The Paulson Doctrine - Treasury Secretary Paulson is no dope. He knows that the U.S. economy - with its extravagant delusions and its expensive bailouts - needs financing from overseas. And he knows, too, that the foreigners are getting worried.
In a free market economy, Fannie and Freddie might be allowed to go under. Investors and lenders would both suffer...but the economy would go on and be strengthened by getting rid of its nasty carbuncles and tumors. But this is not a free market. It is a market where the big players always seem to manage to get an edge for themselves. For example, since 2003, Wall Street paid out a quarter of a trillion in bonuses - most of it on dubious, debt-drenched transactions that were never completed. And then, when the debt goes bad, in comes the U.S. government to bail out the whole system. The Wall Street pros keep their bonuses, with not even a "thank you" to the feds.
Fannie and Freddie can't be allowed to go under - largely because their debt is held by foreigners. Don't get us wrong. The feds would love to stiff the foreigners. But they can't...not yet. The Chinese, for example, are the single largest lenders to U.S. government agencies - including Fannie and Freddie. And the feds desperately need that flow of juice from the Far East to continue. So Henry Paulson came up with what is known as the "Paulson Doctrine" - we'll let the stockholders take a loss, but not the bondholders.
The Paulson Doctrine will hold until it is no longer needed. When will that be? We'll tell you - the foreigners will lose their money when inflation has already turned them against more dollar credits. That is, when inflation has finally convinced them to dump the dollar and refuse to lend more to U.S. government agencies, the feds will have no further use for foreign lenders. Then, they will turn their backs on the Paulson Doctrine and stick it to foreign dollar holders hard.
Bill Bonner
for The Daily Reckoning Australia
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About the Author
Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Comment by Wills on 1 August 2008:
I believe the Chinese have a huge trade surplus (over $100 billion) a year with the US. What can they do? Tell the Americans we don't want US dollars for our T shirts - we want gold or Euros? There's only 7,000 tonnes of gold mined a year - even at US$1,000 an ounce, the mined gold is only worth US$225 billion. Similarly there are not enough Euros floating around. The US also import about $2 billion of oil a DAY. What can the Saudis expect except more US$.
The US can virtually tell the Chinese and the Saudis that "we can keep your economy going if we accept your products BUT you must accept US dollars." Sure, the chickens are coming home to roost but no one is prepared to make the first move.
In 1995 the Japanese had about US$500 billion in TBonds - a staggering sum in those days when the Kobe earthquake struck. There was some fear elsewhere that the Jap may want their money back to rebuild - instead they BORROWED their own money back to do it. Sounds crazy to a careful individual investor, but that's what governments do - they prop up each other's house of cards because the consequences of one of these houses collapsing these days is unthinkable.
DR, you're doing a great job of outlining to your readers for the need for monetary and fiscal restraint and I hope most will take it to heart. However, don't expect our governments to do that. They are there, in their wishy washy ways to ensure that the great American/European/Australian dream totters on albeit with a few potholes along the way.
FIRE UP AND LET THE (MONEY) PRINTING PRESSES ROLL!
Comment by Stropp on 1 August 2008:
What you say here reminds me of that old movie, The Picture of Dorian Gray. In that movie, as you probably know, the portrait of Dorian Gray takes on all the attributes of the protaganist leaving him the picture of health and youth. Mind you, he is still corrupt and diseased, but that is hidden away. Until one day he looks at the picture...