US Versus The World

The $3.8 trillion pro-notes depreciating by the hour

"The dollar reserves of countries that sell goods to the US represent moneys lent to the US to help it buy goods from them, like a shopkeeper lending money to his clients and asking them to buy his goods. It's worse in fact. It is more like the shopkeeper selling his goods on credit against the client's pro-notes".

Five years ago, 86 US cents could buy one euro. Today one needs some 147 US cents to buy one — meaning, in terms of euro, the dollar has fallen by 75 per cent in five years. Benchmarked with gold, less than $275 could get an ounce of gold in 2002; today $800 cannot. So, the dollar, rated with gold, has depreciated by over 290 per cent.

Take the black gold — crude. One needed, as 2002 turned, $21 to buy one barrel of crude which now costs $90. Rated in crude prices, the dollar has fallen by 430 per cent.

The sick dollar

It needs no seer to say that the greenback is dwarfing in real terms. Recently, The Economist magazine quoted Jim Rogers of Quantum Fund, whom it praised as "a shrewdly famous investor," as asking "why would anyone buy dollars."

Ironically, the magazine also recalled, in the same breath, the Iranian President Mr. Mahmoud Ahmadinejad's derisive comment that the US dollar is a "worthless piece of paper." The Economist warned that the dollar 'has been infected by a sense of crisis that bedevils its economy and financial markets.' The 'sick' dollar is the scare of the world today. But why, and how, did the once robust dollar become sick? And where will the dollar illness lead the world to?

Dominating forex

Jim Rogers says – after, perhaps, hedging his falling dollar stocks against other currencies! – that the dollar is not worthy of buy. But what about those who already hold dollar stocks in trillions? As of the second quarter 2007, the total forex reserves held by different countries is $5.7 trillion. Many nations do, but some do not, name the currencies in which they hold their reserves.

Of the global forex of $3.6 trillion held in named currencies, two-thirds, that is $2.4 trillion, are invested in the dollar. In what currencies the balance $2.1 trillion is held is not known. Assuming two-thirds of it is invested in dollars; the global forex reserves invested in the dollar will top $3.8 trillion. That others hold $3.8 trillion means that they hold US securities or assets. Like bank deposits are to a bank, the $3.8 trillion held by others is a debt, a liability of the US to other countries.

Why did this huge debt occur? In one word: the Fed. In less than 15 years, by calibrated strokes of the pen, the US Fed has habituated the once responsible American households to spend beyond their current income and turned them into reckless gluttons.

When individual households spend more than their current income it is micro-economic behaviour. But when that turns into a universal pattern, it becomes a macro-economic issue. More so, if such a nation lacks domestic savings and it is compelled to borrow money from outside to pay for household consumption imports.

This is what has happened to the US. And it happened by design, not accident. The US Fed, led by Mr. Alan Greenspan for an uninterrupted period of 20 years, designed policies to achieve this end. Fed policies simply shifted economic power from families to corporates by promoting compulsive household buying.

And the direct effect of the very policies forced the Federal government to take over household responsibilities by state-organised social security. It is a fascinating story, even a frightening one, because the US Fed is, in substance, today the central banker for the global financial system, whose policies are adopted, or forced to be adopted, by many countries. This is a topic in itself.

Savings deficit

See how the US Fed achieved this result. By repeated interest cuts, from 20 per cent to just 1 per cent in 20 years from 1981 to 2001, the US Fed got US households addicted to buying regardless of needs. At rates of 1 per cent interest, US households saw no meaning in saving. No wonder they felt justified in spending beyond their income.

The fallout? The US savings rate to GDP, which was 18 per cent in 1970s, first came down to 9 per cent in 1990, then to an average of 2.8 per cent in 10 years from 1996 to 2005 and finally to a negative figure of 0.6 per cent in 2006. This drift directly led to households getting addicted to borrow and to spend.

The US household dues on credit cards rose from $338 billion in 1990, when the Fed rates were around 8 per cent, to $1.5 trillion in 2003, when the Fed rate became 1 per cent. Today the dues on credit cards are over $2.46 trillion and the number of credit cards in use is 1.2 billion.

An average American is addicted to 13 credit obligations, nine credit cards and four installment loans! It is difficult to de-addict them today. The result, in just 15 years, US households have handed over all their money to the corporates and become indebted, like Indian farmers have.

Wall Street obsession

The story is not complete without the other effect of the rate cut. As Fed cut interest rates, more and more US households threw their money in stocks in search of higher returns. In 1981, when Fed rate was 20 per cent, some 5.7 per cent US households had held stocks.

When, in 1990, the interest rate was cut to 8 per cent and less, some 25 per cent households frequented Wall Street, a five-fold increase in 10 years. When, in the year 2001, Fed rates were 1 per cent, some 52 per cent of the US households became obsessed with Wall Street, a ten-fold increase in 20 years.

The tail end of the story is still to come. When the stocks that the households held appreciated in the market, they began spending more by borrowing against the unrealised and illusory stock values. This unrealised asset-based lending and spending, yet another topic in itself, is another reason for spending beyond current income.

The appreciation in house values, like appreciation in stock values, also encouraged the households to borrow and spend. This has led to the sub-prime crisis in US. Thus, the US Fed policy that intended to shift money from households to corporates and family responsibility from households to government seems to have worked to perfection.

Trade liberalisation

The Fed's spend-beyond-incomes policy risked domestic inflation. To de-risk against it, the US government had to go for liberalised imports, cut the import tariffs and make import of foreign goods cheap in the US. So trade liberalisation became more a domestic compulsion of the US rather than, as it pretends, a global obligation.

Consequently, the US began buying more goods and services from the rest of the world, than it supplied to them. This led to in increasing deficit on the US current account with the rest of the world. Once this trend started, it intensified like virus.

The numbers are startling. For the 10-year period from 1990 to 1999, the aggregate deficit of the US was $300 billion.

In the subsequent five years from 2000 to 2004 alone, the deficit had aggregated to $2.5 trillion – more than eight times the aggregate for the previous 10 years! Meaning that during the five years 2000-2004, the US has borrowed $2.5 trillion from other countries to settle its current account deficit.

Funding US consumption

Experts describe, even dismiss, the US current account deficit, to manage which US borrows almost three-fourths of all global savings – two-thirds of which is generated in Asia – as just 'global imbalance'. On a closer look, it is American domestic imbalance that is unbalancing the world.

Yes, it is true that today US consumption drives global economy. But who funds the US consumption? The very countries that sell goods to the US, like China and Japan, Korea and Taiwan, Malaysia and Indonesia, Hong Kong and Singapore, and finally, India too.

Their dollar reserves represent moneys lent to the US to help the US buy goods from them, like a shopkeeper lending money to his clients and asking them to buy his goods. It's worse in fact. It is more like the shopkeeper selling his goods on credit against the client's pro-notes.

After all, in the end, the $3.8 trillion securities held by other countries are merely pro-notes of the US. So all that those who exported goods or securities to the US have on hand are the accumulated pro-notes for $3.8 trillion. Are they not just unpaid vendors? The pro-notes held by them are losing value by the day and hour against the euro, gold, oil and also against the rupee.