Since the Bretton Woods agreement in 1945, the U.S. dollar has served as the world's reserve currency. As such, that has provided the U.S. with significant advantages relative to the rest of the world in trade, finance and cost of government debt. Investors have recently shown additional concern about the safety of sovereign debt.
Since 1900, the US Federal Debt has increased from about $2 billion to as of August 31, 2010 approximately $13.370 trillion. In 1945 and after the expenses of fighting World War II, the US Federal Debt only stood at $259 billion.
Of course, the $13.370 trillion in debt is only the tip of the iceberg facing the US taxpayer and the US creditors. Add in off-balance sheet items and the Peter G. Peterson Foundation estimates that the real national debt is about $62 trillion while Jason Saving of the Dallas Federal Reserve suggests that it is more likely $110 trillion. Obviously, an economy with a GDP of about $14 trillion is unable to service the current debt and future liabilities. In 2009, the federal deficit was about 9.9% of GDP. The following chart from the Peterson Foundation shows the spiraling effect of the Obama Administration course of action.
However, since 1980, the U.S. has gone from being the world's largest creditor nation to the world's largest debtor nation and with the increasing deficit spending policies of both Republican and Democratic administrations there is growing concern throughout the world about the viability of the U.S. dollar as the world's reserve currency.
Since the beginning of the 21st century, there have been many signs of uneasiness with the US Currency. The Middle East has tried to set up a mechanism to price oil in something other than US currency. Japan and China, the largest holders of US Treasuries, have cautioned about further increases in the size of their holdings. In fact, since 2004, China has have been attempting to reduce their US exposure by investing in commodities and letting their citizens own gold as individuals. Russia, China and several Middle Eastern oil producing countries have recently added their voices to the need for a different world reserve currency.
The International Monetary Fund as well as the Bank for International Settlements have also added their voices to the rising chorus. Actually, since 1999, the world's reserve currency composition has changed from predominately US dollars as shown in the following charts from the IMF.
Still the US Treasury under Secretary Geithner, the Federal Reserve Bank under Chairman Bernanke nor the members of Congress heeded the obvious dismay that the current fiscal and monetary policies need to be changed or the world will find another medium of exchange.
The correct answer is "suddenly!" Ask Lehman Brothers management or almost any one who has found themselves in that situation. It took less than six months from the time the first analyst suggested that the Greek bonds were in trouble before the Eurozone was trying to raise almost $1 trillion to stave off a financial collapse that threatened most of the Eurozone banks, if not, the world's banks.
Is there a lesson there?
On June 6, 2010, Bloomberg reported:
"The International Monetary Fund said it’s possible to take the “revolutionary” step of creating a new global reserve currency to replace the dollar over time.
The IMF’s so-called special drawing rights could be used as the basis for a new currency, First Deputy Managing Director John Lipsky told a panel discussing reserve currencies at the St. Petersburg International Economic Forum today.
“There are many, many attractions in the long run to such an outcome,” Lipsky told a panel discussing reserve currencies at the St. Petersburg International Economic Forum today. “But this is not a quick, short or easy decision,” he said, adding that it would be “quite revolutionary.”
The SDRs would have to be delinked from other currencies and issued by an international organization with equivalent authority to a central bank in order to become liquid enough to be used as a reserve, he said.
As much as 70 percent of the world’s currency reserves are held in dollars, according to the IMF, leading to calls for nations to diversify their cash piles to avoid excessive exposure to the U.S. economy as it quadruples its budget deficit in a bid to counter the worst recession since the Great Depression."
According to the Associated Press on July 12, 2010 China's Dagong Credit Rating Agency seriously downgraded US sovereign debt from number one in the world to a distant 13th ... so much for the almighty US dollar and Treasury.
"Dagong, founded in 1994 to rate Chinese corporate debt, says it is privately owned and pledges to make its judgments impartially. But in a sign of official support, its announcement Sunday took place at the headquarters of the Xinhua News Agency, the ruling Communist Party's main propaganda outlet.
Dagong's chairman, Guan Jianzhong, said the current Western-led rating system is to blame for the global crisis and Europe's debt woes. He said it "provides the wrong credit-rating information" and fails to reflect changing conditions.
"Dagong wants to make realistic and fair ratings," he said.
Beijing has more than $900 billion invested in U.S. Treasury debt and has appealed to Washington to avoid hurting the value of the dollar or China's holdings as it spends heavily on its stimulus. Dagong's report covered 50 governments and gave emerging economies such as Indonesia and Brazil better marks than those given by Western agencies, citing high growth. Along with the United States, some other developed nations such as Britain and France also received lower ratings than those of other agencies.
Dagong rated U.S. government debt AA with a negative outlook, below the firm's top AAA rating. It warned that Washington, along with Britain, France and some other countries, might have trouble raising more money if they allow fiscal risks to get out of control.
"The interest rate on debt instruments will run up rapidly and the default risk of these countries will grow even larger," its report said."
And so it began! The war against the US reserve currency ... and our printing press!
On July 19, 2010, a week after the Dagong downgrade, Reuters reported that Yu Yongding, a former academic adviser to the Chinese central bank has appealed to state representatives to move away from U.S. debt and invest in assets denominated in other currencies, as well as other financial instruments and real goods. Another influential financial expert, Zhang Monan, of the powerful think tank The State Information Center, also commented to the journal that China should replace increasing amounts of its foreign exchange reserves with hard assets such as gold.
Are these just comments by individual economists, or do these two individuals serve as government conduits to warn about coming events? I believe that these statements reflect the official thinking of the Chinese central bank policy makers. If true, we should be prepared for very interesting moves in the currency and bond markets shortly.
Last week, FOX Business host Neil Cavuto came forward with a dire prediction: Thanks to the rising $13.375 trillion national debt, a downgrade of the United States’ triple-A credit rating is imminent.
“For the first time in the history of the United States, our credit rating will get a nick,” Cavuto declared. “Let me be clear, in the next few months — you heard me right, months, not years — a credit ratings agency will downgrade U.S. debt.”
As we go to press, the U.S. dollar index closed at 81.54. Following the Kansas City Fed's annual soiree at Jackson Hole, the expectation is that the Federal Reserve will move forward with more quantitative stimulus trying to avert a double-dip recession ... of course, the official data fails to realize that the seasonal and hedonic-adjusted figures are somewhat different from the real world which has never made it out of recession.
Here is a comparison of the U.S. Gross Domestic Product and that prepared by Shadow Government Statistics:
The various stimulus programs of the Bush and Obama Administrations have not succeeded in jump-starting a deleveraging economy. In fact, it is highly doubtful that it will. At best, the stimulus programs have just added more debt to the taxpayer and lengthened the time until a recovery will occur. The Keynesian solutions might have worked when the U.S. was the world's largest creditor nation. Today, those same solutions will just make the problem worse.
The following chart shows the movement of the dollar index since 1990. Since its peak in January 2002, the dollar has fallen significantly as the debate began. With the chorus growing louder, perhaps, the US dollar index could well sink to the previous all-time record low before the end of the year.
The improvement in the dollar's value during 2010 can be largely attributed to the perceived "safe haven" status which it has enjoyed for the past sixty years. The question that many investors and others should ponder is what happens when the "safe haven reserve currency status" is gone?
But then - 'Tis Only My Opinion!
Fred Richards
September 1, 2010
Corruptisima republica plurimae leges. [The more corrupt a republic, the more laws.] -- Tacitus, Annals III 27
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