The practice of using the U.S. dollar as the world's reserve currency has become well entrenched in the minds of global investors. In fact, the system has become so habitual that many now believe there is no alternative to owning U.S. debt and dollars, simply because they are about as common as dirt. The reasoning for this is since the market for Treasuries and greenbacks is so large; there is no other parking place for that money, which makes a mass exodus from U.S. debt holdings virtually impossible. Therefore, investors can't sell and values can never go down in a significant manner. Such sophomoric reasoning is akin to saying IBM stock can never fall precipitously unless most owners decided to sell their shares. In reality, all it would take is a one day strike in purchases on the N.Y.S.E. and the IBM share price would plummet. Likewise, if the U.S. experienced just one boycotted Treasury auction, prices would plunge and yields would skyrocket across the board on all U.S. debt.
But the problem doesn't just lie with the United States. The truth is that investors the world over are finally beginning to understand that central banks have a voracious appetite for creating inflation and buying sovereign debt in an effort to keep their banks and their countries solvent.
Today, the Bank of Japan announced that it won't stand for Yen appreciation much longer and that the central bank would soon intervene to buy dollars. In another example, the European Central Bank (ECB) will soon be forced to step up their debt purchases as well. Italian and Spanish debt yields have risen to multi-year highs and are following the footsteps of Greek bonds. In the case of Italy, their Ten year note has surged from just above 3% in late 2010 to well over 6% today. For a country whose debt to GDP ratio is currently over 120%, a doubling of interest rate expenses spells insolvency for European banks and economies. Enter Jean Claude Trichet and his printing press to the rescue. The ultimate "solution" for the Eurozone is for the ECB to take that bad debt off of European banks' balance sheets. You can forget about the IMF or Germany solving the problem in Italy and Spain. The scope of the problem is several orders of magnitude greater than Greece. A massive increase in the Euro money supply is causing investors to fly to gold for safety against ever increasing inflation.
Adding fuel to the gold fire is the recent debt-deal reached in D.C. The disgusting agreement virtually assures that the U.S. will add $8 trillion dollars to the outstanding publicly traded debt over the next decade. That is an increase of nearly 80% in ten years! The back-end-loaded deal will cause the amount of deficit reduction to be just $21 billion in 2012 and $42 billion in 2013. Of course, the total debt reduction depends on rosy assumptions from Washington that are always wrong. For example, the Obama administration predicts GDP growth will average well over 3% for the decade. However, the annualized GDP growth in the first half of 2011 was just 0.9%. That means the actual deficit and debt figures will be far greater than projections and most likely wipe out any perceived debt reduction achieved from the deal. An 80% increase in debt will cause Bernanke to launch QE III and hasten the demise of the dollar as the world's reserve currency and the desire of investors to own gold.
Should we take any solace that the Credit Rating Agencies haven't downgraded U.S. debt yet? We all know they are incompetent but we now know they are liars as well. After threatening to downgrade our credit rating if Washington failed to cut $4 trillion in spending over the coming ten years, neither Moody's, Fitch nor S&P had the courage to follow up on that threat, despite the fact that the total cuts agreed on would amount to only half their required specifications. But a credit rating downgrade on Treasuries did come today from China. The Dagong Global credit rating agency has cut the credit rating on U.S. sovereign debt to A from A+, which is 5 notches below AAA. The agency has also put the U.S. on negative outlook. However, the real downgrade will come when the Chinese, Japanese and Europeans no longer show up at our Treasury auctions. That is what the Tea Party is trying to avoid, but changing the borrowing and spending habits in D.C. is proving to be a nearly impossible task.
The only answer central bankers have to solve an inflation problem is to print more money. And the only solution from politicians to fix slow growth is to spend more money. The more answers we get from government, the further exacerbated the stagflation situation becomes. More evidence of U.S. stagflation has come recently from the ISM manufacturing and non-manufacturing reports, which showed a slowdown in new orders and employment in the sub indexes. This morning's ADP report showed that even after the NBER said the recession ended over two years ago, we still lost 7k goods producing jobs in the month of July. And the Challenger Grey and Christmas report released today indicated that layoffs surged 60% last month to a 16 month high. Meanwhile, YOY consumer prices are up 3.6% and M2 money supply is up 7.5% YOY and rising at a 14.6% annual rate in the last quarter. As the problem with stagflation becomes worse, international investors will eschew U.S. debt and dollars at an ever increasing rate.
Soaring debt to GDP ratios on the sovereign level in Japan, Western Europe and America will spur investors into owning precious metals at an increasing rate. The fiat currency system is soon coming to an end and the dollar and U.S. debt will feel the brunt of that change.