Tuesday, February 10, 2009

A few notes on the US Govt. finances and the value of the US Dollar

Fortunately my views on the US Govt. finances aren’t controversial at all and I’m just repeating what something called the accountability office has been repeatedly warning for quite some time.USG has a total debt of $10 trillion plus and the lowest estimate of this year’s deficit is “more than $1 trillion”, from Brad Setser. Other commentators are guessing anywhere from $2 trillion to $ 3 trillion.If the US Govt. is paying interest on its $10 trillion debt, that interest is being paid out of more borrowings, rather than from its own surplus.The US latest annual trade deficit with China is close to $20 billion. Even if you assume trade deficits with China have been at the same level for the last 8 years, you’re only accounting for a max of $ 160 b in USG Govt. debt, with an assumption that each dollar of China trade deficit leads to a dollar of USG debt.Where’s $160 billion over EIGHT years and where’s a TOTAL USG debt of more than $ 10,000 billion?In this analysis we’re ignoring the estimates that very soon trillions in medicare and social security are going to fall due in the next few years, so the USG deficits are likely to widen further rather than soften.Despite these terrible looking numbers I don’t expect the USG to default in the immediate future. To paraphrase Dr. Roubini, let me now explain in detail why.

Sorry small correction: China has a trade surplus of around $200 billion and around 40% of its exports are to the US. So the latest US trade deficit with China is likely closer to $ 80 billion, and not $ 20 billion as I mentioned above. The trade deficit with China accounts for something like 45% of the overall US trade deficit.Even with this correction, it’s easy to see that the level of total USG debt can’t be explained by China imports, or imports overall, over the last 8 years.

Why at least 2014?As of now the US dollar has a “unique role in international trade” and thereby offers “an exorbitant previlege” to the US Govt. to run “painless deficits”. (These are official terminologies so there’s nothing controversial in using them.)The dollar’s unique role is that most of the international trade amongst third-party nations is settled in USD. Of this, the most compelling is the trade in crude oil, a commodity that most countries import.Till recently around 63% of foreign central bank reserves were held in USD. Combined these together, and you get a realistic explanation for why the USD is overvalued more than 1000% in most exchange rates.This situation never came about as a result of “mercantilism”.This is more a result of US foreign policy objectives since the 1970s, starting with Middle-East military agreements, and the exercise of other geopolitical influence to make sure that the surplus of oil-exporting nations can be accumulated in USD and recycled.The USG will stop receiving foreign funding only when foreign central banks shift away from the USD for their reserves. That requires a shift away from trade settlement in USD. This process requires a widespread perception and understanding that the US geopolitical influence is at an end. That influence is derived from the US military.Unless the US military loses its ability to dominate the world, there will be no complete drain on foreign funding for the USG.Secure in this knowledge, advantages can be gained by asking China to strengthen its RMB, so that the Chinese economy can suffer a further pandemonium, and just as in the case of Argentina in 2001-2002, larger chunks of the local equity market can be purchased by foreign investors at 10 cents on the dollar.

Since 2008: German foreign minister Steinbruck said in media interviews that he prefers a combination of USD, EUR, JPY and RMB as forex reserves rather than predominantly USD. GBP was conspicuously absent in his list. At Davos, Russia’ Putin warned against excessive reliance on one reserve currency. Iran’s Ahmedinijad made self congratulatory speeches in which he claimed that his decision to replace the USD with EUR in Iran’s reserves was both politically and economically advantageous. Even French President Sarkozy expressed misgivings about the USD prior to the 1st G-20 crisis summit.The update is that Russia seems to be rapidly exchanging USD from its reserves for trade & political advantages, a move that Dr. Roubini predicted in his writing with the topic something like “Decline of the American Empire” in late 2008 which is there on his web site.Last week, Russia made out a $350 million loan to Cuba in exchange for information and drilling rights in the Cuban part of the Gulf of Mexico. At a summit of the newly rejuventated CSTO (Collective Security Treaty Organization), Dmitry Medvedev offered a full $2.15 billion to Krygystan, $ 2 billion in loans and the rest in aid.Now I have given you the direction in which you need to reason to know when the USG may at all be forced to default. You have to know the geopolitics from Darfur to Afghanistan, and it’s no joke. My guess is that it will take at least a few more years for the ROW to come to any drastic conclusions about the “value of the US dollar”.

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