Bruce Caldwell Duke Economics Professor discusses FA Hayek’s Austrian school of economics and how the ideas would be applied today.

With uncharacteristic bluntness, Federal Reserve Chairman Ben S. Bernanke warned Congress on Wednesday that the United States could soon face a debt crisis like the one in Greece, and declared that the central bank will not help legislators by printing money to pay for the ballooning federal debt.

Recent events in Europe, where Greece and other nations with large, unsustainable deficits like the United States are having increasing trouble selling their debt to investors, show that the U.S. is vulnerable to a sudden reversal of fortunes that would force taxpayers to pay higher interest rates on the debt, Mr. Bernanke said.

“It’s not something that is 10 years away. It affects the markets currently,” he told the House Financial Services Committee. “It is possible that bond markets will become worried about the sustainability [of yearly deficits over $1 trillion], and we may find ourselves facing higher interest rates even today.”

http://www.washingtontimes.com/news/2010/feb/25/bernanke-delivers-warning-on-us-debt/

Americans must prepare themselves for a massive collapse in the dollar as investors around the world dump their US assets, a former Bank of England policymaker has warned.

The long-held assumption that US assets - particularly government bonds - are a safe haven will soon be overturned as investors lose their patience with the world’s biggest economy, according to Willem Buiter.

Professor Buiter, a former Monetary Policy Committee member who is now at the London School of Economics, said this increasing disenchantment would result in an exodus of foreign cash from the US.

The warning comes despite the dollar having strengthened significantly against other major currencies, including sterling and the euro, after hitting historic lows last year. It will reignite fears about the currency’s prospects, as well as sparking fears about the sustainability of President-Elect Barack Obama’s mooted plans for a Keynesian-style increase in public spending to pull the US out of recession.

Writing on his blog , Prof Buiter said: “There will, before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury bills and bonds are still viewed as a safe haven by many. But learning takes placeHe said that the dollar had been kept elevated in recent years by what some called “dark matter” or “American alpha” - an assumption that the US could earn more on its overseas investments than foreign investors could make on their American assets. However, this notion had been gradually dismantled in recent years, before being dealt a fatal blow by the current financial crisis, he said.

“The past eight years of imperial overstretch, hubris and domestic and international abuse of power on the part of the Bush administration has left the US materially weakened financially, economically, politically and morally,” he said. “Even the most hard-nosed, Guantanamo Bay-indifferent potential foreign investor in the US must recognise that its financial system has collapsed.”

He said investors would, rightly, suspect that the US would have to generate major inflation to whittle away its debt and this dollar collapse means that the US has less leeway for major spending plans than politicians realise.

http://www.telegraph.co.uk/finance/economics/4125947/Willem-Buiter-warns-of-massive-dollar-collapse.html

The St. Louis Fed gets it.

Fed Chairman Ben Bernanke and other senior Fed officials are quite confident that they have the tools and the determination necessary to prevent an unwelcome acceleration in inflation or inflation expectations. Unlike previous episodes, though, the magnitude of the policy responses to the financial crisis and the Great Recession suggests that the FOMC’s margin of error seems much smaller than at any time in the Fed’s history.

http://stlouisfed.org/publications/re/articles/?id=1865

Small speculators are the most long the dollar in over 10 years. Get ready for the next leg down.

Where are we right now?

In terms of the GDP, we are about halfway to depression level. If you look at retail sales, industrial production, we are already well into depressionary. If you look at things such as the housing industry, the new orders for durable goods we are in Great Depression territory. If we have hyperinflation, which I see coming not too far down the road, that would be so disruptive to our system that it would result in the cessation of many levels of normal economic commerce, and that would throw us into a great depression, and one worse than was seen in the 1930s.

What kind of hyperinflation are we talking about?

I am talking something like you saw with the Weimar Republic of the 1930s. There the currency became worthless enough that people used it actually as toilet paper or wallpaper. You could go to a fine restaurant and have an expensive dinner and order an expensive bottle of wine. The next morning that empty bottle of wine is worth more as scrap glass than it had been the night before filled with expensive wine.

We just saw an extreme example in Zimbabwe. … Probably the most extreme hyperinflation that anyone has ever seen. At the same time, you still had a functioning, albeit troubled, Zimbabwe economy. How could that be? They had a workable backup system of a black market in U.S. dollars. We don’t have a backup system of anything. Our system, with its heavy dependence on electronic currency, in a hyperinflation would not do well. It would probably cease to function very quickly. You could have disruptions in supply chains to food stores. The economy would devolve into something like a barter system until they came up with a replacement global currency.

http://www.fairfieldweekly.com/article.cfm?aid=16014

IT is getting harder for governments to buy United States Treasuries because the US’s shrinking current-account gap is reducing supply of dollars overseas, a Chinese central bank official said yesterday.

The comments by Zhu Min, deputy governor of the People’s Bank of China, referred to the overall situation globally, not specifically to China, the biggest foreign holder of US government bonds.

Chinese officials generally are very careful about commenting on the dollar and Treasuries, given that so much of its US$2.3 trillion reserves are tied to their value, and markets always watch any such comments closely for signs of any shift in how it manages its assets.

China’s State Administration of Foreign Exchange reaffirmed this month that the dollar stands secure as the anchor of the currency reserves it manages, even as the country seeks to diversify its investments.

In a discussion on the global role of the dollar, Zhu told an academic audience that it was inevitable that the dollar would continue to fall in value because Washington continued to issue more Treasuries to finance its deficit spending.

He then addressed where demand for that debt would come from.

“The United States cannot force foreign governments to increase their holdings of Treasuries,” Zhu said, according to an audio recording of his remarks. “Double the holdings? It is definitely impossible.”

“The US current account deficit is falling as residents’ savings increase, so its trade turnover is falling, which means the US is supplying fewer dollars to the rest of the world,” he added. “The world does not have so much money to buy more US Treasuries.”

China continues to see its foreign exchange reserves grow, albeit at a slower pace than in past years, due to a large trade surplus and inflows of foreign investment. They stood at US$2.3 trillion at the end of September.

http://www.shanghaidaily.com/article/print.asp?id=423054

Ben S. Bernanke doesn’t know how lucky he is. Tongue-lashings from Bernie Sanders, the populist senator from Vermont, are one thing. The hangman’s noose is another. Section 19 of this country’s founding monetary legislation, the Coinage Act of 1792, prescribed the death penalty for any official who fraudulently debased the people’s money. Was the massive printing of dollar bills to lift Wall Street (and the rest of us, too) off the rocks last year a kind of fraud? If the U.S. Senate so determines, it may send Mr. Bernanke back home to Princeton. But not even Ron Paul, the Texas Republican sponsor of a bill to subject the Fed to periodic congressional audits, is calling for the Federal Reserve chairman’s head.

I wonder, though, just how far we have really come in the past 200-odd years. To give modernity its due, the dollar has cut a swath in the world. There’s no greater success story in the long history of money than the common greenback. Of no intrinsic value, collateralized by nothing, it passes from hand to trusting hand the world over. More than half of the $923 billion’s worth of currency in circulation is in the possession of foreigners.

In ancient times, the solidus circulated far and wide. But it was a tangible thing, a gold coin struck by the Byzantine Empire. Between Waterloo and the Great Depression, the pound sterling ruled the roost. But it was convertible into gold—slip your bank notes through a teller’s window and the Bank of England would return the appropriate number of gold sovereigns. The dollar is faith-based. There’s nothing behind it but Congress.

But now the world is losing faith, as well it might. It’s not that the dollar is overvalued—economists at Deutsche Bank estimate it’s 20% too cheap against the euro. The problem lies with its management. The greenback is a glorious old brand that’s looking more and more like General Motors.
http://online.wsj.com/article/SB10001424052748704342404574575761660481996.html