US dollar closer to crisis

Thu, 30 Sep Pre-Open

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There is an old adage in banking circles. If a bank lends a few thousand dollars to a person, the person has to be worried. However, raise the sum to a few billion dollars and it is the bank that has to worry.

What if the sum involved is not even billion but of the magnitude of a few hundred billion dollars? Well, the lender better be worried big time here. The dragon nation China seems to be going through a similar predicament right now.

Out of its huge cache of US$ 2.45 trillion worth of forex reserves, close to US$ 900 bn are invested in US treasuries, denominated in US dollars. And the dollar is certainly not one of the strongest currencies going around today.

Infact, as per a former adviser to China's central bank, the US dollar is one step nearer to a crisis as its debt levels continue to increase. "Any appreciation of the dollar is really temporary and a devaluation of the currency is inevitable as US debt rises", Yu Yongding, the advisor is believed to have said in a recent speech.

Indeed. The US debt numbers are not one to be taken lightly. The estimated budge deficit, the measure of how much more a Government spends than it earns, for the current fiscal year would be equivalent to 9.1% of the US GDP. As per moneynews, this is going to make it the second largest shortfall in 65 years, beaten only by the 9.9% in 2009.

Besides, the US is projected to have a cumulative deficit of US$ 6.27 trillion in the next decade. Add to this the various unfunded liabilities that stares the Government in the face and the magnitude of the problem only becomes evitable.

Broadly speaking, national debt is nothing but a claim on the future productivity of a nation. Higher the debt, higher the resources that the country has to put aside for debt repayment. There are other ways of repaying the debt as well. And they answer to the name of default and devaluation.

When the debt becomes too much to bear and repay, countries are believed to take the default and devaluation route. This, they do by either refusing to pay up or by resorting to money printing. And it is this latter route that has the Chinese worried.

The Chinese advisor is of the opinion that in order to avoid a rapid devaluation of its dollar holdings, it is imperative that China starts diversification of its dollar denominated holdings into other currencies, commodities and direct investments. However, they will have to ensure that they do so with extreme dexterity. Any rapid diversification is likely to put into jeopardy their own enormous holdings. Indeed, the huge US dollar holdings have become China's problem now more than the US'.