Saturday, March 14, 2009

The fall of the US?

Interesting article...

I think the world is on dangerous ground. The US economy has defied economic principle for so long. Twin deficits (budget and current account), capital flows based on financial rather than real assets, and the world’s biggest ponzi scheme – US treasury bonds (there is no prospect of repayment without more issues of debt – as long as the US cannot run a budget surplus). The US is also in a de facto liquidity trap – their real interest rates are currently negative and they cannot stimulate demand through further monetary policy. The minute anyone starts questioning US treasuries and the dollar as a flight to quality, the whole house of cards looks shaky.

What happens if it collapses? Panic regarding the US dollar as a currency standard – return to the gold standard? IMF SDRs as a reserve currency (unlikely given the link to the US)?

How does it collapse? Plunge in the value of US bonds, flight to “real assets” such as hard commodities, plunge in the value of the US dollar, repricing of oil in other currencies (what – not sure) – petrodollars stop. Without investment in US debt and without the Middle East needing to recycle petrodollars, the US is then forced to run current account and budget surpluses. That dries up US demand for international exports setting off a horrendous second round.

Even if the financial crisis has a more orderly unwinding, the money that streamed into US treasuries as a flight to quality will start looking for returns rather than a negative real 1-2%. Those investors are likely to look to other markets, causing a depreciation of the US Dollar.

China is the first wildcard in all of this. They have kept their currency fixed to a low value against the US Dollar for years to ensure continued cheap Chinese goods and US demand. To do this they have had to support the value of the US dollar and find dollar investment for all the dollars they have earned on exports to the US.

The Middle East is the second wildcard. Oil is paid in US dollars and to support the value of oil the Middle East has had to find US dollar investments for the petrodollars.

If either of those two wildcards change behavior, the whole pack comes crashing down.

The shift of power to the Middle East and China is remarkable.

The implications seem fairly dire. The Japanese have funded US lives for years. Now the Chinese have taken over. What is the implication of massive falls in the value of the investments of those countries?

What is a good investment in the post US world? What is the new gold standard? There were problems with gold as a store of value due to its low intrinsic value. Will we see the IMF or another body act as a “Commodities bank” buying up commodities with future value (metals, oil, coal, etc) and creating some sort of combined unit to act as a new reserve currency?

No comments: