August 29, 2003

Unrestricted Warfare and the Dollar

This post is more like an essay. I'm trying to put a table of contents at the top here so you can quickly scan what's new and jump to what's interesting to you, rather than having to scroll. Be patient with me. (Meditate, if it helps...outside the office right now I hear the chanting of a a Buddhist(?) monk who comes by the window about the same time every night...his voice sounds just like a didgeridoo...amazing.) In the meantime, this is another example of the kind of content--in addition to the investment content--that this medium allows me to publish. It's a more detailed exploration than I could undertake in an e-mail or a monthly issue. And since I'm not actually sending it to you, I assume I'm not imposing. And if you really really think it's too long...stop reading. Otherwise...enjoy. Unrestricted Warfare and Destroying the Dollar “If it wanted to, and if it were smart enough, how could a terrorist organization destroy the U.S. dollar?” This is the question I posed to myself last night over a few beers at my favorite bar, just off rue St. Denis. It wasn’t originally my question. It was posed to me by a reader at the conference in San Francisco. This reader happens to be a Naval Reserve officer. And he and his professional friends do a lot of thinking about what terrorists may or may not be plotting against American interests. “How they might come after the dollar,” he said, “is what keeps the intelligence boys up at night.” The premise of this line of thinking is simple: If you really wanted to cripple the United States, or even send it back to the Middle Ages, you wouldn’t bomb its buildings, bridges, buses, or bourses. You’d destroy its currency. It’s the dollar that gives America its power, the thinking goes. It’s the dollar that makes America strong. It’s the dollar, and the willingness of foreigners to own it via U.S. stocks and bonds that is the source of American strength. It’s the strong dollar that pays for aircraft carrier groups, precision guided missiles, Stryker brigades, and the C-17s that fly American men and weapons to all four corners of the globe. Destroy the dollar, and you destroy America. Practically speaking, there are probably things you COULD to the physical currency to sow chaos in financial markets. You could counterfeit your enemy’s money, like the British did in the Revolutionary War (while they paid their own debts in gold.) Or you could sprinkle anthrax at an ATM in the heart of a major city. That would complicate the use of physical money. Of course there are a lot more digital dollars than real dollars these days. No one knows exactly how many. But the Depository Trust Clearing Corporation clears $1 quadrillion worth of trading activity every year. I’m not even sure what that means, but it amounts to about $3 trillion and 4 billion trades a day. It does all that clearing on computers located at facilities located all over the country. In one of his novels, Tom Clancy had terrorists destroying one of those facilities and vanquishing Wall Street into the ether. Today, they’d have to find them. Then there’s the Federal Reserve, which clears all international trading in dollars. A reader on the message board wrote the following. Although I can’t vouch for its accuracy, it seems plausible: On 9/21/01, I attended a small, private meeting where a senior official of the Fed. Reserve briefed us on the recent calamity in New York. Some of his comments were startling. The New York Fed. Reserve was knocked out by cables that ran under the collapsed buildings. (not reported in the press) The New York Fed is the clearing house for ALL international trading in dollars. The rest of the Fed districts stepped in to share the load and to continue the world trade in dollars. There was a run on the banks in Florida. Little old men and women ran to their bank and demanded all of their assets in cash. The Fed was able to keep this out of the media. In order to stem any further panic, the Fed started injecting 100 billion a day into the system. We were informed that the "normal" cash injection was 1 billion a day. As of our meeting date (9/21/01) they were still injecting at that rate. Our speaker informed us that these funds would be removed from the system when things got back to normal. Then, during a Q/A session that followed his presentation, I asked a "doomsday " scenario question like, "What is your fallback if all your actions are futile?" His response startled me. His words. "We at the Fed will to anything, including direct intervention in capital markets, in order to stabilize the situation." If you really wanted to attack the dollar, you’d attack the electronic clearing systems that make dollar-denominated trade possible. Right? I suppose all of this is possible. But as I was thinking about all this I thought two things. First, the dollar is not really the source of American wealth. A currency doesn’t make a country rich. A sound currency is, perhaps, accompanies a wealthy country. But it’s not the paper that makes you rich. It’s the factories, property, raw materials, labor, knowledge, and skill that are the real source of wealth. Paradoxically, a currency can’t make you strong. In fact, all it can really do is make you weak. Even it’s strength, for America, has been its weakness. The strong dollar has made it possible for Americans to acquire lots of cheap goods and services. But it’s also encouraged a structural shift in the American economy that FAVORS consumption over production. And now, our dollar is our Achilles heel. If foreigners aren’t willing to own it, the dollar will have to depreciate and American standards of living will have to fall. Second, who needs a terrorist to accomplish what the Central Bank is achieving with stunning success. Without a box cutter, and without firing a shot, blowing up a bus, or hijacking an airplane, Greenspan et. al have already done more damage to the dollar than any al Qaeda operative ever could. Who needs an enemy to counterfeit your currency when your own bankers can do it themselves? And all perfectly legally, with the approbation of the public? As an investment question, there’s not much you can do about preventing a theoretical terrorist attack on the dollar. But there IS something you can do about the Fed’s attack. Short bonds. Think of the U.S. government as a company. Its main product is dollars. That product is defective. The proxy for that product is the government bond, which is a call on future dollars, and trades openly in the market. I’ve written a lot about shorting the dollar via bonds this week. So I won’t elaborate here. Nor will I elaborate on the other way to be short the dollar…by being long gold. We’ve spent a lot of time on that too. If you haven’t seen those posts, pay special attention to the chart below showing the ratio between Gold and U.S. T-bonds. This ratio represents, as my trading friend Greg Weldon says, the “Ultimate Battle Between Paper and Gold.” As you can see from the chart, bonds creamed gold for 15 years. That trend is now reversing. Of course you have a risk either way…being short bonds or long gold. The Fed can be the buyer of last resort in the bond market (or encourage the Japanese to buy) and it can be the seller of last resort in gold (although no one can be really sure how much gold is really left in Fort Knox, or if it’s all been leased away to the bullion banks, never to be seen again.) No matter which way you slice it, the real battle in financial markets is not between al Qaeda and the dollar. It’s between paper and gold. And gold is starting to win. But don’t expect paper to go down without a fight.


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