Posted by Nikoletta Ventseslavova

Read this if: You want an objective view of the US economic situation.

Gain: Knowledge on how to protect yourself from a dollar collapse.

For many years the US dollar has been considered as the world’s leading currency. Even today the dollar is world’s reserve currency which means that many other governments keep their savings in dollars. But the recent crisis hit the US hard and this situation might change. The US economy used to be the dominant but many economists believe that China’s economy will become number one in the world by year 2020.

Reasons for the US debt and the coming collapse of the US dollar:

Current account deficit: Imports in the USA are greater than exports and this outflow of currency puts downward pressure on the dollar. In the past China used its foreign exchange reserves to buy US debt, and that countered the effect of the outflow of dollars. Asian countries are now standing aside from greenback as they no longer believe it will retain its value. Between February 2009 and July 2011 the Federal reserve was printing dollars and buying the US debt that could not be sold, but at least for now this money printing has ended. This does not bode well for the value of American bonds.

The severe reversal in the housing market discourages the foreign investors from buying dollars. At the same time it’s very difficult to predict when the housing market will recover.

And one of the most important factors: falling US consumer confidence. Whilst confidence cannot drive a market forever, it has kept US markets buoyant much longer than anyone expected.

The high level of personal debt amongst US consumers – as a consequence of this the US economy is sensitive to any rise in interest rates. Higher interest rates would be one solution to a falling currency and may be necessary to attract investors to finance America’s trade deficit. The Credit Crunch is also a factor, causing a decline in loans, a shortage of funds for lending and a sudden increase in the interest rate.

The high level of government debt – most of the US government borrowing is short term in nature. If the US raises interest rates to defend the dollar the cost of renewing its borrowing when old borrowing expires will make the interest bill prohibitively expensive. The US is damned if it raises rates and it is damned if it doesn’t. In the end, market forces may force rates to rise as lenders turn their back completely on US bonds, and at this point the government will no longer be in control of the interest they pay on new debt they borrow from Peter to pay Paul.

The government budget deficit – The US government has spent 50% more than it receives in tax revenues each year since the 2008 crisis unfolded. This looks set to continue with most of the spending being non-discretionary. There are only 2 ways to fund this: By borrowing more or by printing money. Both scenarios are unsustainable and will lead to an eventual crumbling of the value of the US dollar as interest rates eventually rise.

Recently the national debt of USA reached the maximum approved by the government. This means that the country should not borrow any money from now on. This will cause bankruptcy unless the Senate vote for increase of the debt ceiling. The United States is the country with the highest national debt in the world – 14,392,451,000,000 dollars and counting. This is a huge number. If 1$ banknotes were put one on top of the other, the pile would reach the Moon! However, there is another important fact – the US Debt represented as a percentage of the Gross Domestic Product (GDP is the total revenue of the economy of one country). For the USA it’s 97% of GDP. There are many countries, which owe more than they earn each year: United Kingdom (398% ratio national debt to GDP), Netherlands (ratio national debt to GDP), Norway (861% ratio national debt to GDP) and the extreme case of Ireland (1224% ratio national debt to GDP).  It is interesting to be note that most of the national debt of the USA is owned by US individuals and institutions at 42,2%. China holds 7, 5 % of the debt (they typically owned 20% in the past) and it is the biggest foreign country owner, followed by Japan – 6, 4%, and UK – 6%.

How could this situation with the national debt be solved?

There are several solutions according to the experts:

Increase taxes. This is bad for the business but the country will quickly generate short term funds. This method was recommended by Alan Greenspan, ex. director of the Federal Reserve. Raising taxes crimps productivity however and the government would still need to cut spending massively just to stop bleeding money, even with tax raises. Over time also, tax rises tend to lead to profits moving offshore where it’s harder to tax them and the tax revenues will fall.

Reduce outsourcing. One of the benefits of outsourcing is the cheap labor force. The problem is that Americans lose their jobs because the company moves the production to third world countries in order to cut costs. Unemployment is key factor for the recent recovery of United States. This however is likely to be a bogus argument as forcing companies to stop outsourcing would be equivalent to putting a tariff on imports, and this would lead to tit-for-tat reactions from abroad causing an overall reduction in trade, and a fall in GDP.

Print more money. There are pros and cons to this. When you print money you devalue existing money and generate inflation. From one side inflation is good (for the country printing the money) because more money in circulation makes it easier to repay debt.  The problem with this is that the inflation could become hyperinflation through a loss of confidence in the dollar. “Three Comrades” by Erich Maria Remarque describes the situation  in Germany after the First World War. The inflation was enormous and the prices were  jumping 10 times per day! The cost of one beer was 3 billion Deutsche marks. Hyperinflation would wipe out all wealth in the united states for a period of time.

Richard E. Noble: “Printing money and skipping the Federal Reserve will no doubt create some inflation. But, using that money to buy back Treasury Bonds (Debt.) will be anti-inflationary. On the one hand, we are printing money to put into circulation, but using it to take money out of circulation by reclaiming debt on the other. If it is done properly – with due diligence – the one will cancel out the other and America will one day be debt free and it will cost nobody anything. This will not be a loss or gain – it will simply be a monetary transfer. We will transfer a bunch of one type of paper for another type of paper. If it is done right, nobody will know the difference. And if we want to add an additional check on inflation, when we start buying back our treasury bonds from the Federal Reserve with our free paper, temporarily raise the required reserve security demands. In other words, if the banks are required to hold 10% in reserve – raise that requirement to 12% or whatever. Then as time goes on and we see that inflation is under control, lower the requirement.”

Jim Rogers:“The U.S. dollar is going to be a ‘total disaster’ due to our country’s position as the world’s largest debtor and the policies currently being undertaken by our Federal Reserve. “The Chinese yuan is likely to be a ‘safe’ currency. Bernanke only understands printing money and does not understand economics. “

Default. This solution is very extreme, but it will show immediate results. The problem of this idea is that this could demolish the confidence in the dollar as a reserve currency and in the economy.

So what should a small investor do?

Store your savings in more than one bank.

Store your savings in more than one currency. Gold is always a good investment.

Don’t buy and sell stocks (trade) unless you are a professional. Markets change swiftly nowadays and it’s almost impossible to predict what will happen with your investments.

If you’d like more details about what to do with your money, read here how to protect your wealth

Sources:

“The National Debt With a “Noble” Solution” by Richard Noble

http://en.wikipedia.org/wiki/List_of_countries_by_external_debt

http://www.investor.bg/news/article/118231/337.html

http://en.wikipedia.org/wiki/Inflation_in_the_Weimar_Republic

http://www.investmentpostcards.com/2011/01/17/who-owns-the-u-s-national-debt/