Americans Will Leave This Crisis Poorer than Before

Every crisis has to end and eventually all markets bottom out rather than go to zero. So shall it be this time too.

However, whether there will be heady days of growth soon on the horizon, as early as late second half of 2009 according to some, is a matter of debate. Markets discount the future and a clear prognosis is not forthcoming at this juncture on the expected time frame for revival of growth.

However, a few things are much clearer than the rest.

In the end, determined governments almost always get their way. Assuming that the US government is able to print its way out of the crisis, eventually the excess supply of dollars will lead to severe inflationary pressures. Interest rates will have to rise to counter inflation and that will tremendously add to the debt servicing burden of the government. This burden, short of a miracle, can only be met through printing more money, devaluing the currency further.

Once the inevitability of this starts becoming apparent, the holders of US government debt will not sit idle and watch the value of their investments decrease significantly. It should be a matter of concern, when the head of the government of China, the biggest holders of US debt, asks for a guarantee to protect his investment value. It should be a matter of further concern, when China proposes an alternate reserve currency and finds many backers for the idea.

I think to dismiss all this as mere posturing ahead of the G 20 meet is a fallacious argument. But to think of it, for America, there is no option but to dismiss the idea publicly. To endorse the idea of a new reserve currency implies an untimely and immediate demise of the dollar. I am quite sure that back channels have been activated to assuage the Chinese concerns. The Chinese are focusing on invigorating domestic demand and stimulus money is being spent in the interiors of the country rather than in the coastal areas. Once there is a visible revival in domestic consumption, the Chinese may rush to check out of US Dollars.

One need not be a genius to bet that incrementally very little is being invested in US treasury securities. A domestic demand revival would clearly break the cycle necessitating the Chinese to stay invested in the US Dollar lest a falling dollar completely demolish whatever is left of the Chinese exports to the USA.

Everyone I know is searching for an alternate currency to park their money in if they have to move out o the US Dollar. However, in a world where we have probably seen only the first part of the crisis play out, where there is still money sitting on the sidelines waiting to call a bottom and rush back in, where most of the countries are busy hiding their troubles and their troubled banks behind opaqueness (read suspension of mark to market rules), it is the US Dollar which benefits in the short term due to the openness of its system and the character of the nation where all major issues are discussed and debated openly. Further, the flexibility in the system to massively cut jobs in one swoop (650,000 + jobs lost in March alone) and reduce other fixed costs give American companies a fighting chance to survive the crisis intact.

I had written in October 2008 suggesting a move into the US Dollar for the short term. So far, so good and the theory is holding up well. This trade was worked well but odds are beginning to stack up against the US Dollar though I still do not see a significant US Dollar depreciation in the short run. One possible reason for emerging markets rally is dollars moving out into emerging markets as part of currency diversification rather than a pure equity play.

Our generation has been enriched by experience. We lived through the internet boom and bust. Now we are seeing economies and countries blowing up in front of our eyes. However, I suspect that the enormity of these events will take time to sink in as we are living the history at this point in time. Iceland has blown up and USA, Dubai, Singapore, UK, Ireland, etc are suffering from a massive contraction in housing values. March has been a benevolent month for the markets but let us see if one sparrow will make it easy to herald the arrival of summer. The point is that values are emerging across the globe and the USA might not be the sole beneficiary of money searching for bombed out value plays. It will have to compete with other countries to attract investments. To pay for its obligations, it will have to print more and more money unless the world revives overnight and US coffers are full with tax revenues once again.

With more than 35% of the US corporate earnings coming from overseas, a weaker US dollar may not be a bad thing necessarily for the corporate sector. However, it will make imports expensive and the Wal-Mart days of continuously falling prices may be over.

The net effect of the above detailed events could result in a significantly dented purchasing power for the US consumers. Combine that with the new found propensity of US consumers to save. A combination of both would result in poorer US consumers and a significant alteration to trade and commerce as it stands today.

Comments

[Dave Wrixon:]

The comparative is grammatically unnecessary.

Americans will leave the this crisis Poor!

Apr 05 06:30 AM

[rdondamike:]

In the immortal words of Jackie Gleason, "Spend " . @rdondamike

Apr 05 09:42 AM

[sunnsea:]

A few months of bad numbers and unemployment benefits do not new ingrained habits make. In other words, the bottom line is that everyone is looking for a reflation of the bubble so we can continue to live high. There are still too many SUVs, 4 X 4s and Hummers around to make it feel like we are going to be poorer. When these are mostly off the road and mothers start picking up their kids at school in new hybrid and battery operated cars is when I'll believe there is a fundamental change going on. It will take at least five to ten years of a "poorer" lifestyle for it be thoroughly ingrained not to spend to excess.

Apr 05 10:09 AM

[captainjohann:]

A great analysis. What Indian nation should do to adopt to this American priniting of dollars.

Apr 05 11:07 AM

[Hot Richard:]

Budget Director Peter Orszag does not impress. Folks, it is a massive failure (you can call it a ripoff if you want) and all Orszag is talking about is "health care".

Man-o-man-o-man-o-man. In 40 years...most STILL won't figure out what really happened. Oh, the pain the citizens will endure.

Advice: GET YOURSELF A GOVERNMENT JOB IMMEDIATELY.

Apr 05 11:10 PM

[bobbobwhite:]

The suspension of mark to market "asset" valuation shows clearly that the the US gov't is still prone, at best, to giving Wall Street a soft pass on being fully aware and responsible for its fiscal mistakes and then demanding a full and total hard solution to the economic problems it caused.

Just another proof that the long term incestuous relationship between Wall Street and Washington continues unabated and has surely been enhanced by this latest gift to Wall Street.

Apr 06 01:17 PM