False Assumptions

[courtesy Google Images]

According to Wikipedia:

“The US Dollar Index (USDX) is an index (or measure) of the value of the United States dollar relative to a basket of foreign currencies.

“It is a weighted geometric mean of the dollar’s value relative to [six] other select currencies:

“Euro (EUR), 57.6% weight

“Japanese yen (JPY) 13.6% weight

“Pound sterling (GBP), 11.9% weight

“Canadian dollar (CAD), 9.1% weight

“Swedish krona (SEK), 4.2% weight

“Swiss franc (CHF) 3.6% weight

“USDX goes up when the US dollar gains “strength” (value) when compared to other currencies.

“USDX started in March 1973, soon after the dismantling of the Bretton Woods system. At its start, the value of the US Dollar Index was 100.000. It has since traded as high as 164.7200 in February 1985, and as low as 70.698 on March 16, 2008.”

The USDX is like a teeter-totter.  The dollar sits on one end of the teeter-totter; the other six fiat currencies sit on the other end.  When the value of the US dollar rises (deflates), the average value (purchasing power) of the other six currencies fall (inflate).  When the average value of the six currencies rise, the US dollar’s value falls.

You might suppose that a strong dollar (one of rising purchasing power; deflation) is good and a weak dollar (one of falling purchasing power–inflation) is bad.  You’d be wrong.  In our brave new world of global free trade, the currencies compete for lower purchasing power (inflation) since that decline will foster rising exports from their country, tend to produce more jobs and stimulate their economies.  Therefore governments and central banks compete to cause inflation and reduce the value of their nation’s currency.

Additionally, an overly-indebted government (like that of the US–the world’s biggest debtor) should be determined to cause inflation (decline as measured on the USDX) to allow it to repay its enormous debt with cheaper dollars.  Inflation effectively diminishes the true size (purchasing power) of the US national debt.  Thus, the US government should have a vested interest in a lower number on the USDX

On the other hand, deflation (rising currency value) is anathema to debtors since if forces them to repay their debts in more valuable dollars.  Deflation can push many debtors into bankruptcy and thereby precipitate a national depression.  The US government should fear and hate deflation since it effectively increases the true size (purchasing power) of the US national debt and also predisposes the US economy to slide into a depression.

Therefore, for the past eight months, I’ve been fixated by the astonishing rise in the value of the fiat dollar as measured by the USDX.  During that time, the dollar’s value (purchasing power) has risen from 79 (May, A.D. 2014) to over 95 in the past week.  That’s a 20% rise in the purchasing power of the dollar in just eight months.

That rise has been celebrated by average Americans because it’s helped drive the cost of gasoline down under $2 per gallon.  But that same rise should’ve been cursed by the US government because it has effectively increased the value of the US national debt by 20%.   Yes, the national debt is still (nominally) $18 trillion.  But, in terms of purchasing power (as measured by the USDX) the national debt is now closer to $21 trillion as compared to the national debt in May of A.D. 2014.

Government, which has pushed steadily for 2% annual inflation throughout most of the 70 years since WWII, has allowed 20% deflation in a period of eight months.  In theory, that 20% deflation may have wiped out ten years of previous inflation.

I’m shocked.

For me, this deflation has signaled a reversal in US monetary policy that’s not only massive, but incomprehensible.  Given our overly-indebted government’s vested interest in causing dollar inflation (to allow gov-co to repay its debts with “cheaper” dollars), why would it allow 20% dollar deflation over a period of eight months?

Maybe our government has cut a deal with the European Union and Japan whereby the dollar’s value will go up (deflate) while causing the “teeter-totter” values of the euro and yen to fall (inflate).  That kind of deal would tend to stimulate the EU and Japanese economies and perhaps prevent them from sliding into national or even global depressions.

But, at what price?!

Riding the USDX teeter-totter, if our government allows the dollar to deflate by 20% in order to save the EU and Japanese economies, that level of US deflation could push the US economy into a depression.

Even if the US economy is strong enough to withstand any deflationary forces that might push us into a depression, the fact remains that be allowing 20% deflation of the US dollar, the US government has effectively increased the value (purchasing power) of the US national debt by 20%.

Why would gov-co risk increasing the national debt by 20%?  They must know that doing so will only make it harder for gov-co to repay existing debt and might even force the gov-co to admit it’s bankrupt.

So, given my limited knowledge of economics, it’s seemed incomprehensible to me that government would allow 20% deflation on the USDX over the past eight months..  Incomprehensible.  Bewildering. Mind-boggling.

•  But as I thought about this mysterious contradiction between what government is doing (allowing 20% deflation) and government’s need to inflate the dollar so as to pay off its debt with cheaper dollars–it crossed my mind that perhaps one of my assumptions was mistaken.

For years now, I’ve simply assumed that government wanted inflation, needed inflation, depended on inflation, for the primary reason of repaying its debts with cheaper dollars.  Inflation reduced the value of dollars and thereby reduced the value of debts.  The US government is the world’s biggest debtor.  The logical implication seemed unassailable.  Government had a vested interest in inflating the dollar so as to repay the debt with cheaper dollars.  Therefore, I assumed government would foster inflation rather than deflation.

Government had a vested interest in causing inflation in order to reduce the actual size of the national debt. Government would not act contrary to its own best interests.  Therefore, I assumed that government would persist in causing inflation to 1) stimulate the economy; and 2) make it easier to repay its debts with cheaper (inflated) dollars.

Conversely, I assumed that government would never, never allow US dollar deflation because it would: 1) push the US economy closer to depression; and 2) make the national debt that much harder to repay.

However, all of my seemingly “unassailable logic” was based on a fundamental assumption:  The US government intends to maintain the lie that it can and will repay the national debt.

Given that assumption, the US would inflate dollars forever, if that’s what it takes to seemingly repay the national debt.  “QE to infinity,” right?  Conversely, the government would never allow deflation since deflation would expose the lie and collapse the pretense of repaying the national debt.

But what if my assumption (that government would inflate endlessly in order to seemingly repay its debts with cheaper dollars) was wrong?

What if government had secretly decided, “Screw it–we’re not going to repay all or even most of the national debt”?

Then, the presence or absence of deflation would be largely irrelevant to the size of the national debt. What difference does it make if the national debt increased by 20% or not, if the debt is about to be repudiated?  What real difference would it make if deflation increased “official” national debt from $18 trillion to $21 trillion (or even $200 trillion) if anything over 20% of the nominal debt was about to be repudiated?

All of my earlier “logic”–and my shock at the last eight months of deflation–were based on the assumption that the US government would continue to try to repay all or most of the national debt.

If that assumption were false, the last eight months of deflation wouldn’t be at all shocking–in fact, it might be logical and predictable

I.e., many people who are about to go bankrupt and about to repudiate some or all of their debt, ask if they’d rather repudiate $100,000 in debt or $1 million?  If bankruptcy is inevitable, is it true that you might as well relax and enjoy it?  In fact, shouldn’t you make your bankruptcy as large as possible by increasing the amount that you owe?  Lots of people say Yes.  It’s immoral to exploit bankruptcy, but people do it every day.  Sometimes governments do the same.

In any case, what difference would any amount of deflation make to the government, if the US were to repudiate $18 trillion, $21 trillion, or $200 trillion?  If all or most of the debt is about to be repudiated, what does it matter if deflation makes that debt is small, medium or humongous?

Similarly, if the debt were about to be repudiated in full, what need would there be for inflation to repay the debt in cheaper dollars?

•  So, am I predicting that the US government is about to declare bankruptcy and repudiate all of the national debt?

No.  I’m not yet going that far.

I”m simply saying that: while the past eight months of unchallenged deflation on the USDX:  1) seems “logically” inconsistent with the past 70 years of inflation as a device to reduce the national debt; 2) it does seem “logically” consistent with the possibility that government is planning to openly default on much or all of the national debt within, say, the next twelve months.

So–which presumption is true?  That the US government::  1) intends to maintain the charade that it will someday, somehow repay the national debt; or 2)  that the US government (like Greece, incidentally) is about to admit that the national debt can’t be paid in full and thereby openly repudiate some or all of that debt?

If you can tell me which of those two presumptions is currently true, I might be able to tell you what’s about to happen to the US economy.

P.S.  If the US government knows that it’s about to repudiate some or all of the national debt, will that repudiation take place unilaterally?   Or would it merely be one part of a global “reset” that cancelled the “sovereign” debts of virtually every nation’s government?

Is that the real implication of the US government’s willingness to allow the past eight months of deflation on the USDX?  Does this deflation signal that a global “reset” is fast approaching?