Libya Attack and Federal Reserve Policy Illustrate U.S. Weakness

The attack on the U.S. embassy in Libya and the Federal Reserve's recent announcement of QE3 show how vulnerable the United States is.

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A burnt car is seen after an attack on the U.S. Consulate in Benghazi, Libya, over a film that ridiculed Islam's Prophet Muhammad.

James Rickards is a hedge fund manager in New York City and the author of Currency Wars: The Making of the Next Global Crisis from Portfolio/Penguin. Follow him on Twitter at @JamesGRickards.

The past two weeks have produced dramatic evidence that the political and economic decline of the United States is gathering momentum and moving closer to a point of no return.

On Sept.11, 2012, 11 years after the terrorist attacks in New York City and Washington, D.C., a carefully planned heavy assault using mortars and rocket-propelled grenades was launched on the U.S. consulate and a secret U.S. facility in Benghazi. The U.S. ambassador and other Americans were killed and a contingent of CIA operatives was evacuated. The result was a decapitation of the U.S. diplomatic and intelligence presence in Libya at a critical time in its transition from the Qadhafi dictatorship.

[See a collection of political cartoons on the turmoil in the Middle East.]

Anyone with a rudimentary knowledge of the al Qaeda modus operandi could discern that this was a terrorist attack in the al Qaeda style even if it emerges that some like-minded terror organization actually conducted the attack. Al Qaeda consistently hits targets of symbolic as well as operational significance. Al Qaeda aims for maximum psychological impact in its attacks and often hits two targets at once. Think of the dual African embassy bombings in 1998 or the dual attacks on 9/11 to see this pattern. Al Qaeda also favors anniversary attacks. The 1998 African embassy bombings were on the anniversary of the arrival of the first U.S. troops in Saudi Arabia after Iraq's invasion of Kuwait in 1990. In short, the Benghazi attacks were a textbook example of Islamist terrorism against U.S. interests.

How did U.S. leadership respond? President Barack Obama, Secretary of State Hillary Clinton, and United Nations Ambassador Susan Rice engaged in a series of lies to the effect that the Benghazi attacks were a protest against an obscure anti-Muslim video. This was convenient because it diverted attention from the intelligence and security failures surrounding the Benghazi terror. Why did the State Department and intelligence community ignore warnings that the attacks were coming? Why was the consulate not better fortified and protected? It's easier to blame a video no one saw than accept responsibility for a massive diplomatic and intelligence failure.

[Read the U.S. News Debate: Can Mitt Romney Best Barack Obama on Foreign Policy?]

Two days after the Benghazi attacks another attack was launched, this time aimed at the dollar. Federal Reserve Chairman Ben Bernanke announced that the Fed had begun an unlimited program of money printing intended to lower the unemployment rate. The policy was quickly summarized in the phrase "whatever it takes." Unfortunately for savers and investors, what it takes is inflation.

Economic growth measured in dollars is called nominal gross domestic product, or GDP. Nominal GDP has a real component and inflation component. For example, if real growth is 2 percent and inflation is 2 percent, then nominal growth is 4 percent.

Real growth today is anemic due to high taxes, excess regulation, and business uncertainty. However, the Fed can still stimulate nominal growth by causing higher inflation. They do this by holding interest rates below the inflation rate. The result is negative real interests rates, which are a powerful inducement to borrow. Inflation itself is an inducement to spend before higher prices get out of control. The combination of negative real rates and higher inflationary expectations increases money velocity and gets nominal GDP rising quickly.

[See a collection of political cartoons on the economy.]

Left unsaid is the fact that the Fed must lie about its inflation expectations. If it promises 2 percent inflation and delivers 2 percent, there is no change in behavior because expectations have been met. But, if the Fed promises 2 percent inflation and delivers 4 percent, then behavior can change quickly and money velocity can increase in exactly the way the Fed wants.

This inflation represents theft from savers, creditors, and investors in U.S. Treasury debt and other fixed income promises. Inflation hurts everyone from small savers and retirees to major creditors such as China. The Vice Premier of China responsible for the economy, Wang Qishan, has recently told U.S. interlocutors that China no longer trusts the U.S. commitment to maintain the value of the dollar. China is moving quickly to diversity its reserve position into euros, gold, and other hard assets.

We are left with the depressing sight of the president and secretary of state lying about U.S. diplomatic weakness abroad and the chairman of the Federal Reserve lying about intended weakness in the dollar.

[Take the U.S. News Poll: Should the Federal Reserve Engage in a QE3?]

Machiavelli posed the question, whether it is better to be loved than feared or feared than loved? His answer was the ideal state would be both loved and feared. The United States today is neither.    

Not often do geopolitics and economics converge as powerfully to produce a single warning as they have in the past two weeks. The dual tragedies of the assault on the U.S. consulate in Benghazi and the assault on the dollar by the Federal Reserve are the harmonic resonance of U.S. weakness at home and abroad.

U.S. national security depends ultimately not on blunt force but on confidence that the United States means what it says to allies, adversaries, and its own citizens. Weakness begets weakness in military, diplomatic, and economic matters. The United States now projects weakness from the highest levels regarding the most vital affairs of state. The effects on U.S. interests will be unpredictable in the particulars yet dire in the main.

  • Read Peter Roff: Romney Video Distracts From Obama's Libya Crisis
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