NOTE: This is part of a continuing online novel. Here is the Table of Contents.

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Alan Greenspan felt like he was explaining things to a child.

He had often felt that way.

Clinton had been like a precocious child, always asking questions, trying to trip up the teacher and please him. Reagan had been an obedient child, listening quietly, ready to follow advice.

This was an impetuous child, the kind who might throw his toys if he didn’t like what he was told. And one of those toys was nuclear annihilation.

So Greenspan, chairman of the Federal Reserve Board since the Reagan Administration, had always been patient with George W. Bush, indulgent, even fatherly. But now, for the first time in his long career, he couldn’t afford to treat this child as it wanted to be treated. It was time for some tough love.

The Oval Office was empty. Bush was in earlier than normal, at Greenspan’s request. And except for a personal secretary, he was alone.

“You can’t allow the value of the dollar to keep falling,” Greenspan began, "or even to stay at its present level. Every other country in the world lacks our independence. When their currency falls the impact on them is immediate. Oil costs more, imports cost more, savings disappear.

“But the dollar is a reserve currency. Everything else in the world is pegged to the dollar. This means we can adjust the value of the dollar to suit our needs. When it falls slowly our imports fall and our exports rise until we achieve balance. But if it is allowed to collapse, as it has collapsed, the world will find other reserve currencies, and our freedom of action will disappear.

“It’s true that the Chinese Yuan can’t act as a reserve currency right now. There aren’t enough of them around. Their economy is one-seventh the size of ours. But alongside the Yen and the Euro, the Yuan could be part of a ‘breadbasket’ of such currencies, accepted by oil producers and in international trade because it retains its value.

“In the last month the Dollar has lost one-fourth of our value against the Euro, the Yen and the Pound. We have lost one-half our value against the Chinese Yuan, since it was allowed to float. That means our exports cost less. But it also means our assets cost less. Just as Japan did in the 1980s, the Chinese can now buy up key assets, because the Yuan is now convertible directly into dollars for the first time.

“Do you know the Chinese economy will grow nearly 10% this year?”

“What does this have to do with Taiwan?” the President asked angrily, as though Greenspan had been answering a question he had not been asked.

“The value of Taiwan’s dollar reserves has plunged. If China’s central bank trades Yuan to Taiwan for dollars at less than the market rate it’s a huge benefit to Taiwan’s economy. It’s a huge favor the Taiwanese will not forget, a favor that can be called in at any time.”

“So when Secretary Rice tells me President Chen would like us to move our ships back from the Straits…”

“It could mean many things, sir. It could mean Chen fears the damage a conflict may bring. It could mean he fears the economic fallout the uncertainty will bring. And it could be that he is acting in deference to China, yes, sir.”

The President, for once, was thoughtful. Greenspan took advantage.

“Now, sir, stabilizing the value of the dollar at a reasonable level will not be easy. At the Federal Reserve we have a limited number of options.

“We can buy dollars, as we have done. This reduces the number of dollars in circulation and raises their value. But because the dollar is a reserve currency there are an enormous number of dollars out there. Until the market perceives we are serious about defending the dollar in this way, the value of the dollar will not rise. And if China continues to fight our efforts, by selling dollars out of their own reserve, or reserves bought from elsewhere, well, the dollar will stay weak.

“The second thing we can do is raise interest rates. We have already done some of that because of the higher inflation caused by rising import prices. But at this time, sir, the rate of interest we charge, the discount rate, is still lower than the inflation we see coming three-to-six months out.”

“What will it take?” the President asked.

“I estimate a discount rate of 15% might cause the value of the dollar to come back up somewhat. It would tell the markets that we’re going to maintain the dollar against inflation. This might cause prices to stabilize, and we could, in time, reduce the rate again.

“But there’s a price. All interest rates will rise, sharply and suddenly. Stock prices will fall hard, because investors will compare the return on stocks to those of our bonds and move into bonds, which is what we want them to do.

“The price of an adjustable rate mortgage will rise as far as it can, and some loans may be called if the banks can’t raise them enough. This goes for second mortgages as well, nearly all of which can rise without a cap. And it will go for credit card charges.

“Consumer purchases that depend on easy credit will stop. They’ve slowed dramatically, but they’re going to practically stop. A lot of loans will go bad, a lot of equity will hit the market at once, banks trying to get back the value of the loans. That’s already happened, to an extent. But what we’ve seen so far is, because of caps on contracts, just one-tenth of what we might see in the next six months.

“Credit card rates, even to good customers, are going to rise to 25% or more. You need a premium over what you charge the federal government to loan money to an individual without collateral, and all credit card debt represents unsecured loans. As I said, millions of people are going to have their cards cancelled. There’s going to be a rush to cash, a rush to cash out. If the government has to pay out insurance claims on the loans it has guaranteed in the private market, we’ll have to print money.”

“And that means more dollars in circulation, weakening the currency?” the President asked.

Greenspan smiled ruefully. “You’ve got it.”

“What else can we do?” the President asked.

“The underlying problems are our two deficits, in trade and in the budget. A cheaper dollar helps with the trade deficit. But half that deficit comes in the form of energy. We have to cut our energy use dramatically, if temporarily, to eliminate the trade deficit.

“Second is the budget. Your current budget requires that we borrow $400 billion this year to keep the government operating, and with the economic impact of the dollar’s fall the budget may be no good.”

“No good?”

“If economic activity falls, because of higher interest rates, that means there’s less income to tax, Mr. President. Lower revenues mean a bigger deficit, even after spending cuts. We will get back some of that, increasing employment and production for export markets, but not all of it. Not at once.”

The President sat back, expectantly. Greenspan decided to throw his cards on the table.

“Mr. President, we must declare victory in Iraq and get out. Now. The day after their elections, pull out. You’re going to have to cut domestic spending, too – there must be no shock absorbers for people who lose work or income from this. And, Mr. President, even that may be inadequate, because so much of what we spend is interest on our debt, payments that must be made if the dollar is to have any value at all.

“Mr. President, you’re going to have to tell the American people the truth. We’re broke.”