Escape From the US Dollar

The rush to escape from the US Dollar as a reserve currency is on.

Additional nations are realigning the way that they use US Dollars in conducting their cash reserve management business. Nations that have announced or hinted at a shift in the percentage of foreign exchange holdings held in US Dollars include Russia, China, Japan, Iran, Malaysia, Qatar, Kuwait, and Vietnam. There are probably many more who are quietly making adjustments in the percentage of foreign exchange holdings held in depreciating US Dollars.

The recklessness of the Bush administration with its spend, spend, spend, and borrow, borrow, borrow policies, and the growth of the twin US deficits in the balance of payments and for the federal budget seem to be forcing a change in the way nations will manage foreign exchange reserves. They will be reluctant to continue to accumulate dollars. You can’t really blame nations when they are lucky to receive 5% on Dollar deposits and in recent years are losing 15% to 20% a year in Dollar depreciation.

The following article in The Daily Reckoning details the recent moves to diversify away from the Dollar by Vietnam and Qatar.

“Qatar and Vietnam aren’t exactly marquee players on the world financial stage. But if this is any indication, they’re harbingers of what’s to come for the U.S. dollar:

Announcements on Thursday from the Qatari and Vietnamese governments that they are rapidly divesting in dollar denominated securities will not come as good news to the US government. Overseas investors hold half of America’s $4,400bn of marketable government debt, up from a third in 2001 according to the US Treasury department.

Qatari Prime Minister, Sheikh Hamad bin Jassim bin Jabr al-Thani said on US TV that the government-backed $50bn Qatari Investment Authority (QIA) now had less than 40 per cent of its investments in dollars, down from a high two years ago of 99 per cent.

Given that the Emirate’s oil and gas revenue is in dollars, the latest troubles in the US economy have accelerated the need to diversify investments into non-dollar markets. Currencies such as the Euro, the British Pound and the Swiss Frank, are all looking far more stable as investments for the QIA, said Sheikh Hamad.

Such was the Qatari PM’s concern about the sliding dollar, that he even said an oil price of $125 a barrel would not be unreasonable.

Ouch. Coming on the heels of Kuwait’s decision to decouple its currency from the dollar, and Saudi Arabia’s refusal to cut interest rates in tandem with the Fed last month the notion of the six Gulf Cooperation Council nations forming a single currency pegged to the dollar is looking not only improbable, but impossible.

And what about Vietnam? This too looks like an omen:

On Thursday, the State Bank of Vietnam quietly let slip it would be ending its dollar purchase schemes, which it has been using to hold down the Vietnamese currency. Although it only has middling dollar reserves of $40bn, Vietnam is widely regarded as a barometer for economic sentiment among other, bigger, regional dollar sinks like China, Taiwan, Korea or Singapore. Hans Redeker, currency chief at BNP Paribas, told the Telegraph:

“Vietnam is a relatively small country but it is symptomatic of Asia. The entire region is seeing inflation move up as a result of mercantilist policies of holding down their currencies with ‘dirty floats’, which are designed to help their export sectors. They need to change monetary policy.”

Would the last country to exit the dollar please turn out the lights?”

As an American you may wonder why this should matter to you? For one thing as the Dollar falls on foreign exchange markets it means that everything imported into this country will cost more. We will be in effect importing a strong dose of inflation.

Another almost certain effect as the Dollar continues to fall is that the US Treasury will find it more and more difficult to finance the huge daily gap between what the government takes in as revenues and what it spends every day. Just the war in Iraq is now costing about 12 billion a month.

The US is borrowing tremendous sums from China, Japan, and other countries that enjoy high savings rates among their citizens to cover the deficit. However, as the Dollar falls these countries are going to become less willing to lend the US the money that it needs and even if they do continue to lend will demand higher interest rates.

The weak Dollar therefore makes it much more difficult to control interest rates at home. The Federal Reserve may be able to set short term rates but its control over long term rates is much less than many think.

It is dangerous for America to have a currency with no backing and that nations are losing confidence in. As the Dollar falls there is a risk of a panic setting in that would lead to a rapid destabilizing loss of value to the Dollar. Such an event could lead to a round of hyperinflation in America that would have the potential to wipe out the middle class.

Should America lose its status as the world’s premier reserve currency out of control events that happened in Argentina in 1999 – 2002 could happen in America. Deficits do matter and America is getting dangerously close to finding out just how much they do matter.

America needs to cut back drastically on its spending. Ending the reckless war in Iraq would be a good start. As reducing spending could tip a not so strong economy into recession it is unlikely that American politicians have the wisdom or guts to make the tough decisions that would restore confidence in America and the US Dollar.

You can expect a dramatic Dollar and economic crisis within a year or two. Gold at $750 an oz. , crude oil at $82 a barrel, housing foreclosures at record levels, and wheat at all time highs above $9.00 a bushel, while the US government tells you that inflation and the status of the economy is not a problem, should let you know that economic conditions are not nearly normal.

In my opinion, big trouble is on the way.

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