The Dying Dollar.

'We’re like the untrustworthy brother-in-law who keeps borrowing money, promising to pay it back, but can never seem to get out of debt. Eventually, people cut that guy off"

-American investor Jim Rogers.

More wisdom is hidden in this short sentence than most readers realize, it is in fact the very reason for the sharp decline in the US economy which still lies ahead. Rather than bombarding you with complicated economic data to argue my case, I will instead focus on a less mathematical approach to keep my thesis comprehendible.

Just like ordinary households, nations too rely on loans to finance certain expenses, for instance major and costly infrastructure projects. This by itself is not unusual nor is it a practice which I condemn, of course provided that future income is sufficient enough to repay the debt. Also noteworthy is the fact that these kinds of investments will lead to GDP growth in the long run. Borrowing money to finance a bridge will make transport more efficient, financing a new airport will increase mobility, financing a new refinery will guarantee the flow of affordable gasoline, these are all examples of investments usually financed by borrowing money and will add value to the economy in the long run. So far, no problem.
However, the trouble with the US federal government and average US household at this point of time is that they still have a strong and somewhat unfounded believe in the strong revival of the US economy and keep borrowing tirelessly, waiting for that light at the end of the tunnel which according to me and many world renowned investors such as Mark Faber may never come and continuous rise of poverty in the US is a bleak, yet more realistic future expectation.

Is the US able to repay its debt which is heading toward 10.000.000.000.000 US Dollars? In the old days of inexorable economic growth and the absence of serious competitors such as China and India, this would be considered plausible. Second of all, the money borrowed in those days was generally used for investment purposes rather than consumption. A billion of Dollars borrowed was used to build production facilities or improving infrastructure which in turn created new wealth: more jobs, more money. Today the situation is slightly different, not only is it unrealistic to expect continuous economical growth, but the money borrowed today is not so much used for investment, but mostly for consumption. The average American household seems rather reluctant to face facts and reconsider its unbridled spending habits, most choose for the easy way out: borrowing money. But consumption doesn’t lead to growth, consumption is merely digestion.

I think the trouble today is that most people unjustifiably (or out of ignorance) take America’s prosperity for granted. They assume that the mere fact that the US is free, capitalistic and democratic is enough to guarantee everlasting economic prosperity. This is a huge oversimplification to put it in polite terms. In fact, one could argue that a democracy does not necessarily influence economic growth in a positive way. In China, the party decides that building a highway in a certain area would increase mobility (and thus the economical growth) and only a few days later construction begins. In Europe, it will take years just to convince the environmentalists that this highway is worth the environmental sacrifice, you’d be lucky if construction takes place within two years. As an ever increasing number of American companies relocate their production facilities overseas, the US is still awaiting the gains of globalism promised first by the Clinton Administration and propagandized to this very day by the Bush Administration tirelessly. Looking at the enormous trade deficit with China, one can only come to the conclusion that China stands to gain, whereas the US is the loser in the long run.

Some will denounce my thesis and will quickly point to America’s recent economical growth numbers which aren’t bad at first glance. What they fail to realize is that this growth is little more than statistical/paper growth, it doesn’t translate into growth in average disposable income, in other words: it's technical growth, mainly because of acquisitions overseas by major US companies. When General Motors or General Electric or some other major American enterprise buys a stake in some successful Chinese, Vietnamese, Russian or Indian firm, its assets will grow, its financial situation will perk up, this will show up in the GDP, however this leads to no increase in disposable income in the US. Let this sink in, because this is vital for understanding the fallacy of the economic growth numbers which are presented to us by the current Administration.

The recent surge in gold prices is not due to increase demand for jewelry. The surge in gold prices can be attributed to the increasing demand by investors who are losing confidence in the US dollar and are stocking up on gold. They are in search for some alternative for the US Dollar, since the Euro is heavily linked to the Dollar (which is becoming less stable) and the Chinese and Russian currency are not yet strong enough to take its place, more Central Banks and investors are rediscovering the stability of gold.

Recently, Russia, China, Malaysia, the United Arab Emirates, Thailand, Saudi Arabia, Iran and Syria, have announced that they are taking steps to reduce their enormous stocks of US Treasuries and will diversify their reserves. Even the largest foreign holder of US currency (Japan) is taking steps to reduce its huge holdings of US Dollar reserves. Japan had US Dollar reserves valued at over $700 Billion at the start of 2006.



At this point, the steps taken by the nations above are not very drastic, most of them are merely reducing their US Dollar reserves mildly. However, if the US trade imbalance keeps increasing, Americans refuse to adjust their unbridled spending habits and the neoconservative Administration doesn’t find a way to alter the world order in a less costly manner, I’m afraid that this is just the beginning.

The Economist, a widely acclaimed magazine went a step further and even spoke of "the disappearing dollar." In its cover story it stated: [i]'[The] privilege of being able to print the world's reserve currency, a privilege which is now at risk, allows America to borrow cheaply, and thus to spend much more than it earns, on far better terms than are available to others. Imagine you could write cheques that were accepted as payment but never cashed. That is what it amounts to. If you had been granted that ability, you might take care to hang on to it. America is taking no such care, and may come to regret it.'[/i]

Most financial experts at the top are aware of this and are taking steps to force people to reconsider their rather wild spending habits, this is proven by Federal Reserve president Ben Bernanke’s unstoppable appetite for interest rate increasing, but I’m afraid that as long as the public insists on postponing the consequences of years of financial irresponsibility by borrowing, and the neoconservatives spend trillions on wars, mister Bernanke’s efforts may be in vain.

Lots of criticism so far, but are there any factual solutions? Newsweek provided the most basic solution: 'Americans need to export more and to consume less." I’d like to ad something to this: America needs to export more, consume less, and spend less on costly (2.6 trillion $) overseas “nation building” efforts, which in turn backfires in the form of increased security risks and thus a less favorable investment climate for desperately needed overseas investors.

B.C.



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