would happen “in months.”43 According to Russian media, the stage would be set for a gold-backed yuan to displace the dollar: “Recent media reports suggest that Beijing is considering backing the yuan with gold. This decision, if taken, will likely affect China’s economy and may trigger a new wave of the global economic crisis. For Russia, however, such a scenario may have its benefits. . . . Beijing’s possible move to back the yuan with gold . . . would be a flaunt aimed at demonstrating to the world (and to the USA in particular) that China is capable of taking the risks associated with a departure from the dollar standard.”44

  The desire to enhance the yuan’s status was made clear in a 2010 article published in Qiushi, an official journal of the Chinese Communist party: “The fact that the U.S. dollar is the world’s reserve currency makes the U.S. a financial superpower. Currently, China’s increased share in the International Monetary Fund and its increased voting rights are a very big step forward. The problem is not that the value of this share is expressed in U.S. dollars, but that it would be best if the share could be expressed in RMB. Therefore, for China to challenge the position of the U.S. dollar, it needs to take a path of internationalization and directly confront the U.S. dollar.”45

  It is important to note that such a move has been backed by none other than Russian president Vladimir Putin.46 Russian state-sponsored media, undoubtedly at his direction, have become major cheerleaders for the yuan to displace the dollar: