Wednesday, January 07, 2009

And continuing on that theme...

...we have an article from the Market Oracle (UK) which highlights the dangers to the US Dollar in 2009. Pay close attention to number 3, as it follows up from the last post. Concerning point number 7, see a couple of posts back where we found a chart which shows all the tax and debt obligations that are resting on the very flimsy foundation of taxes on personal income.

Ten Major Threats Facing the U.S. Dollar in 2009
Currencies / US Dollar Jan 02, 2009 - 06:41 AM
By: Eric_deCarbonnel

1) Foreign central banks selling US assets
Most of the nations which have been financing the US's massive current account deficits in recent years have either begun to sell their dollar reserves last year or are planning on selling them this year in order to support their currencies...

After years of bankrolling US consumption with the purchase of dollar assets, most nations are going to be net sellers of dollars in 2009. Just Russia, Saudi Arabia, India, and Japan alone have around $2 trillion in US holdings, and, if the current trade trends continue, America can expect foreign central banks to sell at least 1 trillion dollars this year. This begs the question: who exactly is going to be buying all these assets?

2) The worsening US Trade deficit
The US Trade deficit is worsening because, while imports to the US are falling, exports are falling even faster. Demand for the big ticket durable and capital goods produced by "developed" nations is plummeting much faster than demand for cheap consumer imports, causing widening trade deficits with nations like China. The US's increasing trade and current account deficits means that America needs to attract over 700 billion dollars this year to keep the dollar from weakening.

3) Treasuries
It is extremely important to understand that treasuries are the modern day equivalent of money under the mattress, and that, when a crisis confidence hits the dollar, treasuries will be redeemed for printed cash from the fed. This is due to the fact that the US can't allow treasury prices to crash, for fear of having the world's financial system break down and global trade collapse. So a sustained selloff in treasuries would therefore force the fed to expand its balance sheet by trillions to monetize much of the outstanding federal debt.

Why the government can't let treasuries collapse
Even if the government does not step in to support treasury prices amid a selloff , the end result will be the same. Allowing a crash in treasury market would make the financial system insolvent and cause runs on the bank. The fed would then have to print money to make good on the 6.5 trillion insured deposits around the country, the 1.5 trillion insured senior bank debt, etc... Since trillions of printed dollars would be hitting the marketplace in either case, the fed will choose the least disruptive option of putting a floor under treasury prices with printed money.

Selling treasuries is equivalent to printing money
It is deceptive to think that, because the government is borrowing to fund its deficits and bailouts, it isn't printing money. This is false. Treasuries should be seen for what they really are: "promises to print money".

4) Gold
Rising demand for physical gold is a threat to the dollar because it signals a growing loss of confidence in the paper currency. It is also key to understand that gold prices aren't rising because of the changing fundamentals of gold, but because of the changing fundamentals of the dollar. In other words, gold isn't rallying, THE DOLLAR IS FALLING...

5) China and the yuan
China is in a different situation that most other nations as it has a growing trade surplus, which stood at $40 billion as of November. As a result of disappearing Asian demand for luxury items and commodity prices plunging, imports to China crashed 17.9 percent in November while its exports only fell 2.2 percent. This leaves China with a problem the US could only dream of: huge, unsustainable upward pressure on its undervalued currency.

In order to maintain the dollar peg, China would need to fund not only a large part of the US's gigantic trade deficits, but also the trade deficits of those nations around the world which are selling their dollar reserves. If imports keep falling at their current pace, China will have to buy close to 1 trillion dollars this year alone, which leads to yet another problem: right now, China is not interested In any kind of risky US assets , and what "safe" assets does the US have to sell?...

6) Never ending bailouts
Although many Americans such as myself are growing tired of America's never ending bailouts, it is important to brace yourself because there are a lot more on the way. Here are a few of the bailouts we will be seeing this year which haven't gotten much media coverage.

A) State government bailouts
State budget troubles are worsening . States have already begun drawing down reserves, and the remaining reserves are not sufficient to weather a significant economic downturn. Also, many states have no reserves and never fully recovered from the fiscal crisis in the early part of the decade...

B) Unemployment bailout
State-funded trusts which pay unemployment benefits are running out of money . The federal government has increased these funding problems through its repeated extensions of unemployment benefits, with the total run of the benefits now being 10 months. Since there is a massive, post-holiday wave of layoffs on the way, shortfalls in unemployment funding are going to come faster and be bigger than most anyone expects. In response to these shortfalls, congress will loan the states whatever is necessary to keep unemployment benefits coming, even if they have to print every last penny. After propping up financial institutions and indirectly paying their executives billions of dollars, they now have, politically speaking, no choice.

C) Pension Benefit Guaranty Corporation ( PBGC ) bailout
PBGC is an agency established by Congress to insure participants in defined-benefit pension plans against losing their pension in the case their employer goes under. Nearly 44 million Americans in more than 29,000 private-sector plans are protected by PBGC , and some 1.3 million workers are already covered by plans that have been taken over by the agency. Although the PBGC is financed from insurance premiums collected from companies and the assets it assumes from failed pension plans, it is a widely presumed that the federal government would bail out PBGC . if it became unable to meet its obligations for retirees...

D) Housing bailouts
Since a recovery from our downward spiral is unlikely until the housing markets stabilize, there is a good possibility that we will see another, bigger federal housing bailout this year as congress tries to jumpstart the economy. It is important to note that with every new bailout congress passes, it becomes harder to say no to such a homeowner bailout...

7) US budget deficits and (lack of) Tax revenues
The federal government is a facing record breaking budget deficit in 2009. According to the latest government figures, the deficit currently is expected to be $438 billion. For a reliable idea of what our 2009 deficit will look like, to this number we need to:

A) Add the cost of funding the on-going wars in Iraq and Afghanistan
B) Add the cost of recent programs such as the TARP
C) Add the cost of current and future bailouts for the auto companies
D) Add the cost of another stimulus package
E) Add the cost of the programs promised to us by the new administration...

8) The "flight to quality"
During the second half of 2008, a "flight to quality" began as hedge funds sold foreign assets to meet redemptions requests. These forced repatriations by hedge funds combined with dollar's outdated reputation as a safe haven produced a record breaking rally in the treasury markets. This "flight to quality" is not something that hasn't seen before...

9) A loss of confidence
Confidence is the single biggest factor in determining a currency's value, and periods of deflation, such as America has been experiencing these last few months, tend to undermine that confidence and create hyperinflation . Economic troubles, deteriorating debt ratios, and scary charts are a few of the factors resulting from a deflating economy that can lead investors to lose confidence in a currency...

10) The dollar's former self

The US dollar in 1944
Following the end of World War II, the United States was a global powerhouse whose domestic industries were producing half of the world's manufactured goods. At this time, the US was also creditor nation and held over half the world's foreign reserves. As the US was running a huge balance of trade surplus, these immense foreign reserves were growing fast. In additions to foreign currencies, the United States also held $26 billion in gold reserves, approximately 60 percent of the world's estimated $40 billion. Finally, the dollar was the only post-war currency fully backed by gold.

The strength of the US economy, the fixed relationship of the dollar to gold at $35 an ounce, and the dollar's full convertibility into gold at that price made the dollar as good as gold. In fact, the dollar was better than gold: it earned interest and was more flexible than gold. It was under these strong fundamentals that, in 1944, the Bretton Woods agreement was signed and the dollar became the world's reserve currency .

Today's dollar
The fundamentals backing today are just as amazing as they were back in 1944, except in a negative sense. The US has managed to outsourced its industry to the point of total dependency on foreign imports for its basic consumer goods, energy, and, to an extent, even food. The US can today claim the exalted status of the most indebted nation in human history, with every level of society (individuals, corporations, local/state/federal governments, etc) owing an unpayably large amount of money. The US capital markets have been tarnish by widespread financial failures, haphazard bailouts, and blatant corporate corruption, the latest being the Madoff's ponzi scheme. There are also growing doubts about how much gold, if any, are left in our reserves.

Perhaps the most damning Indictment of our currency comes from this contrast between its past and current self. How can today's dollar be anything but a joke when compared to its former greatness?

The dollar's status as the world's reserve currency
The dollar became the world's reserve currency through its strong fundamental and by having the longest reliable history of increasing purchasing power. Today's dollar has long since lost both those qualities . Those pointing to the dollar's special status and expecting a new dollar bull market should realize that not everything about being the favored international reserve currency is positive. The downside of being the world's reserve is that everyone is sitting on a great pile of your money, which they could decide to dump back into circulation.


As you can see, any or all of these situations could easily occur this year - none are farfetched at all.

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