American debt: the dollar loses its economic value

A Daily Reckoning Special Report

By Bill Bonner

Americans owe more dollars than ever before. Until 1980, debt as compared to GDP never surpassed 150%. Now it is 330%. Many people are finding it hard to pay their debts. And many leveraged bets made on this debt are now going bad, reducing the availability of cash and credit generally. So, back to our views: On the one hand the world is awash in paper money. So much of it is gushing into the world economy that prices notably of oil and gold can only float up higher. And, the dollar, of course, is doomed by inflation. It will be dragged down by the weight of its own numbers. On the other hand, the world is caught in a credit crunch...

American debt: the dollar & China’s problem

Today, we give you not one, but two, apparently contradictory, views. One of them is bound to be right. Most likely, both will be.

First, the basics: China is a big country in Asia with a big pile of cash - $1.4 trillion of it. Most of this currency features pictures of dead US presidents. The USA is a big country in North America that emits these dollars, and uses them to buy things it cannot afford and doesn’t really need.

Meanwhile, Americans owe more dollars than ever before. Until 1980, debt as compared to GDP never surpassed 150%. Now it is 330%. Many people are finding it hard to pay their debts. And many leveraged bets made on this debt are now going bad, reducing the availability of cash and credit generally.

So, back to our views:

On the one hand... the world is awash in paper money. So much of it is gushing into the world economy that prices – notably of oil and gold – can only float up higher. And, the dollar, of course, is doomed by inflation. It will be dragged down by the weight of its own numbers.

On the other hand, the world is caught in a credit crunch. The days of reckless lending are over. Assets – real and imagined – are falling in value, prefiguring a major drop in prices across the board. The housing industry got nailed first. Then, property prices headed down. Finance was next. And then technology. And now stocks, generally, are in retreat…with much further to go.

American Debt: the dollar’s loss of value

The right hand is clearly working the pumps. For clarity, we turn to no less an authority than Mr. Mahmoud Ahmadi-Nejad. You may recognise the name, dear reader. Mr. Ahmadi-Nejad is the desperado in charge of Iran. He was in the news this week, appearing in Monday’s Financial Times. A photo showed him looking rather glum. Of course, you’d probably look gloomy too if Hugo Chavez had his arm around you. Still, Ahmadi-Nejad managed to summarise the entire post-1971 world monetary system so clearly and so precisely; it was almost poetry. A haiku:

“They get our oil and give us a worthless piece of paper.”

Nobel Prize committee, take note.

Mr. Ahmadi–Nejad is not known as a poet, nor as an economist. Still, he went on to give graduate level instruction in central banking: “We all know that the US dollar has no economic value.”

How dollars came to have no economic value is a long story. How there came to be so many of them is shorter; the dollar is the USA’s most successful export. Americans are world champion spenders. They may make up only 5% of the world’s people, but they do 20% of its consuming – in dollars. Central banks, fearing that an over-supply of dollars will drive their own currencies up, print local currencies, use the money to buy dollars, and add the dollars to their reserves. This year alone China has accumulated nearly $400 billion of foreign reserves, mostly dollars. Indeed, it has so many dollars that the Chinese are getting nervous. Wen Jiabao, China’s premier, told an audience in Singapore:

“We have never been experiencing such big pressure. We are worried about how to preserve the value of our reserves.”

Meanwhile, another headline from the FT told us that the greenback is under attack in other parts of the world: “Dollar loses grip on Asian debt sector.”

“The US dollar has lost is status as the pre-eminent currency for fixed-income products such as corporate bonds in Asia, a sector it used to dominate...” said the story. The dollar itself fell to record lows against practically everything – notably, the pound, the euro, and oil. And if the Fed cuts rates again in December – which is given a 90% probability by the futures market – the dollar will fall further…and prices will continue to go up.

But, while the right hand pumps, the left knocks a hole in the bucket. Week after week, more losses are announced. The latest tally by Goldman Sachs estimates total losses at $400 billion from the sub-prime debacle, with a total of $2 trillion of cash and credit sucked out of the financial system. Leverage works in both ways, it turns out. When credit is expanding, a deposit of $10 million can be levered into a $100 million gamble. When it is contracting, a $10 million loss reduces the supply of credit by as much as $100 million.

The drop in the dollar and the drop in housing prices have already cost Americans trillions in implied wealth. It’s money that is going, not coming. Says the Economist Intelligence Unit: “The main risk to the world economy is a deflationary spiral in asset prices.”

Which hand will do the most damage? We don’t know. Probably both of them will smack us sooner or later.

By Bill Bonner - Best-selling investment author, founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.

First published Sat 24 Nov, 2007

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