The Shape of Things to Come

by Kevin D. Freeman on April 18, 2011

This morning Standard and Poors downgraded its ratings outlook for U.S. Government Debt, sending both stocks and government bonds (denominated in dollars) sharply lower. [It is important to note that S&P reiterated its AAA rating on current debt. The cut was for the outlook and it was based on doubts that the government will be able to get its fiscal house in order anytime soon.]

This is a foretaste of what we have been warning against. A downgrade of U.S. government debt would start a downward spiral. First, the interest rates paid by the government would rise sharply, worsening the deficit and debt. Foreign investors would see the value of their bonds fall and the dollar decline and thus require even higher rates to compensate. Without strong foreign demand, the dollar would lose reserve currency status.

All of this is what we deemed PHASE THREE. Now, many observers will rightly note that we brought a great deal of this problem upon ourselves with excessive government spending and ever-increasing Federal Debt. In isolation, this view is right. In context with the Big Picture, however, there is much more to the story.

Our budget deficit was clearly worsened by the attack of 9/11. This not only impacted Federal Spending, but also slowed domestic growth. The Federal Reserve reacted with unprecedented “easy money” stimulus that, at least in part, spawned a housing bubble. Then, starting in 2007, the price of oil tripled over 18 months from around $50/barrel to nearly $150/barrel. All economists agree that this worsened the bursting of the housing bubble. We deem this as PHASE ONE. We have documented how a good portion of this rise was caused by excessive money flows into the paper oil markets with much of that money coming from dark sources. Our research suggests that Sovereign Wealth Funds and others provided significant capital that drove oil and commodity prices higher. This weakened the U.S. consumer, requiring a choice between buying gasoline and paying the mortgage.

With the bursting of the housing bubble and exacerbated recession from an oil price shock, investment banks such as Lehman Brothers became vulnerable due to their leveraged positions. While sufficiently capitalized for the long run, Lehman was hit by a short-term “run on the bank,” also known as a “bear raid.” This isn’t just our view but also the view of George Soros and is well documented by the trading activity. Now, we are not saying that Lehman was in great shape. What we are saying is that Lehman collapsed in a terrible way and at a minimum the situation could have been handled better. We have documented that at least 30% and as much as 70% of the decline in Lehman’s share value was due to naked short selling according to a market expert.

The collapse in Lehman created a credit crisis that was only resolved by the U.S. government ramping up its borrowing. The Federal deficit ballooned from an acceptable $165 billion in 2007 to $1.4 trillion in 2009. So, just as we had begun to recover from the 9/11 attacks, even with two wars, the 2007 deficit was just $165 billion.

So, as you look at the big picture, our excessive deficit/debt that led to today’s S&P downgrade warning, you must recognize the role of the oil price spike and credit collapse. Our research suggests that, at least in part, these events were “pushed” by forces in an act of financial terrorism/economic warfare. We can even demonstrate clear statements from the Chinese PLA, the Communist Party, former KGB, and Al Qaeda suggesting there intentions to do so. Further, they boasted that such actions would be “disguised as market forces” so their actions would not be blamed.

Keep in mind that we didn’t jump on this after the fact. We said clearly in the report published in 2009 that PHASE THREE was on the way. AT the time, the dollar appeared to be quite strong and the downgrade of U.S. debt considered unthinkable.

“Based on the assumed nature of Phase One and Phase Two, a Phase Three attack would likely involve dumping of U.S. Treasuries and a trashing of the dollar, removing it from reserve currency status. This is clearly foreseeable as a risk and even could float under the cover of a natural outcome in much the same way that Phases One and Two potentially have been hidden.

The implications are extremely serious.

If the dollar were not the reserve currency, there would be a mass dumping of Treasury instruments by foreign holders. Treasury interest rates would skyrocket, further worsening the annual deficits due to sharply higher interest payments on expanding debts. The Treasury would have to raise taxes dramatically, further dampening growth or the Federal Reserve would be forced to monetize the debt, worsening inflation concerns. Pushed to the limit, could the U.S. dollar would follow the path of the German currency in Weimar Germany following defeat in World War I.”

This remains the most serious risk we face. Unfortunately, we are subject to outside forces and thus vulnerable to economic weapons. In this context, please reconsider this statement from the Chinese Communist publication Qiushi:

“Of course, to fight the US, we have to come up with key weapons. What is the most powerful weapon China has today? It is our economic power, especially our foreign exchange reserves (USD 2.8 trillion). The key is to use it well. If we use it well, it is a weapon…

China must have enough courage to challenge the US currency. China can act in one of two ways. One is to sell US dollar reserves, and the second is not to buy US dollars for a certain period of time, which will weaken the currency and cause deep economic crisis for Washington…If China stops buying, other countries will pay close attention and are very likely to follow. Once the printed excess dollars cannot be sold, the depreciation of the dollar will accelerate and the impact on Americans wealth will be enormous…

The US will not be able to withstand this pressure.”

The frightening thing is that this is precisely the kind of weapon identified in the book Unrestricted Warfare published by the PLA in 1999. Even more disconcerting is the statement in Qiushi regarding the use of these economic weapons:

“This approach, it said, is market-driven and it will not be able to easily blame China.”

Keep these statements in mind when confronted by the crowd who says we brought all of this upon ourselves. We should bear a great deal of blame. But, our biggest mistake has been arrogantly ignoring the threats.

All posts Copyright (c) 2011 Kevin Freeman, All Rights Reserved

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