“The Foot Bone’s connected to the Shin Bone…”


The currency risk (crisis) facing the United States, referred to most recently by Former Fed Chairman Paul Volker, and former Treasury Secretary and former Goldman Sachs Chairman Bob Rubin in my last post, did not come about in a vacuum. Nearly half of the U.S. Trade Deficit can be directly attributed to our International purchases of Oil. Further, I sincerely doubt the U.S. would have been running a Budget Deficit if the U.S. was capable of producing (extracting) all of its Oil requirements domestically.

This problem has its roots in the 1970’s peak of U.S. domestic oil production. Until that time, the U.S. was the world’s largest creditor nation (and until the mid 1960’s was the world’s largest OIL EXPORTER). As such, the U.S. ran a Trade Surplus. But then U.S. Oil production peaked, and the U.S. began its long, inexorable decent into debt by continuing to increase its Oil imports year after year after year while, at the same time, continuing to promise more than it could pay for in the form of entitlements (Social Security, Medicare, Medicaid, the Drug Benefit…). Hence, we now have the “Twin Deficits” of Trade and Budget fame. In 1969, the U.S. was an Oil exporter, but in 1971 the U.S. became an Oil importing nation - and never looked back. This, in spite of the harsh lessons dealt the U.S. during the 1973 and 1979 oil shocks. At the time of the last Oil embargo, the U.S imported less than 25% of the Oil it consumers. Today the U.S. imports roughly 60% of the Oil it needs to run its economy, while going deeper and deeper and deeper into debt. Further, the U.S. is beginning to import Liquid Natural Gas (“LNG”) for the first time, putting the U.S. further and further into debt and into reliance on foreign energy suppliers (If 25% reliance on foreign Oil did such a number on the U.S. in 1979/1980, just imagine what 60% reliance might do in a supply disruption today).

The only way to pay the debt back is to increase net nominal (not real) tax revenues, actually or de facto. This can be done in a number of ways:

• The U.S. can raise tax rates.
• The U.S. can cut services, entitlements, and spending for defense
• The U.S. can grow the size of its economy, thereby collecting more taxes without necessarily raising tax rates. For this to work, the U.S. must still get a hold of its spending.
• The U.S. can debase (lower the value of) its currency (or its trading partners can do it for the U.S.).

It is extremely doubtful that the U.S. could raise its tax rates enough to make much of a dent in its budget deficit and entitlement liabilities – to do so, the U.S. would have to tax its citizens into penury. How likely is it that the U.S. Congress would cut services and entitlements in the absence of crisis? Pigs have a better shot at flying. Can we grow our way out of this mess? Sure, if we had an unlimited supply of domestic Oil and Natural Gas (“NG”) and if we were also able to control our spending. In order to grow the economy we must increase our consumption of energy. And “therein lies the rub”: The only energy source we can increase consumption of is Coal, and Coal will not run the U.S. transportation system. Coal will not heat the homes of the approximately 60% of Americans that use NG for home heat. Not to mention the external environmental costs concomitant with the use of Coal.

So we are left with the currency. You see, to pay its IOU’s, a government is very much able to print more money and use it to pay its debts. The problem with that is the contra party, the guys that hold those IOU’s, don’t like that very much. They won’t extend any more credit on such terms. They will want MORE of that less valuable money in the form of interest in the future and for the exchange of goods and services that they sell us. That means higher interest rates and higher inflation. Much higher, and we all know what that means.

Now for the Coup de Grace: In just over 4 years, the Boomers will be turning 65, and will want those Social Security and Medicare benefits they have been paying for all these years. Problem is, the system was “pay as you go”, and the money that the Boomers paid in is long gone, and the younger generation is not going to be able to pay for the Boomers “pay as you go” entitlement demands. So how do we pay the Boomers and our creditors and our Oil suppliers? We don’t.

The Oil foot bone is connected to the deficit shin bone is connected to the U.S. Dollar Hip bone is connected to the…

And that’s why the Dollar is going down - like a rock in a pond.

Mentatt (at) yahoo (dot) com