Tuesday, November 16, 2010

The Mushroom Shaped Dollar Debt Sponge

11/16/2010 Portland, Oregon – Pop in your mints…
So what is the point of all this speculation about the dollar no longer being widely accepted as a medium of exchange?  Why would this be important?
The point is that the worldwide real demand for dollars may have hit its high water mark, in the long historical sense, in 1971.  Since then, any increase in relative value has been mostly smoke and mirrors obscuring a long, winding road that the dollar has been following on its way to obsolescence.  As the wheels begin to fall off the "dollar mobile", the only thing that is holding it together is that its debt markets are the deepest that have ever existed.  If a large portion of the US denominated debt market were to be defaulted upon or forgiven (the portion owed by the government in Washington, D.C. comes to mind), inflation in domestic prices would shoot off like a rocket and the whole sorry episode would end in a spectacular, fantastic debacle played out in real life, a debacle the likes of which cannot yet be fathomed.
For a glimpse of how this scenario could play out and speculation that it may already be happening or about to happen, check out a recent post at LewRockwell.com appropriately titled "So Long, Dollar" by Jeff Fisher here
Until the above scenario begins to unfold, we will see roughly zero inflation and 0% FED funds rate as US dollars, like Surge cola, cannot be shoved down people's throats.  People will search for and find more viable mediums of exchange, such as Euros or (hopefully) Silver and Gold.  As this plays out and the real world begins to exit the dollar system, the best we can hope for is for the dollar system to collapse itself squarely on its originators at the FED, like a big paper black hole.
Since we are coming off a fresh report of a bumper crop of mushrooms here in the northwest this year, we offer the following metaphor in case the Surge story has not driven the point home.  The metaphor is the following: 
Picture a mushroom shaped sponge.  Place that sponge in an Olympic size pool full of water.  Imagine that the sponge, which represents the US denominated debt market in this metaphor, has been growing ever since the end of the Great Depression of the 1930s or roughly the beginning of World War II.  Its growth began to mushroom in 1971 and the canopy of our "mushroom shaped debt sponge" grew rapidly from 2000 to 2007.  At that time (late 2007), the sponge had absorbed all of the water that was in the pool.  The water represents the US dollar supply, known as M2 in our key statistics below.  

Are you following this?  I hope so because it gets stranger.
You, representing a bond market participant, go to the high dive.  You notice that the pool is bone dry.  Will you jump?  Of course not!  You yell to the lifeguard (The Federal Reserve) "HEY!  There's no water in the pool!"  This is the point of Jim Kramer's now famous rant in July of 2007: 
The lifeguard slowly walks over and turns on the hose to fill the pool as it does from time to time.  However, the sponge absorbs all of the water that the hose puts in!  What do you do?  No one will swim until you get more water in the pool.  You open the faucet further.  Still, the pool is not filling or if anything, it is filling very slowly.  You need to do something more.  People are now lining up on the diving board and down the side of the pool.  The diving board is about to break and the line of people is starting to get ideas about what to do about the inept lifeguard.
In the above metaphor we, in 2010, are just getting to the point where the lifeguard (the Fed) starts turning up the hose.  People will soon demand that more extreme measures be taken and the fire department will come open up the hydrants and begin to fill the pool.  Eventually, either the lifeguard of fire department will overwhelm the sponge and fill the pool.  We will have hyperinflation once the pool has overflowed.
When will that occur?  Your guess is as good as ours but as M2 listed below begins to approach total dollar denominated debt (roughly $57 Trillion) you will know that it is time to leave the building before we all get soaked!
Stay Fresh!