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By Root 920 0

York traders, bankers and regulators are disturbed in their sleep by frantic calls from European colleagues and counterparts. They all awake to the same sea of red and rush to get to work. The usually sleepy 6:00 a.m. suburban commuter train is standing room only; the normal “no cell phone” etiquette is abandoned. The train looks like a trading floor on wheels, which it now is. By the time the bankers arrive in midtown Manhattan and Wall Street, the dollar index has dropped 20 percent and stock futures are down 1,000 points. Gold is up $200 per ounce as investors scramble to a safe haven to preserve wealth. The contrarians and bottom-feeders are nowhere in sight; they refuse to jump in front of a runaway train. Some securities have stopped trading because there are no bids at any price. The dollar panic is now in full swing.

Certain markets, notably stock exchanges, have automatic timeouts when losses exceed a certain amount. Other markets, such as futures exchanges, give officials extraordinary powers to deal with disorderly declines, including margin increases or position limits. These rules do not automatically apply in currencies or physical gold. In order to stop a panic, central banks and governments must intervene directly to fight back the waves of private selling. In the panic situation just described, massive coordinated buying of dollars and U.S. government bonds by central banks is the first line of defense.

The Fed, the ECB and the Bank of Japan quickly organize a conference call for 10:00 a.m. New York time to discuss coordinated buying of the U.S. dollar and U.S. Treasury debt. Before the call, the central bankers consult with their finance ministries and the U.S. Treasury to get the needed approvals and parameters. The official buying campaign begins at 2:00 p.m. New York time, at which point the Fed floods the major bank trading desks with “buy” orders on the dollar and U.S. Treasuries and “sell” orders on euros, yen, sterling, Canadian dollars and Swiss francs. Before the buying begins, Fed officials leak a story to their favorite reporters that the central banks will do “whatever it takes” to support the dollar and the Fed source specifically uses the phrase “no limits” in describing the central banks’ buying power. The leaks soon hit the newswires and are seen on every trading floor around the world.

Historically, private market players begin to back off when governments intervene against them. Private investors have fewer resources than governments and are informed by the timeless admonition “Don’t fight the Fed.” At this point in most panics, traders are happy to close out their winning positions, take profits and go home. The central banks can then mop up the mess at taxpayer expense while traders live to fight another day. The panic soon runs its course.

This time, however, it’s different. Bond buying by the Fed is seen as adding fuel to the fire because the Fed prints money when it buys bonds—exactly what the market was troubled by in the first place. Moreover, the Fed has printed so much money and bought so many bonds before the panic that, for the first time, the market questions the Fed’s staying power. For once, the selling power of the panic outweighs the buying power of the Fed. Sellers don’t fear the Fed and they “hit the bid,” leaving the Fed holding a larger and larger bag of bonds. The sellers immediately dump their dollar proceeds from the bond sales and buy Canadian, Australian, Swiss and Korean currencies in addition to Asian stocks. The dollar collapse continues and U.S. interest rates spike higher. By the end of day one, the Fed is no longer spraying water on the fire—it is spraying gasoline.

Day two begins in Asia and there is no relief in sight. Even stock markets in the countries with supposedly stronger currencies, such as Australia and China, start to crash, because investors need to sell winning positions to make up for losses, and because other investors have now lost confidence in all stocks, bonds and government debt. The scramble for gold, silver, oil and farmland becomes