The end of the US dollar as we know it

Some men never stop chasing you.
Like my ex-boyfriend Ambar who keeps cropping up in my life now and then to basically seek advice on what to do with his hard-earned money.

“Hey can we meet for a cup of coffee in the evening?” he called to ask a few days back.
“Hmmm. Sure. As long as you keep your queries limited to on what to do with your money,” I replied.
“Ah. Blackmail!”
“But you are so fair,” I replied.
“Fair?”
“Yeah. You are not exactly a black... (pause)... male?”
“Poor joke.”
“So I’ll catch you at seven at our regular place,” I said, closing the conversation.

At sharp seven o’ clock I was at the coffee shop and so was he. And after ordering our regular cups of cappuccinos without any extra cream or chocolate, we got talking.
“So tell me why did you want to meet me?” I asked.
“I was missing you,” he replied.
“Okay, I am leaving,” I said, picking up my purse and cup of coffee.
“Come on sit. I wanted to discuss something serious with you.”
“Okay. Tell me,” I replied, knowing fully well that he had gotten through with the joke.
“My brother as you know is a doctor in the United States.”
“Yes. What about him? Is he ready to divorce his third wife? That Puerto Rican he married?”
“Well! Let’s not get into that. He is very concerned these days on the state of the US dollar. Having lived in the US all these years, almost all his investment is denominated in US dollars. He has asked me if he should start moving some of his money to India.”
“Hmmm. So?”
“Well, as you know, my understanding of these things is as good as zero.”
“That is for sure!”
“So first what I wanted to know from you is why is he so concerned?” he asked, getting to the point finally.

“I cannot get into his mind, but from what I understand his most immediate concern would have been the rating agency Standard & Poor’s (S&P) putting the outlook on AAA credit rating of the US  as “negative”.
“Hold on. Please explain in simple English.”
“See a credit rating essentially estimates the creditworthiness or the ability of an individual or a company or a country for that matter, to repay debt that has been taken. There are various levels of ratings. AAA is the best rating for countries, which means that financial securities issued by the US government are deemed to be extremely safe. There are currently 19 countries which have AAA rating,” I explained.

“And what is a negative outlook?”
“The simple way of explaining it is that in the days to come the rating agency has doubts whether the US will be able to continue maintaining their AAA rating and chances are that the rating agency might downgrade the rating. As S&P said in a statement, ‘We believe that there is a material risk that US policy makers might not reach an agreement on how to address medium-and-long-term budgetary challenges by 2013.’”

“Matlab?” he interrupted with a totally confused look on his face.
“What they are saying in a very euphemistic way is that in the days to come they expect the US to have trouble servicing all the debt they have accumulated through issuing financial securities.”
“Oh!”
“Ever heard of this term called QE?” I asked.
“Yeah. It is the short form for quantitative easing.”

“Yes. The governments around the world led by the government of the United States resorted to printing money and flooding their economies in the hope of reviving their economies. The logic was a lot of this money would seep into the stock and commodities markets. The markets would go up and people feeling rich would go out there and buy real stuff i.e. goods and services.  Once that happens, corporations would rake in the ‘moolah’ and then jobs would be created. And so the logic worked. The markets did go up, but the unemployment continued.”
“Hmmm. Yes this part I understand.”

“The US had the first round of QE around 2008 when the financial crisis first broke out. Since late last year the second round of QE, or QE II, as it is called is on. “
“So?” he asked.
“Now the trouble is that QE II ends on June 30, 2011. And there is great pressure on the government in the US not to continue with it.”
“Oh!”

“But my guess is they might have to continue with the money printing. Since QE II started, the US government is meeting nearly 70% of its fiscal deficit through printing money. Fiscal deficit as you would know is the difference between what the government earns and what the government spends. The remaining 30% it has been financing through issuing financial securities which are bought by foreigners, namely countries like Japan, China and Saudi Arabia,” I explained.

“What are you hinting at?”
“Once QE II is over, the policy of printing money to resort to financing the fiscal deficit cannot be followed. The current fiscal deficit of the US government amounts to around $1.5 trillion. So if the government does not print money to finance it, where will it get the money from?”
“The foreigners might pitch in more.”

“Hmmm. That’s not going to happen. Take Japan, for instance they need money to rebuild after the earthquake. Estimates suggest that they would need around $300 billion for this. Given the situation it is unlikely whether the Japanese will continue to invest in financial securities issued by the US government.
In fact, experts are of the view that Japan might even sell its existing hoard of US financial securities. As Satyajit Das, an internationally renowned derivatives expert wrote in a recent column, ‘Financial markets have assumed that Japan will instead sell its overseas financial investments including around $900 billion US government bonds to finance reconstruction.’”
“Now that is scary!”

“Yes it is. In fact the International Monetary Fund put out some very interesting numbers. Banks across the world face a “wall of maturing debt” amounting to $3.6 trillion. Now banks are not in a position to repay this debt immediately from their own pockets. So they will have to raise more debt to repay this debt. Also, US is not the only country in the world running huge financial deficits. So there is a lot of competition around the world when it comes to financing their respective fiscal deficits through debt or the issue of financial securities.”

“Are we through with it as yet?”
“A few more points. Fiscal deficit is not the only problem. There is also the issue of the past financial securities issued to finance the fiscal deficits of the previous years’ maturing. If you add all that, the US needs money amounting to 28.8% of its gross domestic product, which works out to around $4 trillion. The total world savings for the year are lower than that.”
“So what is the way out?”

“Oh that is simple. The only way out, is printing more and more money to get out of this mess. As investment manager John Mauldin put it in a recent column, ‘Imagine if the United States increased its money supply, which is currently $900 billion, by a factor of 10,000 times, as Brazil did between 1991 and 1996. We would have 9 quadrillion US dollars on the Fed’s balance sheet. That is a lot of zeros. It would also mean that our current debt of $13 trillion would be chump change.’”

“Oh. So that would mean that the US dollar would ultimately become worthless given that there will be so much of it floating around?”
“Yes. That is how it might turn out after all. As Bill Gross, who works for PIMCO and runs the biggest mutual fund in the world said, ‘I am confident that this country will default on its debt; not in conventional ways, but by picking the pocket of savers via a combination of less observable, yet historically verifiable policies — inflation, currency devaluation and low to negative real interest rates.”

“So basically my brother should try and get his savings out of the US?”
“I mean isn’t that obvious by now.”
“Hmmm. Yes it is,” he replied.
“Are you single these days,” he asked digressing from the subject.
Now what do they say about “boys being boys.”

(The writer works in the financial services industry and
can be reached at chandniburman@yahoo.com.
Views are personal.)