Admit it! The root cause of current crisis is OVERVALUED DOLLAR

….and the only solution is to devalue it.

The world leaders are giving the current crisis different name like “Sub Prime Crisis”, “Liquidity Crisis” etc etc. But any person with basic common sense can tell that sub-prime or liquidity can’t be a big enough issue to put the world economy in doldrums. The root cause needs to be diagnosed. Until we admit to the problem, we would be taking wrong medicine.

Let’s diagnose the disease. We have divided the symptoms based on the partial diagnosis made by leaders till date:

So called “Sub-prime Crisis”

1. US consumers are defaulting on housing loans & other loans in big numbers
2. Per capita consumption of US nationals has been 2x-3x in comparison to that of nationals of other developed nations. (per capita consumption of cars, steel, cement, crude oil etc)
3. USA’s fiscal deficit for the last few years is in excess of $ 400 billion each year

So called “Liquidity Crisis”

4. The world holds their savings / foreign currency reserve in USA securities. As it’s the world’s standard currency. And as the return on govt. securities has been falling other the years, nations have started investing in quasi-government organization’s securities like Feddie Mac and Fannie Mae.
5. The world has been buying these debts having faith in USA’s credit worthiness and credit worthiness of its institutions
6. USA financial institutions have packaged and repacked housing, credit card and other debts in form of CDOs etc and sold it to the world. Now these financial institutions are going bankrupt

So called “Outsourcing” problem

7. USA is dependent on China and other countries for most of its consumption. USA is importer of almost everything. Salary and cost differential in USA is leading to outsourcing of major chuck of goods and services from developing countries
8. Most of USA manufacturing industry is dead. US automobile companies are about to go bankrupt. Japan & others are able to build better cars at lower cost. IBM has sold out the hardware business to Lenovo.
9. Salary level in USA is substantially higher than in developing countries, which is leading to brain drain problem for developing nations and job loss problem for USA.

So called Consumption led "growth”

10. Standard of living is higher than rest of the developed world. Per capita consumption of US nationals has been 2x-3x in comparison to that of nationals of other developed nations. (per capita consumption of cars, steel, cement, crude oil etc)
11. Consumption has been growing without increase in jobs. Salaries are high despite of limited skill advantage. Imports has been growing and exports have been falling
12. China & other countries had been investing their foreign exchange reserve in US securities against nominal return of 2-3% when opportunity cost of the fund is much higher

Diagnosis:

Point 1-3: USA as a nation and US nationals has been living beyond their means. Consumption led growth has been financed by debts which has started to haunt USA

Point 4-6: World has been duped by the financial engineering of US financial institutions and misplaced faith in USA’s credit worthiness. However, now the world is slowly realizing the risk & mistake

Point 1-6: The world economy growth in last few years was led by unsustainable debt driven consumption by USA. Problem in servicing of debt is leading to world economy going into financial crisis.

Point 7-9: USA has become inefficient and high cost economy. They are unable to compete even in traditionally strong sectors like automobiles, IT hardware etc.

Point: 10-12: Consumption in USA has been growing despite of fall in production activities because developing countries had been subsidizing USA consumption by investing in dollar denominated securities with nominal return.

Actual Disease:

Dollar is Overvalued

Point 1-12: USA currency is overvalued. Due to overvaluation imports are cheaper and exports are costlier. Hence import led consumption is increasing while manufacturing is falling. Overvalued dollar has killed domestic industry and has made US economy inefficient.

“Invisible hand” is absent

Point 1-12: If it was any other country the demand and supply of Dollar would have corrected the currency imbalance. However, as Dollar is the world’s standard currency of trade – the excess supply of dollar had been leaking away into foreign currency reserves of other countries in form of US securities. As other nations were ready to lend to USA against its nominal rate securities USA has accumulated unsustainable amount of debt which it is not in a position to pay back.

SOLUTION – DEVALUE DOLLAR!!!!!!!!

Therefore the only solution to the current problem which we prefer to call ‘Dollar Hegemony’ is to devalue dollar. My estimate is: 40 to 50% devaluation in dollar is required to bring it to parity. And of course dollar should loose its “World’s standard currency of trade” status.

The implications:

Positive for US:

1. Fall in real value of outstanding debt: As dollar value will fall by 50% the value of debt in real terms will also fall by 50%. Again value of houses in dollar terms would double. This would be a big relief for the mortgage market and can help turn it around. It will help US nationals deeply in debt.

2. Manufacturing will become competitive: Salaries in USA will adjust automatically. They are at unsustainably high levels which is making USA uncompetitive. Once dollar is devalued by say 50% automatically salary in USA would fall in 50% in real terms. Making USA industry competitive again. Companies like General Motors etc will be able to compete against Japanese and German cars. Salaries & other retirement benefits of US employees is the major issue pulling these companies down.

3. Imports will become uncompetitive: Imports from countries like Chine etc are undervalued due to overvalued US dollar. Once exchange rate is readjusted imports will become uncompetitive restricting unsustainable level of import driven consumption

4. Job creation: Increased manufacturing activities and reduced imports will lead to job creation in the economy. Foreigners like Indian nationals who are taking up large chunk of US jobs in IT, technology research, doctors, nurses etc will find it no longer viable to move to US as in rupee terms their salary is US would be reduced substantially. Outsourcing problem would be solved to a great extent.

Negatives:

International Impact: Devaluation of Dollar will have a huge international impact. Countries like China which hold substantial foreign reserve in dollar denominated securities will suddenly see their reserves depreciating by as much as 50%. Devaluation of dollar will make their exports to USA uncompetitive leading to large scale unemployment and bankruptcy in their country. This will create social unrest through out the world. It can lead to war between nations for resources.

Crash of financial system & global trade: The whole financial system which is today based on faith in US dollar will come crashing down. The world will need to devise a new order for trade and financial settlement.

Elasticity of import & exports: Not all exports and imports are perfectly elastic. Oil imports will not fall substantially in volume in short term. Similarly replacing IT talent of India would be difficult in short term. Similarly for exports, even if the prices fall substantially volume of exports might not increase for arms and ammunition etc.

Savings & Retirement fund: People who had been saving rather than going for debt driven consumption would be penalized due to wrong doing of borrowers. It will create a moral hazard. Their saving would depreciate by 50% overnight in real terms and they might not have enough retirement funds to take care of their old age.

Conclusion:

The international repercussion of Dollar devaluation is so grave that it can’t be done overnight. It has to be a slow process with enough time for nations to adjust. Countries need to be given time to liquidate their dollar denominated foreign exchange holding. World also need time to device and operate new financial and trade order.

But what need to be done immediately is to recognize the real Disease. The world currently suffers from Dollar Overvaluation. Admitting to the disease is the first step. Denial will only aggravate the disease and create other complications due to wrong medicine. Unless we come out of denial mode world will not start moving in the right direction. Bush & Paulson of the world might say that ‘fever’ called sub-prime crisis / liquidity crisis has been cured but it will come back again and again in some form or other – Bear Stearns / Lehman Brothers / AIG / Citi Bank / General Motors / Ford / Chrysler / …………………………………………

Open letter to Prime Minister of India (Sh Manmohan Singh)

Dear Sir,
The financial crisis faced by the world is a graver situation than that of managing the stock market. What Finance Minister Sh P. Chidambaram is doing currently is pushing the dirt under the carpet and hoping it is not uncovered before the next elections.
To be fair to you the current problem is US making and not of your making but this Financial Tsunami is not fair in its impact any would destroy everything that comes on its way. In 1991 you built the dam of Globalization that powered & irrigated our fertile land for almost two decades. But today this dam is in risk and it can destroy the fertile land. You being the architect of the dam knows better than anybody else how to save the dam of globalization destroying own lands.
We need to do two things urgently to avoid importing the US financial crisis:
1. Diversify the foreign exchange portfolio and move out of US treasury bonds and other dollar denominated financial instruments.
2. Start trading in Crude and other major foreign trade items in Euro and other currencies rather than dollar. At least diversify
As you know law of demand and supply applies to all currencies except dollar due to dollar hegemony. The dollar is already over valued due to this even after years of fiscal deficit and relentless borrowing. However, the current financial crises pose a real risk to dollar and dollar hegemony. All the billion dollar looses that US government is nationalizing has to be paid somehow and ultimately it would be paid by printing more dollars. And as you know very well, printing more dollars means distribution of USA loses to the world.
The printing of dollar, inflation and depreciation of currency is a very slow process and something that can be handled in the long run. The risk current situation poses is sudden devaluation or crash!!
The world is currently standing on thin ice which is melting with each passing day and everybody is wishing that it never reaches a situation when we go down under. The current crisis is sign of crack on the thin ice floor. If we all keep standing till the end we all will go down into great depression soon. As the cracks become big, grave panic would be created and one or few of the members would try to run to the safer place. And we should remember that goliath named China is also standing with us on the same thin ice and if he moves, due to its weight the ice floor will surely break. We have to make sure that we more to a safer place before the goliath begin his move.
(The thin ice here is Dollar based financial system where all major international trade is done in dollars including crude & petroleum products and major share of foreign exchange reserve is kept in dollar denominated securities. People standing are nations who are part of the international financial system and the cracks are the financial crisis. Going down under is Great Depression & the safer place is a world of neutral currency with no single currency hegemony).
China has more than trillion dollar of foreign currency reserve and most of them are parked in low interest paying dollar denominated securities of US institutions like Freddie & Fannie. Sooner than later China will realize that US government with its increasing nationalization of loses would not be in a position to return back these reserves. The only option for US govt is to print more currency to pay back China and others and that would create excess dollars in the world economy leading to collapse of the currency. China to reduce the loss would start moving out of dollar into other currencies or Gold. Or if it’s a fools and doesnot understand the risk of thin ice would force US government to increase the interest rate on these securities. Either ways, the US will be faced with increased financial crisis and the current financial system will collapse.
Again shift of oil trade to other currencies would reduce the demand for dollar required for oil trade and hence the currency will collapse.
Believing that not moving can save us all is foolhardy. One: sooner or later somebody will panic and run across the cracking thin ice floor. (in fact few countries have already started the move). Otherwise the foolhardy US financial management will ensure that the ice melts so much that the whole world goes down into great depression. USA is rooted in his own system and it can’t run. Its time that we desert him otherwise we all will go down with him.
Its time the world decide to move to a world of neutral currencies where value is derived from demand and supply and no single country has enough power to govern the world financial system. The only thing that is stopping us all is the ‘fear of change’. In the long run, the new world would be better than the current one for all of us.
Sir, I hope as in 1991 you will be bold enough to drive the change rather than closing your eyes to the thinning ice hoping that we don’t go down under before the May elections.

Regards,
Neeraj Gutgutia

“Distress Sale” is keeping Dollar Strong temporarily

The US financial companies are falling like bunch of cards, the economy is in recession, and import bill is rising still Dollar is becoming strong. What’s happening?

“As our U.S. trade problems worsen, the probability that the dollar will weaken over time continues to be high. Running a huge trade deficit is costing us money, sooner or later. Already the prediction I made last year about one fall-out from our spending binge has come true: The ‘investment income’ account of our country - positive in every previous year since 1915 - turned negative in 2006. Foreigners now earn more on their U.S. investments than we do on our investments abroad. In effect, we’ve used up our bank account and turned to our credit card. And, like everyone who gets in hock, the U.S. will now experience ‘reverse compounding’ as we pay ever-increasing amounts of interest on interest.” – Warren Buffett

The USA economic performance and current financial crisis should and will lead to depreciation of dollar. My bet is this crisis would dethrone Dollar from being the “standard currency” of the world and this phase would go down in history as end of dollar era. (Read: End of Dollar Hegomony)*

Against the general logic dollar is appreciating due to fire sale or distress sale by US companies. US companies are selling out their investments (equity investments in developing markets, bonds etc), subsidiaries (Citibank, Lehman Brothers) to strengthen their balance sheets. They are also selling out stakes (Citibank, Merrill Lynch etc) to Temasek and Saudi funds of the world at ‘fire sale’ price in distress attempt to survive. This temporary phase of ‘fire sale’ is leading to fall in buyer country currency and appreciation in Dollar. The temporary upside blip is due to unsustainable capital inflow.

For the time being this may lead to appreciation in Dollar but it is also reducing the future income of USA from abroad. Temasek and Saudi investors of the world will be taking out dollars from USA every year in form of dividends, salaries and expenses.

Apart from future income this fire sale is also reducing the US aura that was derived from these financial institutions. USA is no more ‘the land of endless opportunities’. Soon US B-Schools won’t be as attractive place to study as finance institutions retrench jobs. The fall of these might corporations like Bear Stearns, Lehman Brothers, General Motors, Merrill Lynch, Citi group would end the awe that people have for USA. And with the awe “Made in America” brand would loose its premium.

Biggest Export of USA is neither Intel Chips, nor Boeing Aircrafts, nor McDonald burgers nor Microsoft Windows. The biggest export of USA is Dollar (as investment good). As a result of this financial crisis the world will stop seeing dollar as an attractive investment and that would be the demise of Dollar. And then Dollar depreciation would lead to further depreciation of dollar as US exports & imports are fairly inelastic.

*PS: Sanjay Kaler thanks for sharing this Ron Paul speech. This is the best piece of info I have read on this topic till date.

‘Confidence’ is the underlying asset for Dollar. Do your own valuation of ‘Confidence’

I have lost confidence in US Dollar and I am betting that Dollar will soon crash. These sorts of things don’t happen very often and therefore so called ‘experts’ (Microsoft Excel operators) will not be able to predict it. But once in a looooooong while these things happen as it happen with Russian Rouble. Russia was looked upon as superpower when that happened and predicting crash in their currency was nothing less than blasphemy then. Eventually it happened and then people marked those events as end of USSR era. I believe the current period will go down in history as end of USA era.

As I had mentioned 3 years back here in my blog the underlying asset to Dollar is Confidence and not Gold as it should be. And as you know the confidence is a very fickle asset, you don’t know when it disappears.

Newsweek: "Americans are glum at the moment. No, I mean really glum. In April, a new poll revealed that 81 percent of the American people believe that the country is on the "wrong track." In the 25 years that pollsters have asked this question, last month's response was by far the most negative. Other polls, asking similar questions, found levels of gloom that were even more alarming, often at 30- and 40-year highs………… "

Dollar is the prime currency today and is the standard for international trade. Almost all of international Crude Oil trade happens in Dollar. Most of the trillion dollar reserve held by China is in Dollar and same is true for more than 300 billion dollar reserve of India.

For decades now dollar has been the acceptable standard and nobody ever questioned it. After the Bretton Woods Agreement in 1944 when dollar became the international standard for trade, USA was supposed to keep Gold as underlying asset. However, in 1971 USA, unilaterally, has done away with that practice and has been happily printing Dollar ever since with Confidence as the only underlying asset. Till date Confidence has been an appreciating asset all the while with USA companies ruling the world economics. But with the turn of events over the last 12 months – Housing price crash, subprime, Credit crisis, bankruptcy of banks and financial institutions, bankruptcy of automobile companies - USA looks much more venerable today. This bubble has built up over the years as USA kept borrowing from the world to meet the domestic consumption bill of its nationals. CDOs etc had managed to delay the inevitable by creating fake confidence, but then it can only delay.

I believe the current government will continue to delay the inevitable will all kind of financial jugglery just to keep Republican chance alive in the next election. But the new government will have to clean the house and we can expect Dollar Crash prediction coming true around that period. In the meanwhile like Indian Government, USA government will keep on increasing the deficit bill (by off balance sheet items) impact of which will be felt with a lag only after the elections.

Frankly all countries will get adversely impacted by the Dollar Crash in the short term but for the long term general good it’s high time that World practices some “currency diversification”. Few major impacts against which countries & companies should guard against are:

1. Holding all or substantial part of Foreign exchange reserve in Dollar or Dollar denominated US government securities. India and China both are running this risk and I believe many more country is doing the same. It’s high time that we diversify.
2. International trade in critical items like crude only in dollar is another big risk. You don’t know when exactly the music will stop and you should guard against being caught with the parcel when the music stops.
3. Financial instruments which increase your exposure to Dollar. In the current world of financial derivatives, carry trade etc there may be many financial bombs hidden in your treasury department which you might not be aware. Its time to check your cupboards.
4. There are other risk like too much dependence on USA for exports which is difficult to diversify in the short term (IT companies face major risk here)

Sudden move by countries like China and India to diversify there foreign exchange reserve risk or move towards crude trading in currency other than dollar can trigger the crash but we don’t have any other option but to walk the thin ice. Sooner than later the ice will melt.

USA Government and especially Fed are trying to avoid the inevitable. Now it’s a matter of your confidence in their capability to tide over this crisis. I don’t have the confidence and hence I suggest diversification. (Note even if the dollar crash doesn’t happen there is nothing to loose by diversification. Diversification to currency like Euro will only help in the long run).