Email
Print
Share"The US dollar is not strong because people want to hold the dollar, but it's strong because people have debt in dollars."
--George Soros, renowned hedge fund manager
"You know, I have been here for almost a month now and still haven't figured out what I want to do," she said, late on a Sunday afternoon.
"When you don't know where you are going, the journey is the reward," I replied.
"So funny," she replied rather agitatedly.
"OK, let's go out somewhere," I said, grabbing her hand and leading her out of the house.
"What's on your mind? You know, you can be really weird at times," she said as we reached the bus stop.
"We'll take the first bus that comes here, wherever that goes," I said, sounding weirder.
One did five minutes later; a 33 to somewhere. We hopped on and bought two tickets to the last stop.
"Where does this bus go?" she asked.
"I don't know!" I replied.
"Is this some sort of a joke?"
"Like I said, when you don't know where you are going, the journey is the reward. So, enjoy it."
"Oh! I think I'll flip the point you are trying to make. Take the US dollar, for instance. From what we have been discussing, we know it will ultimately crash --- when and how, we don't know. Destination known; road unknown. You know where you are going, but not how and when you will get there. Is the journey still the reward?"
And I thought I had the penchant for linking anything to anything.
"Interesting," I said. "But I think I have some idea of how the US dollar will get there. For 2009, the projected fiscal deficit of the United States is $1.85 trillion. That's four times higher than the maximum deficit the US has previously run. This estimate has been made by the Congressional Budget Office (CBO). It also estimates that the deficit will be $1.4 trillion in 2010. Estimates made also suggest that between 2010 and 2019, the US will run a total deficit of $10 trillion. As you know, fiscal deficit is essentially the difference between what the government earns and what the government spends. And given that it plans to spend more than what it earns, the remaining money needs to be borrowed. Also, like most forecasts, this forecast is also a wee-bit optimistic, I feel."
"As in?"
"See every forecast is made using some assumptions. The CBO has assumed an unemployment rate of 8.8% for 2009. The rate has already touched 8.9% at the end of April. Also, from the way it looks, unemployment in the US is only going to increase in the days to come. Other than this, CBO assumes that the gross domestic product (GDP) growth in 2010 will be 3.8%. Now, given that the GDP contracted by 6.1% in the first quarter of 2009, hoping it will grow at 3.8% the very next year is pretty optimistic. My view is the US fiscal deficit will be more than what it is being projected. And all this money will have to be borrowed."
"Yeah, it will have to be borrowed. But with countries like China and Japan ready to lend to the US, where is the problem?"
"Hold on. In March, China and Japan were net buyers of $48.5 billion of financial securities issued by the US government. These financial securities pay a certain rate of interest and are issued to borrow money. Even Russia bought $8.3 billion of financial securities issued by the US government. Some experts have questioned the credibility of these figures, but assuming you and I trust these figures, there are some serious problems otherwise as well," I said, looking out the window, and realising how little traffic the city had on a Sunday afternoon.
"And what are these problems, if I may ask."
"Estimates suggest the US government needs to borrow $1 trillion by September. It will be very difficult to raise such humongous amount of money given that exports of the major buyers of these securities are falling. Chinese exports are down 41% and Japanese exports are down 38%. These countries earn US dollars through exporting goods and services.
These dollars, in turn, are used to buy securities issued by the US government. When exports fall, dollar earnings also fall. Given that, where will all the dollars to buy these securities come from? Also, we need to remember that the US is not the only country in the world that is running a fiscal deficit. Most of Europe is running a fiscal deficit, and so is Japan. And all these countries need to borrow. One estimate suggests the US, Japan and Europe need to borrow $5 trillion over the next two years. Now, let me be optimistic for a change and assume that there are enough buyers for these securities. But even with that, will the US government manage to find buyers for financial securities amounting to another $5 trillion, which it needs, over the next four years? This, given that the government will continue to spend more than it earns."
"Hmmm... I see even optimism can lead to pessimism. So what is the way out?" she asked as a spurt of wind blew her hair on to my face.
"I guess the only way out is to print money. The Federal Reserve of the US is currently authorised to print $1.75 trillion. This money will be used to buy back financial securities issued by the US government. The theory is that more money in the economy will lead to people spending people more and that in turn will revive the economy. Most western economies are resorting to this in order to get their economies up and running again. Bank of England is planning to buy back bonds worth 75 billion pounds. And the European Central Bank, the central bank of the European Union countries, also recently announced that it would start printing money."
