The Dollar Is Doomed 16 comments
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We have all heard too much already about the debt crisis: the U.S. Citizen is overextended in consumer loans and mortgage debt. Banks and commercial real estate are overextended. The Federal Government is printing and lending money at a furious pace, effectively assuming the debt of its corporations and citizens. Fellow SA Contributor Jim Welsh wrote an excellent article on this.
While the U.S. Consumer pares down his debt, the Federal Government is increasing their own by an even greater amount. The Federal Government is overwhelmed by its own liabilities: Social Security is effectively insolvent and a 36 Trillion Medicare shortfall is looming. If you think the Federal Debt is already too large, you ain't seen nothing yet.
The Social Security mess is the least of the government’s problems, as it can be fixed with slightly higher taxes and less benefits. Medicare is far more difficult to fix. The Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds, in their 2008 Annual Report, warned that over the next 75 years, the government will need to find an additional $36.3 trillion (in 2008 dollars) above and beyond what is already budgeted for beneficiaries.
The Peterson Foundation calculated the federal government’s total accumulated liabilities using the audited financial statements of the U.S. government. As of September 30, 2008, the Federal Government had $56.4 trillion in total liabilities and unfunded promises for Medicare and Social Security. This works out to $184,000 per capita.
There are only four remedies:
- Raise taxes to confiscatory levels
- Renege on healthcare obligations (cut benefits)
- Massive Borrowing.
- Weaken The Dollar.
The government will employ a combination of all of the above. Remedy 1: If taxes were raised to draconian levels, tax evasion would become rampant and government collections would come up short. Taxes will certainly go up, but not to the confiscatory levels required to meet future obligations. Remedy 2: A major cut in benefits is political poison, but a few cuts can be made.
The government will resort to what has always worked in the past: It will borrow massively and devalue the dollar. Because the US is seen as a safe place for foreigners to park their excess cash, and the Dollar’s reserve currency status, government borrowing costs are comparatively low. Additionally, foreign governments (mostly China and Japan) have been buying US Bonds in order to absorb excess cash caused by the huge trade deficit. They do this in order to keep their currency cheaper and thus the prices of their goods competitive. Due to dollar devaluation, over the past decade, the US Government has had a negative real rate of interest. Given these generous terms, the U.S. government will borrow as much as it can as long as it can.
There is another motivation to devalue the dollar: Making the U.S. Dollar cheaper makes American exports more competitive and helps raise employment in export industries.
Our creditors are no dummies. The first step is to cut off new credit. This is already happening: Treasury Department data shows that investors in China have sharply curtailed their purchases of bonds in January and February.
Andy Xie wrote a compelling article about this in the Financial Times.
The global environment is extremely negative for savers. The prices of property and shares, though having declined substantially, are not good value yet and may decline further. Interest rates are near zero. The Fed is printing money, which will eventually inflate away the value of dollar holdings. Other currencies are not safe havens either. As the Fed expands the money supply, it puts pressure on other currencies to appreciate. This will force other central banks to expand their own money supplies to depress their currencies. Hence, major currencies may take turns devaluing. The end result is inflation and negative real interest rates everywhere. Central banks are punishing savers to redeem the sins of debtors and speculators. Unfortunately, ethnic Chinese are the biggest savers.
Diluting Chinese savings to bail out America’s failing banks and bankrupt households, though highly beneficial to the US national interest in the short term, will destroy the dollar’s global status. Ethnic Chinese demand for the dollar has been waning already. China’s bulging foreign exchange reserves reflect the lack of private demand for dollars, which was driven by the renminbi’s appreciation.
The second step occurs when creditors demand higher interest rates. The interest on the debt becomes unmanageable and the government has no choice but to monetize the debt by printing money. This devalues the currency and inflation erodes the real debt. The dollar started devaluing at the beginning of the current decade.
SAFE HAVENS
Predicting exchange rates is a risky business. How fast and how far the Dollar or other currencies will fall, no one knows. I agree with Xie that “Other currencies are not safe havens either.” The rest of the world is in the same pickle. During the Great Depression, a period of “Beggar Thy Neighbor” ensued in which there was a global round of competitive currency devaluations. Each nation strove to make their exports more competitive and thus raise employment levels. In such a world environment, the safest assets are real assets – assets with tangible value.
ASSETS THAT WILL BE HURT THE MOST
- Cash, Bonds, Annuities and preferred stocks (all currencies) will be hurt.
- Because the ECB has a stronger stance against inflation than most, the Euro will be hurt far less. Therefore Euro-denominated bonds should hold up the better than the Dollar or Pound Sterling.
ASSETS THAT WILL HOLD THEIR VALUE
- Inflation-protected securities (WIP, TIP).
- Commodities, Gold and Precious Metals – these are less preferred investments because they are stores of value, not income-generating investments.
- U.S. and Foreign Equities and REITS.
DISCLOSURE: Author is long VNQ, U.S. Equities, Non-U.S. Equities, Emerging Markets Equities, US TIPS and WIP. You should perform your own due diligence and consult with a professional before investing.
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This article has 16 comments:
The only thing keeping China from floating the yuan is that they want to keep their currency cheap and thus their exports cheap. They need to keep their exports cheap to keep the restless masses employed.
On May 07 10:17 AM Bull Run wrote:
> I see the world in the future a little different, China is much like
> the US in the 20's and 30's , huge movement of population leaving
> the farm and heading to manufacturing jobs in the city,which eventually
> produced consumers because of disposible income. China will eventually
> allow it's currency to float on capital accounts, because the present
> system, is becoming unmanagable . This will create the Chinese consumer.
> At present the Chinese consumer is restricted by the Yuan being fixed
> at 16 cents, but if if is allowed to float, it'll go par with the
> US dollar..Then you see the "new world order", Chinese consumers,
> just as America emerged from the 20's and 30's .Presently the US
> dollar will continue to fall, the CDN dollar is rising 1/2 cent a
> day, and US long bond yield will rise, ( 30yr bond is headed for
> 7% this summer), all a reflection of America's excesses that need
> long term financing.Comparing America's economy with the rest of
> the world, America is far more in serious trouble. and the reason
> is, their middle class is bankrupt. The 1st time in history (since
> the 1940's) that American families have a Negaitive Net Worth.. they
> owe more than they own..No other country (western group of 7) has
> this problem, and this means countries will have to find new markets
> to sell to, namely China, Brazil, India. The real problem going forward
> is the US dollar as a world currency,an many nations realize this
> , Except America, which has greatly beneifited form it's world status.How
> long can this contiue? Just like the Chinese unwilling to float their
> currency, how long before this changes?? The worlds economy as we
> know it is changing, and it will change drastically, but when and
> how?
Check out my article where I crunch the numbers and explain in depth.
capitalisthero.com/Hed...
Because I am an avid follower of this subject - can you tell me where you got your data on this? (ie point me to a specific source or website)
thanks in advance
On May 07 10:17 AM Bull Run wrote:
> is, their middle class is bankrupt. The 1st time in history (since
> the 1940's) that American families have a Negaitive Net Worth.. they
> owe more than they own..No other country (western group of 7) has
My question for capitalist hero: yes borrowing at 5% to buy a house and get a mtg makes sense, but I always wondered how one is going to keep up with property taxes and other everyday food item inflation while incomes fail to keep up with inflation. How do you afford to keep the house especially in some of the bankrupt states?
On May 08 02:29 AM capitalisthero.com wrote:
> If you want to hedge inflation buy a house. You can borrow at less
> than 5% with a 30 year fixed when hyperinflation is on the horizon.
>
>
> Check out my article where I crunch the numbers and explain in depth.
>
>
> capitalisthero.com/Hed...