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Dollar Supremacy Slipping?



“One of the penalties for refusing to participate in politics
is that you end up being governed by your inferiors.”
—Plato

“Inflation is the senility of democracies.”
—Sylvia Townsend Warner

FDIC Closer to the Edge?


In our September 4 commentary “FDIC R U OK?” we stated our opinion that the rapid depletion of the FDIC’s insurance fund due to a growing number of bank failures might force the agency to tap the federal government for billions of dollars. Despite FDIC Chairman Sheila Bair’s assurances to the contrary, we wrote:

“If the FDIC’s insurance fund is depleted, the regulator has the ability to access a line of credit at the Treasury Department which was extended by Congress earlier this year to $100 billion – along with the ability to borrow $500 billion through 2010.[1] Chairman Bair has recently said the FDIC doesn’t expect to tap the Treasury line of credit – and that, “The FDIC has ample resources to continue protecting insured depositors as we have for the last 75 years.”[2] As we survey the heavily jobs dependent housing market, which so many banks are tied into – and add in the faltering commercial real estate market – we don’t believe her at all.”

We still don’t believe her. In a recent interview, Bair stated, “We haven’t made any decisions yet but we are actively considering alternatives to a special assessment (on banks).”[3] The FDIC’s deposit insurance fund has dropped to $10.4 billion as 94 banks have been seized in 2009 alone.[4] The agency, which is mandated by law to raise assets when the fund drops below a certain level, had indicated banks might be required to pay another special assessment by the end of the year.[5]

And on September 29, we learned the FDIC has proposed banks prepay their insurance premiums for the last quarter of 2009, and next three years (through 2012).[6] Under this new plan, the FDIC would forego charging another special assessment on banks this year.[7] The proposal has been prompted by FDIC estimates that its insurance fund will be in the red by the end of the current quarter – and that bank bailout expenses will reach $100 billion by the end of 2013.[8] (Note: the FDIC’s prior estimate of bailout costs through 2013 was $70 billion).[9] The FDIC also estimates the proposed prepayments would raise around $45 billion.[10] Banks are supporting the prepayment plan because premiums paid to the FDIC’s insurance fund are treated as an asset when the payment is made, and an expense in the quarter the payment is due/originally scheduled.[11] (You gotta love accounting).

To us, there are so many ominous aspects of the proposed plan, we don’t know where to start. The proposed prepayment reminds us of how low interest rate financing in the automotive and housing sectors earlier this decade (and “cash for clunkers” more recently) – was used to accelerate economic activity forward from the future. The inevitable trough in activity/revenue eventually does come though – and then what? To us, accelerating FDIC premium payments by over three-plus years begs the question, “Where’s the money going to come from if there is another shortfall in the insurance fund?” We don’t have a crystal ball – but we do notice one troubling thing. And that’s what seems to be an ongoing pattern of under-estimation by the FDIC, the Federal Reserve, the Treasury Department, and the rest of the government as to how bad things really are. If the FDIC’s insurance fund does need to be replenished sooner that expected – what’s next? A special assessment in 2010? Another 3 year pre-payment through 2015? We think not on both accounts. Instead, we pay special attention to House Financial Services Committee Chairman Barney Frank’s statement in a recent hearing:

“This is not the time to raise assessments on the banks… We will have money lent I hope through the fund which will be paid back out of assessments”[12]

To us, phrases like “I hope” don’t exactly instill a lot of confidence. But this is where we are folks. And to us, it looks like taxpayers may well get a chance to foot the bill once again. Hardly a surprise. We can hear the money printing presses humming already.

Federal Reserve Indicates Stimulus Will Continue


The Federal Reserve Bank has now committed to purchasing the full $1.25 trillion of mortgage bonds – after previously stating it would buy “up to” that amount.[13] The Fed also indicated it would keep interest rates between zero to .25%, stating that rates will remain low for an “extended period.”[14] The Fed’s Open Market Committee statement indicated the Fed may delay shrinking its $2.1 trillion balance sheet until it secures a recovery.[15] Thus, we believe recent talk of withdrawing government stimulus, seems to be turning out to be just that – talk.

It’s long been our belief the Fed will delay withdrawing stimulus longer than they’ve led us to believe. With the state of the economy, including jobs – we feel any stimulus withdrawal could very likely send the economy into a “Double Dip Trip.” We’d not be surprised next year to see the Fed announce more purchases of Treasury, Fannie Mae, and Freddie Mac debt to keep interest rates low in an attempt to once again juice the economy with low borrowing costs. (Again, all with newly printed money).

Dollar Supremacy Slipping?


In the London Telegraph, Ambrose Evans Pritchard gives this opinion:

“Crucially, China and rising Asia have reached the point where they can no longer keep holding down their currencies to boost exports because this is causing mayhem to their own economies, stoking asset bubbles… A monetary policy of near-zero rates – further juiced by quantitative easing – is completely incompatible with circumstances in most of Asia, the Middle East, Latin America, and Africa… What is occurring is an epochal loss in the relative wealth and economic power of the old G-10 bloc of rich countries compared to rising regions of the world. The euro, yen, sterling, Swiss franc, and other mature currencies will be relegated along with the dollar in this great process of rebalancing, but the greenback will bear the brunt.”[16]

Is Pritchard right? He might be – especially if the U.S. keeps printing money to fund its liabilities. (Other than increasing taxes and cutting spending – we see no other way for it to do so). Also, the U.S. – by expanding money and credit, has exported that inflation to its trading partners like China. The Chinese have been all too happy to take our newly printed dollars to expand their economy. Now they face a dilemma. The absorbed dollars are creating inflation in their own country. To cure it – they can choose to let the Yuan float – and gain in value – hurting their exports in the process. This could cost jobs and political stability. Another major problem for China is the massive amount of dollars it already owns. It’s become increasingly obvious the Chinese are attempting to get rid of them before they drop significantly in value. That’s why we see them purchasing natural resources interests all over the world – along with increasing their gold holdings.[17] [18] [19] However, they can’t easily dump all their dollars at once because they’ll likely drive the value of them down. Like a guest at Thanksgiving dinner, the Chinese have happily gorged themselves to excess. But now they’re having trouble getting through the door. And the house may be on fire.

And then there is the U.S. We’ve said it before and we’ll say it again – history teaches us governments tend to repudiate their debt by printing it away. Good for the government? Perhaps. Bad for Dollar holders. Whether they be foreigners or U.S. citizens.

All quite interesting – and in our opinion, full of potential opportunities.

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another. And bull markets are what we hunt. As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Stephan R. Ernharth, JD, AIFA
Vice President
Ernharth Group
www.ernharth.com

Go to www.ernharth.com/economic-commentaries to read past articles from our Economic Commentary series.

  1. Bloomberg; “FDIC Problem Bank List Surges, Putting Fund at Risk”; August 27, 2009
  2. Ibid.
  3. Bloomberg; “FDIC’s Bair Seeks Alternative for Second Fee, Lauds Prepayments”; September 24, 2009
  4. Bloomberg; “FDIC’s Bair Seeks Fee Alternatives, Prepayment Has ‘Advantages’”; September 23, 2009
  5. Ibid.
  6. Bloomberg; “FDIC Proposes Banks Prepay Fees Through 2012 to Boost Reserves”; September 29, 2009
  7. Ibid.
  8. Ibid.
  9. Ibid.
  10. Ibid.
  11. Ibid.
  12. Ibid.
  13. Bloomberg; “Fed Signals Growth Return Insufficient to End Monetary Stimulus”; September 24, 2009
  14. Ibid.
  15. Ibid.
  16. Telegraph.co.uk; “HSBC Bids Farewell to Dollar Supremacy”; September 20, 2009
  17. The Globe and Mail; “China’s Bold Move Into the Oil Sands”; September 1, 2009
  18. World Gold Council; “Chinese Purchase Could Lead to Structural Shift in Gold Holdings, Says WGC”; April 24, 2009
  19. Wall Street Journal; “Chinese Firm Offers to Buy Australia’s Energy Metals”; September 8, 2009