Does $7.76 trillion of US Government Guarantees Make The US Dollar A Safehaven Status?

US dollar bulls always insist that the US dollar dispenses its role as safehaven currency when global economies are under strain.

This view has been bolstered by the recent surge of the US dollar fuelling rambunctiousness in their convictions.

While we don’t dispute the US dollar’s role in the past, our belief is that the recent activities of the US dollar has been nothing more than the exercise of deleveraging or debt deflation, the unwinding carry trade and from its status as an international reserve currency standard (where most loans have been US dollar denominated) as discussed in Demystifying the US Dollar’s Vitality.

To consider, we recently cited that US taxpayers were faced with some $4.28 trillion (see The US Mortgage Crisis Taxpayer Tab: $4.28 TRILLION and counting…), a Bloomberg report now tabulates US government guarantees to hit $7.76 trillion or about 50% of the US GDP!

Excerpts from Bloomberg (HT: C. McCarty), ``The U.S. government is prepared to provide more than $7.76 trillion on behalf of American taxpayers after guaranteeing $306 billion of Citigroup Inc. debt yesterday. The pledges, amounting to half the value of everything produced in the nation last year, are intended to rescue the financial system after the credit markets seized up 15 months ago.

``The unprecedented pledge of funds includes $3.18 trillion already tapped by financial institutions in the biggest response to an economic emergency since the New Deal of the 1930s, according to data compiled by Bloomberg. The commitment dwarfs the plan approved by lawmakers, the Treasury Department’s $700 billion Troubled Asset Relief Program. Federal Reserve lending last week was 1,900 times the weekly average for the three years before the crisis…

``Bernanke’s Fed is responsible for $4.74 trillion of pledges, or 61 percent of the total commitment of $7.76 trillion, based on data compiled by Bloomberg concerning U.S. bailout steps started a year ago…

``The Fed’s rescue attempts began last December with the creation of the Term Auction Facility to allow lending to dealers for collateral. After Bear Stearns’s collapse in March, the central bank started making direct loans to securities firms at the same discount rate it charges commercial banks, which take customer deposits.

``In the three years before the crisis, such average weekly borrowing by banks was $48 million, according to the central bank. Last week it was $91.5 billion.

``The failure of a second securities firm, Lehman Brothers Holdings Inc., in September, led to the creation of the Commercial Paper Funding Facility and the Money Market Investor Funding Facility, or MMIFF. The two programs, which have pledged $2.3 trillion, are designed to restore calm in the money markets, which deal in certificates of deposit, commercial paper and Treasury bills.

``The FDIC, chaired by Sheila Bair, is contributing 20 percent of total rescue commitments. The FDIC’s $1.4 trillion in guarantees will amount to a bank subsidy of as much as $54 billion over three years, or $18 billion a year, because borrowers will pay a lower interest rate than they would on the open market, according to Raghu Sundurum and Viral Acharya of New York University and the London Business School.

``Congress and the Treasury have ponied up $892 billion in TARP and other funding, or 11.5 percent.

``The Federal Housing Administration, overseen by Department of Housing and Urban Development Secretary Steven Preston, was given the authority to guarantee $300 billion of mortgages, or about 4 percent of the total commitment, with its Hope for Homeowners program, designed to keep distressed borrowers from foreclosure.

``Most of the federal guarantees reduce interest rates on loans to banks and securities firms, which would create a subsidy of at least $6.6 billion annually for the financial industry, according to data compiled by Bloomberg comparing rates charged by the Fed against market interest currently paid by banks.

``Not included in the calculation of pledged funds is an FDIC proposal to prevent foreclosures by guaranteeing modifications on $444 billion in mortgages at an expected cost of $24.4 billion to be paid from the TARP, according to FDIC spokesman David Barr. The Treasury Department hasn’t approved the program.

``Bernanke and Paulson, former chief executive officer of Goldman Sachs, have also promised as much as $200 billion to shore up nationalized mortgage finance companies Fannie Mae and Freddie Mac, a pledge that hasn’t been allocated to any agency. The FDIC arranged for $139 billion in loan guarantees for General Electric Co.’s finance unit.

``The tally doesn’t include money to General Motors Corp., Ford Motor Co. and Chrysler LLC. Obama has said he favors financial assistance to keep them from collapse.

Amazing stuff. From $4.28 to $7.76 trillion in guarantees, subsidies, bailouts, stimulus packages with more to come.

Our idea is once the deleveraging dynamics ebb, all the recent strength seen in the US dollar will immediately be sapped.

The epicenter or “cause” of the world’s miseries can’t simply account as our safehaven. Such is a delusion.

And all the Keynesian malarkey of falling demand =falling prices loop will likewise evaporate.

The US dollar index had a remarkable one day fall.

Courtesy of Bespoke Invest

According to Bespoke, ``As equity markets stage their second straight day of gains, the US Dollar index is having its worst day since 1985, and its 5th worst day ever (since 1970). And today's fall for the Dollar broke the uptrend the currency had been in over the last couple of months, although it is still in a longer-term uptrend off of its Spring lows. Falls in the Dollar are coinciding with gains in equity markets and economic stability worldwide, since the US currency is now being treated as a safe haven. Go figure.”

Courtesy of Bespoke

As you can see, the US dollar index has broken down from its interim trend, suggesting further liquidations ahead. Pls be reminded the US dollar index is principally weighted against the Euro with 5 other currencies making up the rest of the basket.

Our thought is that commodity and Asian currencies (possibly some EM currencies with current surpluses) could lead the rally.

How has the fall in the US dollar fared to other markets?

Courtesy of stockcharts.com

Well, it’s a contagion in reverse. Former “safehavens” now victims of liquiditations; it’s not just the US dollar but obviously across the Treasury yield curve 10 year note, 3 month bill, 1 and 5 year notes.

And most importantly, some quarters have attributed the recent vigorous stock market rally to the appointment of President elect Barack Obama of Tim Geithner to the post of Hank Paulson or the incoming Secretary of the US Treasury.

While we believe that this causal chain is tenuous at best, a Geithner as 'the messiah rally' will likely to be a sucker’s rally. Yet if the market continues to rally from the recent lows (and establish a bottom!) even with Mr. Geithner doing nothing, as he is yet to assume office in 2009, then he might just be anointed a ‘saint’!

But this doesn’t seem inspired from a Geithner rally…

But probably one from Gold. Gold appears to have provided the recent market leadership.

The recent equity rally during late October hasn’t been confirmed by a rally in the commodities markets or in gold.

This isn’t the case today and looks like a broad market rally. Essentially, it’s a rally among all those asset classes that have been massively sold.

Three thoughts:

1. US dollar’s fall reflects cyclical forces of overbought conditions and may be temporary as the deleveraging dynamics continue. Conversely, equities and commodity markets have been in patently oversold conditions that the present gains reflect simply an oversold bounce.

2. A rotation in deleveraging. Because the US dollar and US sovereigns have immensely gained during the recent market volatility, the deleveraging process could have transferred been into a profit taking carnage in the US Treasuries market and the US dollar and inversely a reverse flow into oversold assets.

3. Markets could incipiently be smelling inflation. With $7.76 trillion of taxpayer exposure in the US and $trillions more from governments elsewhere, perhaps markets are starting to realize that the sheer magnitude of concerted inflationary policies are beginning to have some impact.

To quote CLSA’s Christopher Wood in today’s WSJ Op Ed, ``In this respect the present crisis in the West will ultimately end up discrediting mechanical monetarism -- and with it the fiat paper-money system in general -- as the U.S. paper-dollar standard, in place since Richard Nixon broke the link with gold in 1971, finally disintegrates.

``The catalyst will be foreign creditors fleeing the dollar for gold. That will in turn lead to global recognition of the need for a vastly more disciplined global financial system and one where gold, the "barbarous relic" scorned by most modern central bankers, may well play a part.