The writing has been on the wall for some time now, and over the last several months there have been many none-too-subtle hints from China, France and a host of other nations about what they think of the dollar. The recent G-20 meeting in Pittsburgh was very much a consensus on abandoning the U.S. dollar as the world’s reserve currency and creating a new global reserve currency. Many scoffed at the viability of such an undertaking, declaring it to be unattainable, but anyone who has been paying attention to what our own Federal Reserve has been doing, who has grasped an even cursory understanding of the history and theory of money, and who has been observing what the other members of the G-20 have been quietly up to were not surprised by today’s announcement that the Arab gulf states, China, Russia, France, Japan and others are planning to divest themselves of their U.S. dollars and end all dollar transactions for oil.

This is a monumental and historic change in global monetary policy, and could soon prove devastating to the dollar. Indeed, it begs the question: will the dollar collapse? Unfortunately, the possibility is becoming increasingly likely despite the pictures of rainbows, sunshine and lollipops emanating from top policymakers, central bankers and analysts in and around Washington and New York. This is most unfortunate because very many people in this country stand to be completely blindsided by these unfolding events and just about the only source for information is foreign press. Too many Americans are right now under the illusion that the “recession” is all but over, that we are in the process of a “jobless recovery” and that our continuing to spend trillions of dollars that we don’t have is of no consequence because the Federal Reserve knows exactly when to begin reducing the money supply to stave off any harmful inflation. There are several serious problems with this entire situation that warrant attention.  (continued...)

The favorite U.S. financial cocktail of fiat currency, inflationary monetary policy, and massive deficit spending that has been the staple of U.S. economic policy for decades could soon result in a hangover that the dollar might not survive. Already new concerns are being raised as to what might happen is China and Japan refuse to continue buying U.S. debt. Tiger Management founder and chairman Julian Robertson told CNBC: “It's almost Armageddon... (more here...)

Yet another part of the “Stuff That’s Not Quite Right In America” series…

As I turned on my computer and saw this headline, “FDIC may borrow money from U.S. Treasury,” glaring at me, I thought, “Wow! This just keeps getting better and better!” [Small hint of sarcasm]. The article on forbes.com stated, in part, that, “Federal Deposit Insurance Corp (FDIC) might have to borrow money from the Treasury Department to see it through an expected wave of bank failures, the Wall Street Journal reported.” Isn’t that just great?

So, let me see if I have all of this right: Fannie Mae and Freddie Mac, you know the government-sponsored-public-private partnerships that you and I are required to financially back via our contributions through the IRS in an enterprise that is able to take on the riskiest of loans without fear of loss because it is all guaranteed by Uncle Sam, are essentially broke because they took on too many risky loans. They also sold many of these loans to other banks that took them, presumably, because they are guaranteed through Freddie and Fanny to be backed by the government. So, the mortgage bubble bursts and banks begin to fail, but that’s OK because they’re just the smaller Mom & Pop banks – Oh. Wait! All, that is, except IndyMac in California… But that’s OK, because there are only a few that failed, right?

Wrong. Though only a few failures have resulted the dollar value has apparently exceeded the $45.2 billion FDIC Deposit Insurance Fund used to repay insured deposits at failed banks has been drained. What this essentially means is, you choose a bank to deposit your money in and then deposit it. The bank takes your money that you deposited and loans it out to other parties and entities in various ways in order to make more money for itself, all the while giving you – the people who make it possible for the bank to make more money in the first place by entrusting them with your money – a small percentage of interest. The bank makes more, likely because it can pool more money together to loan out than you can as an individual. So, then the people or entities default on the loans they took out from the bank – again using your money. The bank loaned them your money and now it no longer has your money because those who took out the loan couldn’t pay it back. So, the bank no longer has your money. It no longer has any money with which to repay those who deposited money there in the first place. This is a problem – especially when it is your money and you show up at the back to collect it, wait in a line for over eight hours and then see the manager put up a sign in the window – from behind locked doors of course – that the bank is closed and will re-open under the control of the Federal government as soon as the FDIC figures out what to do. 

FDIC is the Federal Deposit Insurance Corporation. According to the FDIC website, “The FDIC receives no Congressional appropriations – it is funded by premiums that banks and thrift institutions pay for deposit insurance coverage and from earnings on investments in U.S. Treasury securities. With an insurance fund totaling more than $49 billion, the FDIC insures more than $3 trillion of deposits in U.S. banks and thrifts – deposits in virtually every bank and thrift in the country.” Receives NO Congressional appropriations – that’s good, right? On the surface, yes, but…

Now I’m no economist, but to me this is a bit misleading. FDIC says it “is funded by premiums that banks and thrift institutions pay for deposit insurance coverage and from earnings on investments in U.S. Treasury securities.” [Emphasis mine] This is, I think, a more intelligent sounding way of saying that the banks themselves pay for the FDIC insurance. Here’s where I get confused, I think… “With an insurance fund totaling more than $49 billion, the FDIC insures more than $3 trillion of deposits in U.S. banks and thrifts – deposits in virtually every bank and thrift in the country.” See my point? They have $49 billion to cover $3 trillion. I guess they don’t think it possible for much more than $49 billion to go into default. I hope they’re right, but I think they’re wrong, as evidenced by the very fact that FDIC needs a bailout.

FDIC Chairman Sheila Bair said that with a rise in the number of troubled banks, the FDIC's Deposit Insurance Fund used to repay insured deposits at failed banks has been drained.

“In a bid to replenish the $45.2 billion fund, Bair had said on Tuesday that the FDIC will consider a plan in October to raise the premium rates banks pay into the fund, a move that will further squeeze the industry. The agency also plans to charge banks that engage in risky lending practices significantly higher premiums than other U.S. banks, Bair said.” [Thomson Financial News] This hasn’t been done since the savings and loan crisis in the 1990s.

According to the Wall Street Journal, “The fact that the agency is considering the option again, after the collapse of just nine banks this year, illustrates the concern among Washington regulators about the weakness of the U.S. banking system in the wake of the credit crisis.”

This is the way I see it: Freddie and Fannie get away with doing what they want, investing in riskier loans for increased profits because their original private funding is guaranteed by the government – so why not take the risk. They can then sell those loans to other banks that also understand the risk involved – and the potential payout. If the loans are defaulted on, no problem for Freddie and Fannie – Congress to the rescue! For everyone other than Freddie and Fannie, they count on FDIC. Obviously a problem arises when the FDIC fund is spent and lots more money is needed to stabilize the banks, so FDIC NOT being funded by Congress goes to the Treasury to borrow money. That would be the same Treasury that has to auction off U.S. debt to anyone who is willing to hold it in order to keep the government running. So, now we are at the point to where the agency that insures our banking system – a rather important aspect of the overall economy- is broke and needs a bailout from a Treasury that doesn’t have any money. 

Who will pick up this debt? Who knows? Undoubtedly the lowest bidder. At present, over 25 percent of our entire debt is being financed by foreign interests and of that, over 20 percent is held by the Communist government of China. Suffice it to say that there is indeed a rather high probability that the Chi-Comms will pick up the tab for this one too – at least for now.

The Underlying Message

Can the U.S. survive their relationship with China? This question is worth pondering for many reasons, the most obvious one being the fact that the Chinese are not going away any time soon. It is also worth pondering because China underwrites a substantial amount of the U.S. national debt. That the Chinese are to be taken very seriously as players on the world stage was the primary message that the state wished to convey via their spectacular opening ceremony for the Beijing Olympics.   True, the Chinese have been players for some time now, but this message was meant to declare something more: “We’re here, we’re a world power, and you’d all better be prepared to deal with us on our terms, because we are the future.”

This is a major problem for the United States because our relationship with China has very significant consequences, domestically and internationally, economically and politically. Possibly the most damaging aspect of our courtship with a brutal, totalitarian regime is the damage done to our credibility in the world, and here at home, our confidence in our government and what it is suppose to represent. Of course, some will thumb their noses at such a claim, reminiscing back to when we were nice to the Soviets – just before their evil empire collapsed. Sure, one could argue that toward the end of the Cold War we were sort of making nice with the Soviets, pretending to have dialogue with Chairman Gorbachev who, by all accounts was far more reasonable and realistic than any of his predecessors; but, one must keep in mind the important fact that at the time we were obliterating them economically, and they knew it. Not only that, but they also knew that there was absolutely nothing they could do about it. Their demise was imminent and so they were diplomatically making the best of a very, very bad situation. Unfortunately, things are very different regarding our relationship with China.

Learning Lessons From Uncle Joe

The Soviets simply ruled with an iron fist, demanding total allegiance, yet offering no incentives whatsoever for mandatory compliance - only the possibility that you might not be sent to the gulags or shot if you were a good and compliant subject. So, when Gorbachev allowed even the slightest economic and political reforms, the entire system collapsed because once the people got a taste of freedom, the fires of liberty were stoked and momentum swung decidedly to the cause of liberty which, of course, quickly overwhelmed the state apparatus almost before it could collect itself to react. It was as if neither side, the state or the people, could actually believe what was happening; but, the deciding factor was that the people, once experiencing even a mere flicker of liberty - were not going to squander their only opportunity for liberation in over seventy years.

Let us be clear here: the Chinese were paying very, very close attention to those events, and as a result the party apparatus in China greatly benefitted from Moscow’s mistakes.   Instead of really granting what we in the west would consider true economic reforms, Beijing allows foreign investors and businesses to enter the Chinese market but under the strictest of terms – they [the Chinese government] dictate the terms, period. Not much room for negotiation. If you want access to 1.3 billion potential customers, you will comply. As for the average citizen, there is no question that their quality of life has, at least on the surface, improved over the last decade. To look at scenes from Beijing or other major cities in China, one might as well be looking at any other major city in the west… that is except for the secret police, phone tapping, government monitoring and control of the internet, the highly visible presence of soldiers and police on every block and, lest we forget, the fact that there are cameras on trashcans, street lights, building facades, inside of restaurants and hotels – which are all bugged – so that the government can ensure compliance and crush dissent. That is, crush dissent as in Tiananmen Square and Tibet, with absolute overwhelming, brute force and no mercy whatsoever. 

A Workers Paradise, To Be Sure

Some economic ventures are run by Chinese subjects [I dare not call them citizens] while most of the larger ones are run by the state or handpicked and very well connected party cronies. But really, one could make the argument that while people “run” these enterprises, it is the state that really “owns” them, because in a totalitarian dictatorship rooted in Marxist despotism, the state really and truly owns everything – even the rights of the people, and the people can do whatever they want to – so long as they get permission from the state via the police.

Imagine yourself a loyal and compliant subject of the Chinese Communist Party, with a nice big picture of Mao at the entrance to your apartment and, of course, an even bigger one of President Hu Jintao, with lots of flowers and such around it like an altar for votive offerings. Say you are a woman and you and your husband would like to have a baby. Great! Now, all you have to do is to fill out the state application and questionnaire, submit to the required tests medical and otherwise, and then visit your friendly local police and have an interview wit a government/party official who will either approve or deny your application. If denied you may reapply, but you must be careful because you could be labeled a dissenter for not gleefully accepting the party’s decision on your behalf and thereby guilty of anti-party and anti-revolutionary activities. This unfortunate label could result in yourself and any number of your family and/or friends being tried, convicted and sent to a “re-education camp” where you will learn all bout the virtues of the great Communist Revolution, etc. After several years of torture, beatings, rapes, and brutal slave labor, like building Olympic venues or factories where products for western consumption will be produced, you might even be fortunate enough to be sent to work in one of those factories. 

The New Balance factories are very nice – modern, roomy, clean. That’s because you don’t get to spend much time in your room that you must rent from the factory located on the “factory campus” because you probably work 12 to 14 hours per day, and then get clean the factory workspaces and then, finally, your room. Of course, your room must be cleaned and inspected before you head down to the cafeteria where you pay for your food. [If your room doesn’t pass inspection, you get fined.] Then perhaps it’s off to a rehearsal for a show being put together to impress a visiting party official and some corporate officers from the U.S. or Europe. You’d better remember when to step and when to hold up the pretty colored signs and when to shout, because if you mess up and ruin the show, it’s back to the “re-education camp” for you! Or, perhaps it’s just easier to take you out by the garbage dump and shoot you in the back of your head – then the state can bill your surviving family [assuming there are any] the 15 cents it cost them for the bullet they had to waste on you. But, I digress.

Let’s assume you have your baby without being an anti-revolutionary criminal. Lets imagine that after a few years you end up pregnant again, unplanned of course, because you would never dream of intentionally having a second child in violation of the party’s one-child per family edict. The state says you must have an abortion. Or, let’s imagine you get pregnant with your first baby without having obtained your government permit to have a child. A friendly policeman notices your bulge and asks for your papers, which, of course, you do not have. You are arrested, and transported to a facility where they murder your baby. Then they may charge you with being an anti-revolutionary criminal – a sworn enemy of the state! Or, imagine you are one of the lucky subjects allowed to run a business. You get to run a McDonalds – that is until the day one of your employees gets angry with you and denounces you to the police, who promptly come and speed you away to the “re-education camp.” 

This is how they treat their own people. Sure, they are allowed to have some creature comforts that make life a bit easier, but these things can be taken by the state away in an instant, because you are only allowed to have these things at the pleasure of the state. 

The party and the state are synonymous, and smart enough to know that people tend to get a bit complacent when they are comfortable. The more stuff they are allowed to have, the more favorable they are likely to view the state – it’s amazing how a few years of “re-education” can make these things so clear! The state is also smart and despotic enough to know that every once in a while it needs to let the people know who is in control. Make no mistake – the people understand this perfectly, and they comply, for what else can they do? Just think of it as a combination of Starbucks and Stalinism.

A Potential Credibility Gap?

Whatever image China wishes the world to see, the fact of the matter is that those poor people are living in fear under a brutally authoritarian despotic regime. Some human rights organization’s estimates of the number of people imprisoned in China run between 1.5 to 3 million, with the number of prisoners executed running between 10 to 15 thousand and some estimates up to 100,000 in 2007. It is likely that the latter number is inclusive of those who died during while engaged in or as a result of forced labor. Most agree that in the years since being awarded the 2008 Olympics, China has sought to re-cast itself as a kinder and gentler authoritarian system. There are even some organizations that estimate the number of executions has dropped almost 40 percent since 2001. This would be a welcome trend if it were permanent, but one must ask honestly what will happen after the next uprising or pro-democracy protest? Keep in mind that China is a nation of 1.3 billion people and that the secretive, authoritarian party, while surely keeping meticulous records itself of the numbers of prisoners and related information, would never allow the actual numbers to be released, so it is safe to assume that the numbers could well be far higher than those listed above. 

One can easily see, then, how close economic ties with such a regime may raise some eyebrows around the world. America is supposed to represent liberty and freedom, while the Chinese regime represents fear, oppression and death. And, if you haven’t heard yet, they underwrite our national debt. Let me say that again: China underwrites our national debt. Once more time for those who need to hear it: a brutal, despotic authoritarian regime that randomly imprisons and executes its subjects, that supports the government of North Korea – you know, that worker’s paradise where their barely sane “Dear Leader” is starving them to death so he can build weapons and just keep them in line – as well as many others oppressive and outright evil regimes throughout the world – they own a substantial portion of our debt. 

This is from the Treaurydirect.gov website: http://www.treasurydirect.gov/instit/auctfund/work/work.htm

“Marketable securities can be bought, sold, or transferred after they are originally issued. The U.S. Treasury uses an auction process to sell these securities and determine their rate or yield. Annual auction activity:

Offers 4 types of securities with varying maturities

Conducts approximately 200 public auctions

Issues more than $4.2 trillion in securities [emphasis mine]

To finance the public debt, the U.S. Treasury sells bills, notes, bonds, and Treasury Inflation-Protected Securities (TIPS) to institutional and individual investors through public auctions. Starting in February 2006, Treasury resumed the auction of Treasury bonds. Treasury auctions occur regularly and have a set schedule.” Their words, not mine.

Visit http://www.treasurydirect.gov/instit/auctfund/work/auctime/auctime.htm for the published schedule of these auctions.

This is how it works: Congress decides yet again that they need to spend far more money than we have because they, somewhat like the Chinese and the Soviets I guess, have come to the conclusion that the government ought to provide everything we need, and even more that we don’t. Bills filled with pork and out of control budgets are passed. The Treasury then has to figure out a way to pay for this, because the people who decided to spend more than we have won’t. Logically, the Treasury auctions off portions of the debt to the bidders who will charge the lowest interest rate. Over 25 percent of the entire debt is presently being financed by foreign interests and of that, over 20 percent is held by the Communist government of China. Nice. So much for heeding the warnings of our Founders about becoming involved in foreign entanglements! If other countries own your debt, and especially countries to whom you are ideologically opposed; if that isn’t foreign entanglement I am hard pressed to understand what is.

Consequences

Ideologically speaking the Communist government of China is our enemy, and yet we have allowed ourselves to become very vulnerable to them. Think about this: what would happen if all of the foreign entities holding portions of our debt called our loan? When the Treasury says it auctions bonds, bills, etc. “to finance the public debt” that is government speak for “to keep the government running.” But what is the true price we pay? Consider that the Chinese Communist government plays a major role in keeping our government financed, and I am sure that the full impact of this situation is not missed on our government officials when they have to tiptoe around the globe consulting with the Chinese to ensure that we do not upset them by our intended actions. What will be the ultimate cost? How can a free people allow themselves to be financed in part by tyrants – tyrants of a magnitude that the Founding Fathers could not even begin to fathom.

It is going to far to say that we are, in a very real way, now beholden to the Communist government of China? Will it be possible to wrest ourselves from their influence in our affairs and our economy? And what of our reputation in the world and the subsequent influence backed up by that reputation? Is it not slightly hypocritical to claim to be fighting to bring freedom and liberty to one part of the world while enabling it to be oppressed in another? Any what will be the ultimate economical impact on our nation and, for that matter, on the world? How long can we sustain such a detrimental trade deficit with China where we cave in to their terms almost on command? What has happened to the America that less than a decade ago was the sole remaining superpower after defeating the Soviet Union? 

And speaking of the Soviets, it appears they’re back – and with a vengeance too. Those old KGB guys haven’t lost their touch – invade your neighbor while the rest of the world is watching the Olympics. Brilliant strategy. Especially when you know that Georgia’s biggest ally, the United States, however much we protest and demand a Russian withdrawal, is more or less impotent when it comes to this situation. The Russians want their Soviet Empire back and they are testing the waters: what will the U.S. do? What can they do? For our poor ally is that with our battle weary and overextended military, a looming economic crisis, a weak dollar and a popular political movement demanding we stick our heads in the sand and pretend that all is well, the unfortunate answer is: not much. And so the future for Georgia is uncertain indeed.

What is certain is that the Chinese are once again paying close attention to what Moscow is doing – and will learn from any mistakes. Make no mistake about it: our relationship with China in its current form is absolutely deadly for us. It is suicide. It is the beginning of our abdication of superpower status at a time when those who most appreciate liberty, like Georgia, are looking to the U.S. for leadership and action to inspire and help them, yet all we can offer is words. And talk is cheap, especially when it is backed up by a plunging dollar, an unconscionable deficit and a government that fails to see the consequences of cozying up to tyrants and preferring to let the U.N. take the lead. Make no mistake about it, Beijing has one eye on Moscow and the other on Taiwan, and we, my follow Americans, have precious little time to take back or government before it signs our death warrant and becomes the cause of our downfall. Can we survive a relationship with China? Our action or inaction over the next several years will be the determining factor. So, either we can work together to pull Washington’s collective head out of its rear, or we can start studying Chinese and Russian. Personally, I prefer the former.