Ten Major Threats Facing The Dollar in 2009
By: Eric deCarbonnel, iStock Analyst, Friday, January 02, 2009
1) Foreign central banks selling US assets
Most of the nations which have been financing the US's massive current account deficits in recent years have either begun to sell their dollar reserves last year or are planning on selling them this year in order to support their currencies. These nations generally fall into three categories:
A) Oil Producing Nations
Oil producing nations have built up lavish spending habits and large dollar reserve in recent years as a result of profits from rising oil prices. Now that commodity prices have crashes, those profits are gone, and those Oil producing nations will have to bankroll their spending by selling their accumulated dollar assets. Saudi Arabia, for example, is projecting a 2009 Budget Deficit, which it intends to finance by selling off its US holdings. Russia, meanwhile, has already sold over 20% of its $598.1 billion reserves, and it can be expected to continue doing so this year.
B) Emerging markets that have been relying on capital flows to fund their trade deficits
Many emerging markets around the world have been running trade deficits in recent years financed by capital flows. The most prominent example from this group is India.
India's strong capital flows from tourism, software services, and remittances not only financed its trade deficit, but also increased its foreign reserves to an all-time high of 316.2 billion in May of 2008. However, due to the global slowdown and selloff of emerging markets, those capital flows have now reversed. India's central bank, for example, has been forced to sell off its US holdings to curb its currency's decline, and its total reserves have decreased by $62.2 billion. The central bank's dollar sales in October alone exceeded purchases by a record $18.7 billion. India now has $254 billion foreign reserves left, the majority of which will be sold this year to protect its currency.
C) "Developed" Nations
The US isn't the only "developed" nation in trouble. Other "developed" nations (ie: nations that chose to outsource the polluting and labor-intensive parts of their economies) are also collapsing. Japan, for instance, has seen a disastrous drop in demand for goods.
Japan's Industrial production fell 8.1% in November from the previous month (the biggest drop in the measure since the government started releasing comparable figures in 1953). Demand for Japanese exports is vanishing: November shipments of automobiles plunged 31.9 percent and shipments of microchips and other electronics components fell 29.0 percent. Due to this disappearing demand, Japan has incurred a trade deficit for two straight months for the first time since October-November of 1980.
With their own economic problems to deal with, it will not be other "developed" nations like Japan which will fund the US trade deficit in 2009. In fact, should the dollar begin to collapse, these nations could even be forced to sell their dollar reserves to protect their own currencies.
The dollar implications of this should be clear
After years of bankrolling US consumption with the purchase of dollar assets, most nations are going to be net sellers of dollars in 2009. Just Russia, Saudi Arabia, India, and Japan alone have around $2 trillion in US holdings, and, if the current trade trends continue, America can expect foreign central banks to sell at least 1 trillion dollars this year. This begs the question: who exactly is going to be buying all these assets?
2) The worsening US Trade deficit
The US Trade deficit is worsening because, while imports to the US are falling, exports are falling even faster. Demand for the big ticket durable and capital goods produced by "developed" nations is plummeting much faster than demand for cheap consumer imports, causing widening trade deficits with nations like China. The US's increasing trade and current account deficits means that America needs to attract over 700 billion dollars this year to keep the dollar from weakening.
It is extremely important to understand that treasuries are the modern day equivalent of money under the mattress, and that, when a crisis confidence hits the dollar, treasuries will be redeemed for printed cash from the fed. This is due to the fact that the US can't allow treasury prices to crash, for fear of having the world's financial system break down and global trade collapse. So a sustained selloff in treasuries would therefore force the fed to expand its balance sheet by trillions to monetize much of the outstanding federal debt.
Why the government can't let treasuries collapse
Even if the government does not step in to support treasury prices amid a selloff, the end result will be the same. Allowing a crash in treasury market would make the financial system insolvent and cause runs on the bank. The fed would then have to print money to make good on the 6.5 trillion insured deposits around the country, the 1.5 trillion insured senior bank debt, etc... Since trillions of printed dollars would be hitting the marketplace in either case, the fed will choose the least disruptive option of putting a floor under treasury prices with printed money.
Selling treasuries is equivalent to printing money
It is deceptive to think that, because the government is borrowing to fund its deficits and bailouts, it isn't printing money. This is false. Treasuries should be seen for what they really are: "promises to print money".
Rising demand for physical gold is a threat to the dollar because it signals a growing loss of confidence in the paper currency. It is also key to understand that gold prices aren't rising because of the changing fundamentals of gold, but because of the changing fundamentals of the dollar. In other words, gold isn't rallying, THE DOLLAR IS FALLING.
Gold is history's oldest and most stable currency. Its utility is simply that it is rare, and for 5,000 years people have used it to store value for the future. All the gold that has ever been produced would fit in a solid cube of about 19 meters on each side, and this cube is only expanding by about 12 centimeters a year (2%). Since the value and supply of gold itself is fairly constant over long periods of time, the main driver of the fluctuations in gold prices is the ebb and flow of confidence in paper currencies. Rising gold prices are, therefore, a signal of a weakening currency, which is why governments hate them and try to suppress them.
Right now, there is unprecedented worldwide demand for physical precious metals. As a result of this surging demand, gold futures have experiencing backwardation, a rare market condition where gold futures trade under spot prices. It is a signal that gold prices are headed higher and that confidence in our currency is fading quickly. When gold prices break above 1,000 again, the event should be recognized for what it is: the herald of a dollar collapse.
5) China and the yuan
China is in a different situation that most other nations as it has a growing trade surplus, which stood at $40 billion as of November. As a result of disappearing Asian demand for luxury items and commodity prices plunging, imports to China crashed 17.9 percent in November while its exports only fell 2.2 percent. This leaves China with a problem the US could only dream of: huge, unsustainable upward pressure on its undervalued currency.
In order to maintain the dollar peg, China would need to fund not only a large part of the US's gigantic trade deficits, but also the trade deficits of those nations around the world which are selling their dollar reserves. If imports keep falling at their current pace, China will have to buy close to 1 trillion dollars this year alone, which leads to yet another problem: right now, China is not interested In any kind of risky US assets, and what "safe" assets does the US have to sell? (Please don't say treasuries. All dollar denominated assets are inheritably unsafe due to the currency's horrible fundamentals.)
Trying to prop up the dollar would end up destroying its currency without benefiting its economy, and China knows this, which is why you have Chinese central bankers on record as saying that, "The US dollar is unlikely to be stable next year". Even more ominous for the dollar, China stealthily announced its plan to make the yuan an international currency on Christmas Eve last year.