Thursday, August 18, 2011

Why is the US dollar a doomed currency ?

First of all, the US dollar is a weak currency because of the USA current account deficit which stands at 561 billions dollars in 2010 according to Wikipedia List of countries by current account balance. The US is actually last in this ranking (191), with Spain being number 190 with a current account deficit of 6.740 billions.

A large current account deficit is the result of an imbalance between exports and imports.

Second, the USA also has massive debt obligations with current government debt of 14.6 Trillions (Source: Debt Clock) excluding unfunded liabilities. That debt represented 92.7% of GDP in 2010 according to the IMF, and is close to 100% now. Some historical studies (cf. "Growth in a Time of Debt", Reinhart and Rogoff)explain that when a country debt to GDP is over 90%, the likelihood of paying down the debt decreases significantly as it affects economic growth rates negatively.

There are no clear number for unfunded liabilities, as the total debt varies between 60 Trillions and 115 Trillions. But consider this: The total net worth of households and non-profit organizations in the US amount to less than 60 Trillions as of today (See Business Insider Chart below).

Such a large amount of debt will never be repaid, and the US has few options:
  • Default on the debt directly. This is highly unlikely.
  • Massively cut expenditures (e.g. military) and decrease benefits (social security, unemployment benefits) and possibly increase taxes at the same time. This is not very likely and its implementation may not be successful. This would actually be supportive for the US dollar, but painful for the economy in the short term (1 to 2 years).
  • Print more money (e.g. Quantitative easing) in order to pay for debt. This is called monetization of debt. This is the easy way out and the most likely. However, this creates inflation and will lead to a decline in the value of the USD dollar overtime and may even lead to a full blown currency crisis leading to hyperinflation.
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