Deficits Threaten US Dollar Supremacy

Everything is happening…just as we thought it would. Stocks are rising. And people think they see better times coming.

Whoa…this is eerie!

Following the great crash of ’07-’09 cometh the rebound. Hesitant, cautious at first…

Then, people begin to believe it. They begin to see the “green shoots” of a revival. Stock prices rise. The green shoots sink deeper roots and flower. Pretty soon, people think they are knee-high in clover.

Confidence is rising. Consumers, house-holders, investors – all think the worst is over. And if the worst is over, better times must be coming. If better times are coming, prices should be rising. And investors should be making money. And businesses should be expanding.

It’s all happening as forecast. Except that businesses aren’t expanding. The underlying economy is not really getting better. It’s actually getting weaker. But we’ll talk about that another day.

Today…we issue a warning: watch out, the greenback is going into the toaster oven…

Yesterday, the dollar held steady at $1.36. Meanwhile, the Dow gave up 29 points…after a strong day yesterday. Oil rose over $60. And gold gained $5 to $926.

First, here’s what Nouriel Roubini had to say in the New York Times:

“We may now be entering the Asian century, dominated by a rising China and its currency,” Roubini contends. “This decline of the dollar might take more than a decade, but it could happen even sooner if we do not get our financial house in order. The United States must rein in spending and borrowing, and pursue growth that is not based on asset and credit bubbles. For the last two decades America has been spending more than its income, increasing its foreign liabilities and amassing debts that have become unsustainable.”

Yes, it could take more than a decade. But investors could take a big loss any day. All it would take would be a sudden move by China…or a shocking inflation figure in the US…or a Treasury bond auction that doesn’t go as planned.

Everyone is watching the United States…carefully. And foreigners hold trillions’ worth of dollar-based assets outside the US. These are dollars that people hold, not to pay their bills or buy gasoline, but as a speculation. They’re speculating the greenback will hold its value as well or better than the other things they might do with their money.

Europeans hedge their bets against the euro – with dollars. Asians hedge their bets against falling stock prices. Russians hedge their bets against the ruble. Latin Americans hedge their bets against their own pesos, bolivars and cordobas. Everybody likes dollars because they are the most trusted money in the world. For the last 50 years, nothing could compete with the dollar. (Even though the dollar lost value against a number of other currencies over long periods of time.)

These foreign holders are already nervous. They’ve seen the mess the US has gotten itself into. They read the headlines. They watch the news. They know that the US is running a budget deficit this year equal to four times the biggest budget deficit ever – a record set just last year. It is as if a runner broke the record in the 100-yard dash…and then ran the course four times faster a year later. This is not progress. This is spooky.

The Chinese already let the US know they were worried. “We trust you to protect the value of our assets,” they said to the American Treasury secretary.

And as long as they trust the US to keep its promises and protect its money, they’ll continue to hold US dollar investments – notably, US Treasury bonds. But just wait until the US loses their trust. In a matter of minutes, China could dump enough US dollars to set off alarms all over the world. All of a sudden dollar holders would rush for the exits – each one trying to get out before the others. In minutes, the dollar market could collapse…taking down US Treasury bonds with it.

Our Pittsburgh correspondent thinks he sees this happening soon.

“Bye Bye US Dollar!!!” writes Byron King. “We’ll go to bed one night and wake up the next morning and the dollar will be toast…

“Wow… Have we in the US screwed ourselves, or what? The rest of the world has to be watching us and laughing up its sleeve. A big, muscle-bound superpower with a declining industrial base, sitting around navel-gazing about how much more of our industry we’ll dismantle; how much of our energy production we’ll curtail… Meet the future…”

*** Friend and colleague Byron King sent the following article from the Financial Times:

“Brazil and China eye plan to axe dollar,” the article begins.

“Brazil and China will work towards using their own currencies in trade transactions rather than the US dollar, according to Brazil’s central bank and aides to Luiz Inácio Lula da Silva, Brazil’s president.

“The move follows recent Chinese challenges to the status of the dollar as the world’s leading international currency.

“Mr Lula da Silva, who is visiting Beijing this week, and Hu Jintao, China’s president, first discussed the idea of replacing the dollar with the renminbi and the real as trade currencies when they met at the G20 summit in London last month.

“An official at Brazil’s central bank stressed that talks were at an early stage. He also said that what was under discussion was not a currency swap of the kind China recently agreed with Argentina and which the US had agreed with several countries, including Brazil.

“Currency swaps are not necessarily trade related,” the official said. “The funds can be drawn down for any use. What we are talking about now is Brazil paying for Chinese goods with reals and China paying for Brazilian goods with renminbi.”

“Mr Zhou recently proposed replacing the US dollar as the world’s leading currency with a new international reserve currency, possibly in the form of special drawing rights (SDRs), a unit of account used by the International Monetary Fund.

“In an essay posted on the People’s Bank of China’s website, Mr Zhou said the goal would be to create a reserve currency ‘that is disconnected from individual nations.’”

Until tomorrow,

Bill Bonner

The Daily Reckoning