The Yellen succession and the value of the Dollar

By: Sam Brown | Wed, Jul 12, 2017
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According to Politico, National Economic Council Director Gary Cohn is President Trump's candidate for the Federal Reserve chairmanship. He shall replace Janet Yellen when her term comes to an end in 2018. This makes sense if we look at the economic and political challenges facing the US. The hard data point with increasing frequency towards a slowing of the economy. Current projections for GDP growth for the first six months of this year are around 2 per cent. In the second half it may be even lower. Carmageddon is looming on the horizon. Consumers are staggering under a debt load of more than $12 trillion whilst wage growth is almost non existent. Once the car bubble bursts, mass personal bankruptcies will bring down the housing market and a recession will follow. Almost 50 per cent of all households have less than $500 in savings to cover unforeseen shortfalls. Many US corporations are indebted to the gills. The situation is dire.

Gary Cohen is one of the most prominent leaders of the US banking cartel that owns the Federal Reserve. What can he do to represent their interests? US banks like to parade their "strong balance sheets" and their "earnings power". On closer inspection however things are not what they seem to be. The deterioration of the economy increases the risk of substantial loan losses. Underwriting, mergers and acquisitions and trading activities will suffer when the economy goes down. Loan growth will come to a halt. The derivatives exposure of US banks is frighteningly high. The latest OCC "Report on Bank Trading and Derivative Activities" as at the 31 March 2017 states that the notional amount of derivatives on the books of US insured commercial banks and savings institutions is a staggering $182 trillion. Anybody who went to a betting shop will know that betting can cause serious financial losses. How will the US cope if only 10 per cent of these financial bets go wrong? With an overall debt load (on and off balance sheet debt) between $250 and $300 trillion already? More than 70 per cent of these derivatives are linked to interest rates. So what happens if interest rates go up? Who will lose and who will win? The banks would certainly be wiped out. It may be important to mention that the Federal Deposit Insurance will compensate banks for derivative losses first, before any US citizen's deposits are saved. It has less than half a trillion Dollars of funds. The likelihood that deposit holders will be compensated is therefore slim.

In my previous article I have written about the massive interest in the precious metals markets by investors as well as price manipulators. It may be of interest to the reader that the OCC report also shows that notional amounts of precious metals contracts held by US banks went from $27 billion at the end of Q4 2016 to $40 billion at the end of Q1 2017, the highest level in 17 years.

Considering the dismal situation what actions can Mr Cohn take if he becomes Fed chair to salvage the banking industry and the economy? Raising interest rates is the dumbest or most reckless (depending on your reading of the Federal Reserve board) idea going because it would trigger derivative and loan losses at the banks, bankrupt consumers and corporations and push the US into a recession. Policy changes like a meaningful healthcare reform or improvements in taxation appear unlikely because of the power of the lobbyists. They hire politicians like taxis and will not give up any privileges. Interest rates could be lowered but on balance, this may not do much to stimulate the economy. The only major instrument left is the US Dollar. Only a marked and sustained devaluation can bring about, but will not guarantee, a reversal of fortunes. The banks themselves will need a devaluation to avoid massive loan losses. Industry would need a devaluation to be able to cope with competition from Asia and Europe. A devaluation would bring about a spike in inflation and thus replace the likelihood of a hard bankruptcy with a soft one. Italy is a country that has gone through this process time and time again until it made the mistake to join the EURO. It has a dysfunctional government like the US and devaluations kept the wheels turning. Every couple of years a few zeros are chopped off the face of the bank notes and here we go again!

By Sam Brown


Author: Sam Brown

Sam Brown

Sam is a private fund manager.

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