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| The Outlook for the US Dollar What are some of the problems of the US dollar? Excessive debt, federal, state, personal How to finance the current account deficit? This run away debt currently requires a daily inflow of capital from abroad of USD $2 billion. There have been great imbalances built up in the US economy in recent years. Not only does the US budget deficit grow at a tremendous pace as a result of the current aggressive financial policy that introduced tax cuts and subsidies, but, what is worse is that there seems to be no end to the record-high current-account deficit. The equity boom of the 1990s brought into the US investors’ money from throughout the world. This has changed in the new millennium, as foreign investors are less keen to invest in the US equities market. Confidence has not been fully restored after the serious scandals in the US corporate market, and now there is concern about the real estate mortgage credit groups - Fannie Mae, Ginnie Mae and Freddie Mac - which continue to have to restate profits downward. Investors are no longer happy with corporate bonds, so that leaves the US government bond sector. Those who are buying the large majority of US paper are foreign central banks. Foreign central banks have plenty of funds when they go shopping at the FED, which is instructed by the Treasury Department to issue sufficient government bonds to cover the deficit. Global reserves of dollars have risen dramatically since 2000 with the biggest accumulation into the central banks of China and Japan. The Chinese renminbi is locked to the US dollar and with the dollar declining by about 30% in the past almost 3 years, this has caused a Chinese currency depreciation that has led to a record high trade surplus thanks to China's improved competitive power. In addition, foreign direct investment is flooding into China, and all these things together have caused Chinese reserves to explode. Further, in the first quarter of 2003 alone, Chinese reserves grew by USD $60 billion, bringing aggregate reserves to about USD $350 billion. These dollars are extensively invested in US government bonds. What does all this mean? It means that China can have a significant impact on the USD. The US dollar can go down dramatically if the Chinese begin to pull billions of dollars out of bonds and diversify their reserves into gold or Euros. Now, America becomes more dependent on China than China is dependent on America. The reserves held by the Bank of Japan have also grown spectacularly. The Bank of Japan was busily buying US dollars and selling yen as the dollar was falling in order to prevent the yen from appreciating against the dollar. This intervention has been the highest in history by Japan as it tries to defend its currency in order to remain competitive with its sales of goods and services. Now, what happens if the US forces the Chinese and Japanese to revalue their currencies upward? The Chinese and the Japanese foreign currency reserves will decline accordingly and thus reduce the demand for US bonds. With reduced buying of bonds, who then will finance the debt of the US? Bottom line, the US dollar may well end up being sacrificed on the alter of US over-consumption. The strong US dollar policy is just a vague memory of the past. When US politicians and government officials talk today about the almighty dollar…it is in a whisper. A Taxing Treasury Proposal If Treasury Department officials get their way, a new IRS regulation could be in place soon that would drive away tens of billion - maybe even hundreds of billions - of dollars worth of foreign investment capital from US banks. Treasury is pushing to finalize a regulation that would require American banks to report interest paid to foreigners in order to allow foreign governments to tax interest income earned by their citizens. With over $1 trillion of foreign capital in the US banking system - approximately $200 billion of which could be covered by the proposed regulation - banks would likely suffer an exodus of investors who wish to remain free of the taxman in their home countries. The US Congress exempted interest on foreigners' bank deposits from US taxation and reporting to foreign governments because it wanted the US to be a "tax haven" in order to attract foreign capital. It worked. The US now lays claim to more deposits by foreigners than any other place on earth. That's why Congress, on two separate occasions in 1976 and in 1986, reaffirmed the policy goal of sheltering interest income earned by foreigners in US banks. If this proposed regulation change does takes place it will encourage the EU's tax collection efforts momentum to go after small, low tax nations. The US would suffer again, since a lot of the money invested in the Caribbean banking centers - almost $800 billion by Treasury's own estimates - winds up invested in the US. Now, during a time when the US is struggling with deficits, huge tax cuts and "guns and butter" policies, the timing of this regulation seems unbelievable. Who will finance the debt of this country that is presently standing at a record high 5% of GDP? And, if the banking system loses tens of billions of dollars, or more, there will be a lot less money available for loans to car buyers, homeowners and small businesses. Again, at a time when we are told that the recovery of the US economy is just around the corner, consumer confidence still remains low. Unemployment is up with no turnaround in the labor market likely. Americans are deeply in debt and do not have much of a cushion in which to weather the hard times. The household savings rate is just 3.5%, personal bankruptcies are up and mortgage rates have bottomed and are moving upward. This is not a good picture. |
