Our Version of The Risks of A US Dollar Crash

``The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system”- Ludwig von Mises Human Action p.555

The prospective shortfall from the frontloading of fiscal deficits has prompted accelerated concerns over a crash of the US dollar.

For some the definition of a US dollar crash is simply a wave of selling of US financial claims from major official creditor nations, i.e. central banks and sovereign wealth funds.

For us, the incentive to drastically and simultaneously unload US assets appears unlikely, because it won’t be to any country’s interest to foment a US dollar crash as this will be equivalent to mutually assured destruction. To quote Luo Ping, a director-general at the China Banking Regulatory Commission who spoke with levity over a recent public engagement, ``“We hate you guys. Once you start issuing $1 trillion-$2 trillion [$1,000bn-$2,000bn] . . .we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.” [emphasis mine]

Moreover, many have been suggesting for the US to massively devalue by running up the printing presses, a step similarly undertaken by then US President Franklin Delano Roosevelt during the Great Depression. This should ostensibly reduce the real value of debt by reducing the currency’s purchasing power.

However, the privilege from “devaluing” translates to lost savings and a significantly lower standard of living and even more poverty. To quote money manager Axel Merk of Merkfund.com, ``Somehow policy makers have it backward. Many of us like our jobs, but not so much that we love to give up half our net worth for the opportunity to go back to work.”

Besides, the basic problem of the US dollar devaluation seems to be, “to devalue against whom or what”?

During the Great Depression, the US dollar was operating on a gold standard platform which allowed for it to devalue. Our paper money system isn’t tied to gold anymore.

I might add that to conduct an arbitrary massive devaluation can be construed also as a form of non tariff protectionism.

Therefore, it would seem rather unlikely for the US or for that matter to any major OECD country or regional economies to perhaps impose on such irresponsible protectionist stance without expecting the same punitive retaliatory measures.

This means, as we have repeatedly pointed out in the past, the likely scenario from unilateralist US dollar devaluation could be the risks of a currency war, which ultimately leads to the disintegration of the present paper money system, and possibly, a world at war.

While many countries appear to be itching towards adopting or gradually espousing non tariff populist protectionist policies such as export restrictions, import quotas, anti dumping duties, non automatic licensing, technical regulation to trade covering health and environment and subsidies to national industries, it is unlikely that governments could veer towards radicalism. Nations which depends on trade, together with the World Trade Organization and multinational companies will possibly lobby to maintain sangfroid temperaments.

Hence, an orderly coordinated devaluation may occur only if done under an international rapprochement similar to the 1985 Plaza Accord. The same multilateral approach can be undertaken when considering global debt restructuring or a reconfiguration of the monetary architecture.

Nonetheless we beg to differ from the conventional expectations of US dollar crash paradigm.

We concur with Brad Setser when he cites that the present dynamics as shifting from reduced significance of external based financing to increasing contribution from domestic savings.

Here is Mr. Setser, ``The overarching assumption behind the stimulus is that a rise in US household savings (linked to the fall in US household wealth) will create a pool of domestic savings that will flow, given the ongoing contraction in private investment, into the Treasury market. The rise in private savings and fall in private investment will allow the US government to borrow more even as the US economy as whole borrows less from the rest of the world. The key to the Treasuries rally in 2008 was the surge in private demand, not the strengthening of official demand. My guess is that the Treasury market will be driven by developments in the US – not developments in China – in 2009.”

This means a US dollar crash will probably occur if private creditors alongside official creditors instigate a run on the US banking system. That will happen only if a surge in inflation or the debt burden becomes intolerable. On the other hand the other possible scenario, as mentioned above, could be a currency war. Of course there maybe other possible scenarios, which at present, escapes our thought for the moment.