Monday, December 8, 2008

Dollar Devaluation Is A Threat

In Barron's, Jim McTague takes a few shots at Ron Paul and misses by a mile.

Some asset prices (that were artifically overvalued due to credit and excessive leverage - like real estate) are deflating. Enormous amounts of Federal Reserve Notes are being printed.

Jim McTague's illogical reasoning is summe up in in two sentences:
The danger is that, despite all the government stimulus, demand will stay weak.
Paul doesn't believe this.

Jim McTague says, "... demand will stay weak" and that Ron Paul doesn't believe that demand will stay weak. Jim McTague just put words in Ron Paul's mouth, as Ron Paul isn't talking about demand. Ron Paul is talking about excessive growth of fiat (backed by nothing) money. More money is being printed out of thin air, and this is the DEFINITION of inflation.

Inflation defined:
a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services.

Ron Paul for over a year has been saying that we are entering an inflationary depression. Ron Paul has been right, while Jim McTague may want to go to Austrian economic school.

Inflation Not a Threat -- Yet

STOW THE RED WHEELBARROW BACK IN THE SHED. DESPITE forebodings by Texas Rep. Ron Paul and other gold bugs about hyperinflation, your wallet will be sufficient to hold your spending money for the foreseeable future.

Paul and other inflation hawks correctly note that the Fed's printing presses are running full tilt. Nevertheless, some economic experts argue that we won't require wagonloads of debased currency to buy a stick of butter, mirroring Germany's 1923 nightmare. Reason: Deflation still hangs like a low, dark cloud over our sinking economy. Too few dollars are chasing too many goods, and this will worsen as unemployment hits 9% or more sometime next year. People fearful of losing their jobs are hoarding cash. Banks have become careful, stingy lenders. The danger is that, despite all the government stimulus, demand will stay weak.

Paul doesn't believe this. He argues that an estimated $8 trillion in bailout commitments by the Treasury and Federal Reserve and other government units has increased the monetary base by 75% over the past two months. "If something that is used as money becomes too plentiful, it loses value," writes Paul in a recent article. "That is how inflation and hyperinflation happens. Giving the central bank the power to create fiat money out of thin air creates the tremendous risk of eventual hyperinflation." He favors a return to the gold standard.

That $8 trillion represents committed funds, not actual loans and investments. You can't add it to the monetary base until it's in someone's bank account. Much of it is being used to cover losses on existing loans, not for new ones. The Fed demands lots of collateral to ensure that lending doesn't get out of hand. And most of its loans are short-term and can be unwound very quickly -- another mechanism to inhibit hyperinflation.

Some experts argue that Fed chief Ben Bernanke is simply replacing money annihilated in our economy's "Great Deleveraging" and that he should print even more. Retired securities lawyer Frederick Feldkamp, a Michigan native, says the Treasury's nationalization of Fannie Mae and Freddie Mac alone erased $33 billion in bank capital. The Treasury inadvertently wiped out the two mortgage giants' preferred stock, which hundreds of banks had held as core capital, and which was considered so safe that regulations let the banks leverage that capital by as much as 50 to 1 when making loans. Feldkamp reckons that when banks wrote off the $33 billion in preferred stock, support for about $1.65 trillion in debt was erased -- a significant credit contraction.

FBR Capital Markets, in a Nov. 19 report, estimated that Goldman Sachs (ticker: GS), Morgan Stanley (MS), Citigroup (C), JPMorgan Chase (JPM), Wells Fargo (WFC), Bank of America (BAC), AIG (AIG) and GE Capital (GE) combined need $1 trillion to $1.2 trillion of equity capital to shore up their balance sheets so they can begin lending again. FBR estimates that the eight have $12.2 trillion in assets and just 3.4% of that -- $406 billion -- in tangible common capital. "The sheer size of the capital deficiency, coupled with the opaque nature of credit risk, will keep private capital sidelined... ." FBR says.

This isn't to say that inflation won't become a problem down the road. Paul Wachtel, a New York University economics professor, says the Fed should be planning an exit strategy, so that it can absorb cash reserves from lenders when the economy rebounds. Absent such a plan, you may get a chance to use your wheelbarrow when buying that stick of butter, after all.