Friday, January 05, 2007

The Collapse of U$D Economy?? - Part II

More than 2 years back, I had written about The Collapse of Dollar Economy?

The reasons for such a blasphemous statement were as follows:

  • The U$D is/was valued not because it represents strong fundamentals, but because it is/was the monopoly currency in the global oil-trade (and since every country need oil, they need to buy and keep U$D as forex)

  • Betting on that, the US economic policies have allowed its debt to grow to an almost insolvent levels, which is not sustainable in the long run,

  • However, Euro as an alternative petro-currency poses a major threat to petro-dollar.

    Finally, I have found a taker of this argument in none other than David Walker, the Comptroller of the US. In an accompanying note to the Financial Report of the United States Government, realeased on December 15th, 2006, he cautions:

      Despite improvement in both the fiscal year 2006 reported net operating cost and the cash-based budget deficit, the U.S. government’s total reported liabilities, net social insurance commitments, and other fiscal exposures continue to grow and now total approximately $50 trillion, representing approximately four times the Nation’s total output (GDP) in fiscal year 2006, up from about $20 trillion, or two times GDP in fiscal year 2000.

      As this long-term fiscal imbalance continues to grow, the retirement of the “baby boom” generation is closer to becoming a reality with the first wave of boomers eligible for early retirement under Social Security in 2008.

      Given these and other factors, it seems clear that the nation’s current fiscal path is unsustainable and that tough choices by the President and the Congress are necessary in order to address the nation’s large and growing long-term fiscal imbalance.

    Meanwhile, a month old news-item in Financial Times reports that Oil Producers are gradually moving away from U$D... replacing it with Euros


    Anonymous said...

    There are a couple of interesting posts at:
    One of them "Curtains for the greeback?" discusses this topic. My own feeling is that it will take a long time since 1) many other countries seem to be banking on trade 2) USA is one of the main consumers, 3)USA is less protectionist than EU,4) many countries seem to see USA as less unsable than other countries and 5) various developed financial and credit facilities. But there seem to some disillusionment with globalization and moves towards protectionism. These later points are discussed in the post " The great disconnect over the US economy" at the same site and in several posts by Mark Thoma. Of course, these are just my impressions formed from blog readings and not any deep study.

    Madhukar said...

    Agree, Prof
    this will not happen overnight. Countries hold large reserves in USD, and dumping them all into the currency market, will hurt them since it will reduce the valus of USD.

    But if one looks at the last couple of reports of Bank of International Settlements, the shift in changing the forex portfolio is happening gradually over last 4-5 years... the purchase of US treasuries is also on decline

    I dont think the value of USD in curency maket is tied to trade or protectionism (or lack of it) - the only thing which so far could not be purchased without dollar was oil... it is this power of USD that is getting challenged

    I have given some other reasons for this decline in the part-I of this post earlier.

    Prometheus_Unbound said...

    You know while in the past half year or so, the dollar has done much better than original speculation, Warren Buffet still continues to hold a sizeable chunk of his bet (USD 21.6) against the dollar. Have a look at this site:

    If you have time have a look at "The Price of Loyalty" ny Bush's first Treasury Secretary. Along with Greenspan, he's dealt at detail on the profligate tax cuts the Bush Administration handed out during their first term. Using the projected budget surplus of future years to play to the gallery instead of trying to solve the issue of financing of retirement dues for the ageing US population. Very much a Enronesque tragedy as you put it. ;)

    Anonymous said...

    Its an interesting post. There is no doubt that US$ is going down, it will take time. Rightly said Madukar, countries have large reserves of USD

    meltyourfat said...

    It is definitely a good post.
    I would ask the author a question.
    What is the incentive for Oil Producers to move away from Dollar to Euro?

    Most of those Oil producers has mammoth assets which are Dollar based. Even China doesn't have any interest in Dumping dollars as their biggest market is United States and they continue to depend on Dollars.

    I am sure, downtrend for dollar has been set, but it is not alarming as much as everybody is expecting.
    Hope i am clear.

    Supratim said...


    I think there is one more factor you must consider in your economic analysis: Normally, when a country has foreign debt and its currency depreciates, its debt increases in nominal terms and its ability to service it reduces it. That is what contributes to creating a debt trap.

    This does NOT apply to the USA: because it borrows in US$. So, when its currency goes down (aginst the euro, say), its debt obligation or interest obligations does not change in $ terms. But, for the European, Japanese or Chinese lender, their asset value has depreciated!!! So, it is not in their interest to sell US treasuries even if the dollar falls, because they hurt as well. And, in some ways, more immediately compared with the USA. It is an interesting economic construct in which the US operates - so, it is not so easy to predict the demise of the dollar. Economists have been predicting it since the eighties.

    The other thing about the US national debt - my belief is that the current president and administration has been reckless in their policies. And, the administration will change in 2008 - and so will policies. Suddenly, all the nos could change if the Democrats repeal the Bush tax cutback and bring back troops from the US.

    The thing people don't really understand about the USA is how flexible and efficient their systems are. Their economy bounces back in a year or two from crises, where others are out for a decade.
    Case in point: the Japan real estate bubble went bust in the 80's. Japan's growth is just abt recovering now. The dot com bubble went bust in 2000. USA was back on the rails in 2003. You have to consider anecdotal evidence, too.


    Madhukar said...

    Meltyourfat, Supratim

    This post is an extension of a couple of ealier postings which are linked in the postings. I had given the data and reasonings there. I also gve the links to the data sources in my post, so would also request you to go though them - if I go into that again, this response itself will become a posting ;0)

    Nevertheless, let me try to respond:

    One, EU is becoming an increasingly larger market for oil-producers than US. Even in 2000, the crude oil imports by EU accounted for 27% of total world oil trade as compared to 25% by the US. As EU becomes larger with other counties joining in, it would account for alost 50% of OPEC Oil crude sales.... It makes economic sense to sell in Euro to save on tasaction costs.

    Secondly, yes, this shift is not likely to happen overnight (countries, as you rightly point out have huge forex in USD, and dumping them into market will only hurt the country because it will reduce the value of thei USD assets). The post is about long-cycles and not about quarterly ups-and-down in the currency values. So if one looks at long-cycles/trends (and I am quoting from the earlier posts):

    - In January, 2002, China announced its intention to diversify its portfolio of reserve currencies to increase the proportion of Euros in the kitty. This was a significant development, since China is not only one of the largest single market and exporter, but also holds $208bn - the second largest after Japan - in forex reserves in US$. While the forex currency portfoilio is a state secret in China, according to BNP Paribas, the Central Bank for Euro, this could have led to the share of US$ in China's forex portfolio from around 80% in 1998 to less than 50%.

    - Between, 2001 and 2003, Canada increased the Euro proportion in its forex reserves from 23% to 42%, while reducing the US$ from 75% to 55%.

    - In August 2002, Iran converted more than half of its forex reserves from US$ to Euro. Switching to oil payment in Euro would be just the next step. With 12,000 million tonnes of oil reserves, Iran has the 5th largest oil reserves in the world.

    - In January, 2003, Russian Central Bank announced that it had increased its Euro holdings in forex from 5% to 10%, while reducing the dollar's share from 90% to 75%. It made sense also, since 42% of Russia's imports come from Europe.

    - by mid-2002, many central banks in Taiwan, HongKong, and East European countries, had also started increasing their Euro holdings, while going slow on buying US$. Following the trend, in March 2003, Bank Indonesia was also considering shifting its forex from US$ to Euro.

    - The other country in the "Axis of Evil" - North Korea - also stopped dealing in US$ from December, 2002

    - At the end of June 2004, OPEC members' Euro denominated deposits reached 44 billion Euro nearly doubled compared to 23.5 billion Euro held in the third quarter of 2001... By comparison, OPEC dollar denominated deposits stood at $132.1 billion, down from $145.3 billion in the third quarter of 2001.

    And lastly, the US debt (Supratim, I am not talking about account deficit, but debt), will continue ot increase, since for last one year or so, US is falling fa short of its targets in selling US treasuries (not enough buyers:((

    Obviously, I don’t hold the crystal ball, and cannot predict future - but to me these are some of the reasons why I feel that the momentum is gaining towards shift of global economy out of the 'petro-dollar paradigm'. It just needs a "tipping point" for it to become a snowball...

    Supratim said...

    Dear Prof,

    I agree with your many points about why the dollar will continue to be under pressure. Besides those points, I would add the skewed domestic picture too - low net savings of households, top 1% of US households capturing c. 70% of the productivity gains of the last decade, the looming hole in social security, the looming health insurance crisis, etc

    However, these are all known and have been known for a while. If something is known, it is usually discounted by the market and reflected in the price (in this case, of the US$)

    Points to consider:
    1. Maybe the current $ price vs the Euro is the correct price, adjusted for all this imbalances. After all, the Euro has appreciated by 50% against the $ over the last 5 years - not a mean feat.

    2. Maybe the $ is a more managed currency than we really understand. That the European, Japanese and Chinese govts will act in concert with the US govt to prevent a continuous slide of the dollar. Oh, wait a minute, they already do this!

    3. My experience of markets is that for big events, it never follows Conventional Wisdom (CW). If everybody is talking about it, then it is CW, and it is already piced in and discounted by the market. And, the thesis that the dollar needing to fall is CW. The thing that you need to watch out for is the unpredicted event - that is what really causes big movements in markets.

    For example - Russia stopping gas supplies to EU through Belarus. Now, this was an unexpected event. If the issue escalates and Russia's standing as a reliable supplier falls, then Russia's bonds could take a hit, which could spread to other emerging markets, and suddenly everyone flees to the $.

    Recently, a huge hedge fund in the US lost over 50% of its asset value (U$6bn) due to failed trades on the energy sector. In any other country, or even in the US pre-LTCM, this would have caused a huge financial crisis, as these were all leveraged trades. Yet, the US equity, debt and currency markets did not even blip on this news. Just a pointer to the flexibility of the US markets and how risk is managed.

    So, yes, you could have a $ meltdown in the next 3/5/10 years, but it will not be due to the reasons that you have underlined.