The Fed's Secret Weapon

[Exsubmariner]

With all the epic discussion on monetary policy and its far reaching effects into the economy, I have been thinking of the unthinkable. That is, an utter collapse of the currency. It is conceivable that the circumstances might exist one day for the fed to lose its grip on control of the fiat dollar system.

We are far from those circumstances now. A lot, and I mean a lot of earthshaking, changes would have to transpire for the situation to reach these circumstances, but there is a possibility. Even with the collapse in the sub prime lending market and its ripple up the mortgage food chain, there are still economists out there who take the position that there is a boom in the making after the fed cuts rates to stem the tide of lenders who cannot balance their finances in the face of increased dollar costs.

The gold bugs, on the other hand prey for armageddon. They secretly hope that the dollar will begin a death spiral brought on by banking collapse, dumping of dollars into the US market by foreign holders, runaway inflation, surging energy prices, etc. I have read estimations that under such circumstances, the dollar would fall so far that gold would be worth on the order of $50,000 an ounce. Conservative estimates would put the short term from $3,000-$5,000 after a sudden seismic shift. All else being equal, I'm sure gold would only still buy you a suit, a hotel room for a night, and a good meal if you had an ounce of it. The investor, however, would be able to eliminate masses of debt after such a revaluation, and thus the appeal.

But, what would the fed do? Suddenly, the power to control interest rates would be only a random force in a stormy sea.

It dawns on me that I have already witnessed the use of this in my lifetime. But, it was quiet and hardly anyone noticed.

The fed would reissue the dollar.

Large holders of cash would suddenly find their stockpiles worthless. Citizens holding currency in domestic banks would suddenly find themselves holding equivalent new dollars and all that funny money being hoarded by foriegn governments would be completely useless.

This has already happened with the $100, $50, $20, $10, and $5 bill.

Holders of cash would have a big problem if the currency suddenly changed color. They would have to divest themselves of their dollars by spending them and getting new dollars back in return.

This would have the effect of getting everyone to do business with each other again. That is, after all, what the fed is for.