Edit by Moderator- This thread has been locked due to the excessive political angle. FatWallet does not allow political discussion.

Found an interesting article at http://www.rediff.com/money/2007/jun/11dollar.htm

The coming collapse of the US dollar

The skew in the global financial system -- commonly called 'global imbalance' -- seems to be fast spiralling out of control.

For some time now economists have been engaged in the mother of all debates: whether the US dollar would collapse by as much as 40% when compared to other currencies (some are even betting on the US dollar going belly-up) or whether there would be an orderly devaluation -- that is, a gradual revaluation of other currencies vis-�-vis the US dollar.

In effect, the question that is confronting us is not 'whether' but 'when' and by 'how much.'

This global imbalance can be understood in economic terms by simply examining the massive size of America's twin deficits -- trade and budgetary. Put modestly, Americans have been living way beyond their means, consuming much more than what they could possibly afford and, in the process, borrowing far beyond their capacity for too long.

This was facilitated by a policy of maintaining weak currencies across the world, notably in Asia. This policy of maintaining a competitive exchange rate for their currency to boost exports has resulted in a race to the bottom amongst various countries.

Nevertheless, this arrangement suited countries, both Asian (with a huge unemployed population) and American, (as it provided cheap imports for its huge consumption binge).

While the going was good, everyone profited and expected the arrangement to continue indefinitely. Unfortunately, linearity as a concept has limited appeal in real life, much less is global macroeconomics.

No wonder, of late, countries are discovering that this arrangement has its limitations. The current account deficit of the United States translates into current account surplus of exporting countries. To cover this deficit, US borrows: this corresponds to the forex reserves of exporting countries. The crux of the issue is that no other country, barring the US, has such a huge consumption pattern and an ability to absorb this huge export surplus.

In substance, countries are producing their goods, exporting it mostly to the US, and parking the resulting export surpluses with the US to facilitate US to finance its imports!

Clearly, the global imbalance is a by-product of this mindless competition by various countries to devalue their own currencies and the reckless consumption in US. Naturally, it is indeed tempting to blame US consumption for this crisis. However, one must hasten to add that the emerging economies -- notably Asian countries, especially after the1998 currency crisis -- with their fixation for weak currencies, are equally to be blamed.

The net result? Well, consider these facts:

By mid-May 2007, the US National Debt stood at approximately at mind-boggling $8.85 trillion -- i.e. approximately $28,000 for every American.

The basic structure of the American economy is that the deficit of the US government is 4% of the GDP and the household sector 6%, which are offset by a domestic savings of 3%, largely from corporates, leaving a substantial national deficit of 7% to be covered by the capital flows from the rest of the world.

The current account deficit of the United States for 2006 is estimated to be in excess of $850 billion. This approximates to 7% of its GDP. Surely, even for the US, this is unsustainable.

In order to ensure that this money is routed into America and to sustain its gargantuan borrowing programme, the US has repeatedly raised its interest rate to its current levels of 5.5%. While the very size of the US debt makes any further increase in interest rates virtually impossible (as it would make borrowings uneconomical), any cut in interest rates to stimulate its economy and make it competitive would mean that the US may not get the money it requires to sustain itself.

On March 28, 2006, the Asian Development Bank [Get Quote] is reported to have issued a memo, advising members to be ready for a collapse of the US dollar.

Since end March 2006, the US Federal Reserve has stopped publishing the quantum of broad money (that is the aggregate of US dollars circulating in the entire world -- technically called 'M3') in the US economy. This is the worst possible signal that the US Federal Reserve could have sent to the world.

Suspended sense of disbelief

Obviously, what aids and sustains the US dollar is a 'suspended sense of disbelief' amongst countries about the value of US dollar. Yet, common sense tells us that the excess supply will obviously result in a fall in the value of any product. The US dollar is no exception.

Late Iraqi leader Saddam Hussein was fully aware of this paradigm. Seeking to exploit the inherent weakness of the US dollar, Saddam wanted to trade his crude in Euros, which would have lead to a lower demand for the US Dollar and thereby triggered a dollar collapse. And those were his 'weapons of mass destruction -- WMD.'

And if some analysts are to be believed, Venezuela and Iran too possess the very same WMD. Naturally, it requires some specious arguments and military intervention to protect the US dollar. Never in the history of mankind has a national army protected the national currency so vigorously as the US Army has done is the past decade or so.

What is bizarre to note here is that despite the fact that crude is produced mainly in the Middle East; officially it can be purchased in dollar terms from one of the two oil exchanges situated in New York and London. Obviously, should Iran carry out the threat to commence oil trade in Euros or better still an oil exchange, the US dollar would come under tremendous pressure.

The US dollar is akin to the promissory note of a defunct finance company. It is common knowledge that a currency, when not backed by anything precious is just a piece of paper. When US abandoned the Gold Standard in early 70s, countries habituated by then to the US dollar under the Bretton Woods arrangement continued to accept the US dollar as an international currency without demur as the world was not prepared for any other alternative. Else, the global economy would have collapsed by 1971.

But the diplomatic silence did not solve the problem. It merely postponed it and it has come back to haunt us.

Post gold standard, by a tacit approval of the Organisation of Petroleum Exporting Countries (OPEC) and strategic manoeuvring, the US had ensured that its currency is implicitly backed by crude, instead of gold. This explains the American 'geo-political and strategic interests' in the Middle East.

But over time even this was found to be insufficient and consequently the oil standard of the 70s gave way to an implicit multiple commodity standard of today. Naturally, commodity prices -- including crude prices -- have soared in the past few years. Unfortunately, this arrangement too is failing the US. No wonder, the US dollar increasingly resembles a promisory note of a defunct finance company.

It is no coincidence that global trade in most commodities, including oil, is denominated in US dollars as the respective international exchanges are located in the US. To what extent are the prices of these commodities manipulated to protect the US dollar is anybody's guess.

However, it may not be out of place to mention that a barrel of oil which cost less than $10 to produce is sold approximately at $70 in the international market.

But as commodity prices go up it has lead to inflation across the globe. No wonder, countries are forced to increase their interest rates to fight inflation.

This has triggered an interest rate hike across continents and the US is finding it extremely difficult to sustain its current borrowing programme: it hardly has any elbow room to manoeuvre.

Doomed if it does, damned if it doesn't

Meanwhile, countries are increasingly realizing that the value of the US dollar that they are holding is fast eroding, whatever be the 'officially managed exchange rate.' And if fewer people want the US dollar -- as for instance when oil is traded in Euro the demand for the US dollar will fall -- it would trigger an avalanche.

No wonder, the US Fed is unwilling to make public the M3 figures, as it does not want the holding position of the US dollar to be publicised.

Interestingly, in such a doomsday scenario, some economists are still betting on central banks of other countries to defend the US dollar. It would seem that the US has 'outsourced' even this sovereign function to the central banks of other countries. After all, should the US dollar collapse, the biggest losers will not be the US but those who have US dollar-denominated forex reserves.

Naturally, countries holding US dollar reserves are caught on the horns of a serious dilemma -- should they seek to correct the global imbalance, it could result in the imminent collapse of the US dollar, and should they continue to defend the US dollar, they would be a long-term loser as the current arrangement has seeds of self-destruction.

While every central banker is conscious of this fact and thereby seeks to postpone the inevitable while nervously looking for his counterpart in any other country to break ranks and thereby trigger the collapse.

Surely, the emperor is without any clothes. There are only two possibilities from here on: Either we are witness a global meltdown of the US dollar, or allow controlled US dollar devaluation (read, revaluation of other currencies). If it is a global meltdown the global economy is doomed, if is an orderly devaluation, it is damned.

We're #30 on the list.

CIA Factbook

Future members of FWF:

110 United Arab Emirates 9.00 2006 est.
111 Kuwait 8.10 2006 est.
112 Russia 8.00 2006 est.
113 Botswana 7.10 2006 est.
114 Libya 5.60 2006 est.
115 Wallis and Futuna 5.60 2004 est.
116 Equatorial Guinea 4.70 2006 est.
117 Oman 4.50 2006 est.
118 Chile 3.90 2006 est.
119 Estonia 3.60 2006 est.
120 Hong Kong 1.00 2006 est.

I sincerely hope that US will be able to pay off the debt. Since falling $ will have catastrophic effects in the global market and may even lead to another economic recession.

It is a 100% certain conclusion that the US will be able to "pay off the debt". They have to - by law - when it is due. The more appropriate question is whether or not the US will continue with growth-centric policies so that this debt will continue to be insignificant compared to the size of our economy when it is due.

Our debt is no bigger now than it historically has been in relation to the size of the economy, so the focus should continue to be on economic growth, not debt reduction.

This seems to be often overlooked, but to the US financing spending through borrowing or through taxes has the same cost. That is, there is nothing inherently "good" about spending tax money and nothing inherently "bad" by spending borrowed money.

Here are 5 things that China can do with their US dollars, thanks to the big trade surplus with the US (source)

1. Buy stuff from us.
Our proper reaction: "Thanks for creating US jobs."

2. Invest in dollar-denominated real assets.
Our proper reaction: "Thanks for helping us grow, and for increasing our tax base. We look forward to the extra growth, and the extra tax dollars we'll collect from you."

3. Invest in dollar-denominated financial assets such as Treasury securities.
Our proper reaction: "Thanks for trusting us to invest your money in our own growth and security; we’ll use a portion of the extra growth to pay you the 4.5% interest we promised. Feel free to continue buying T-bonds and notes with your dollars; that's money we would otherwise have to tax away from our own people, and it also helps hold down the interest rate we'll have to pay you."

4. Hoard the dollars.
Our proper reaction: "Thanks for trusting in our currency more than yours, thereby making future inflation of our currency even less of a worry than it is now. In essence, this means the goods you sold us turned out to be absolutely free. Thank you very, very much."

5. Dump the dollars for another currency.
Our proper reaction: "Your masochism is puzzling. Nonetheless, thanks for the goods you sold us before you caused the value of the dollar to drop a smidgen, inexplicably making it more difficult for us to continue buying goods from you."

czarandy said:This seems to be often overlooked, but to the US financing spending through borrowing or through taxes has the same cost. That is, there is nothing inherently "good" about spending tax money and nothing inherently "bad" by spending borrowed money.I would argue that the opposite is true. Spending tax money is generally "bad", and spending borrowed money is generally "good".

Tax money is dollars that are taken out of the hands of the general public, reducing the ability of the general public to facilitate economic growth through spending their own money. That leaves it up to the government to spend this money as "efficiently" as possible, which history has shown isn't all that efficient. This also leaves Mr. and Mrs. Taxpayer unhappy because they have less money in their own pocket.

Borrowed money is dollars that people willingly lend to the government in exchange for an interest producing asset. Every dollar that is borrowed by the public sector is dollar asset in the private sector. The government still has to spend this money as "efficiently" as possible, but this money actually gets paid back to the private sector, with interest. The best part about it is that the economic growth that this exchange helps promote also helps the government to perpetually borrow this money and pay it off without any increased drain on the economy or the value of the currency. It is truly a win-win situation for both parties.

TexAsh said:WalStMonky said:kamalktk said:Remember when the dollar "collapsed" versus the last "new dominant" currency? It was 94-95, and the dollar collapsed over a few months from 105 yen to 80 yen. The world collapsed and every American was forced to live in tent cities and refugee camps for a few years.

It was horrid, horrid I say. Some were forced to consume their young to stay alive, those of us who were more fortunate had to cook over greasy fires in 55 gallon drums...those who forget the past are doomed to repeat it!

So much for a serious discussion I can see the thread being hijacked...
I made a serious and sarcastic reply. I was living in Singapore during 94-95 and was on the "winning" side of exchange rates as the Sing $ strengthened versus the US $. I also was living in South Korea duing the Asian financial crisis of 1997 when the won lost half it's value versus the dollar. So I've seen both sides firsthand. Despite much public gnashing of teeth by the media/politicians, life went on pretty much normally.

The difference now is that Bush and Congress has spent away our safety nets. We as a country are levereged to the hilt. In the nineties there were no other countries that could topple us economically now there is Europe and soon China and India. It's true China needs us to buy their goods but once their consumer base gets enough wealth they won't need us anymore to prop up their economy - then where will we be? Where will our growth come from? All we really own right now are the brand names - all the manufacturing is done in China. Already the Chinese are making their own brands of electronic equipment that are being made in the same factories as the world class American brands. What becomes of them when people find that they can buy the same exact product sans the brand name for 25% less. Anyone else notice the off brand HD tvs in BJs and Costco?