There’s a debt crisis brewing not only for European countries, but for America. Investment Contrarians editors have been critics of the U.S.’s inability to reign-in government spending. Based on the White House’s own figures, the national debt will reach $20 trillion by the end of this decade—about 140% of our current Gross Domestic Product. In our studies of history, countries who have incurred considerable debt, countries that have experienced a consistent national debt to GDP multiple of 120% or more have experienced currency devaluation. The U.S. dollar has already been in a free-fall since 2009 against other major world currencies. We expect the devaluation of the U.S. dollar to continue as the U.S. continues to pile on the debt. You can find regular commentary on the U.S. dollar in Investment Contrarians.
While many people are aware that the Chinese economy is now the second-largest in the world, China’s currency, the yuan or renminbi, is also moving upward in the world rankings in terms of global transactions.
According to the Society for Worldwide Interbank Financial Telecommunication (SWIFT), the world’s global payment system, the yuan has moved up from 20th in the rankings in January 2012 to 14th position in December 2012. The Chinese yuan is now above the Danish kroner in terms of global payments. (Source: “RMB Tracker: January 2013,” Society for Worldwide Interbank Financial Telecommunication web site, January 24, 2013.)
That is a significant move and an indication that the Chinese economy is becoming more integrated worldwide.
Why does this matter to the average American?
For a long time, America’s economy has been the global leader and the U.S. dollar has been the global reserve currency. Every other nation was seen as secondary to America’s dominance. This is now starting to shift.
As the U.S. national debt level continues to grow, the strength of the Chinese economy is enabling considerable efforts to be made at developing globally interconnected markets that can survive and thrive without the U.S. dollar.
While the Chinese economy is certainly not perfect, it doesn’t have to be. With the rising level of U.S. national debt, the Chinese economy just needs to be relatively better than the U.S. economy, though not in absolute terms.
The point is that the rise of the Chinese economy over the past decade and the looser restrictions that the Chinese government is placing on the yuan mean that global businesses and investors have … Read More
One area that worries me most about the current Federal Reserve monetary policy action is the unintended, long-term consequences of the current program. Unintended consequences are the side effects that can sometimes be more harmful in the long run than the short-term benefit of the initial program.
Keeping monetary policy extremely easy in such an unprecedented manner for so long can have serious long-term ramifications.
The most obvious side effect is that, with the greater availability of easy money, funds are flowing into assets, driving up prices. The question is: will investors who are spending money on assets fueled by cheap money end up suffering significant losses down the road?
I am glad to see that some members of the Federal Reserve are beginning to voice their concerns regarding monetary policy. Recently, the Kansas City Federal Reserve President, Esther George, stated, “We must not ignore the possibility that the low-interest rate policy may be creating incentives that lead to future financial imbalances.” (Source: Torres, C., “Fed Concerned About Overheated Markets Amid Record Bond Buys,” Bloomberg, January 17, 2013.)
One potential worry is that the low interest rate environment resulting from this monetary policy action is causing investors to search for yield in increasingly riskier assets.
One area that has seen a strong increase in demand is speculative-grade bonds, or junk bonds. According to Credit Suisse, an index of over 1,500 junk bonds is now yielding a record-low 5.9%. (Source: Ibid.)
The problem is that when the Federal Reserve begins to tighten monetary policy, many if not all of the investments made over the past couple of years might suffer significant … Read More
The U.S. dollar has been the world’s reserve currency for decades, but that position might be under attack. With the rising level of U.S. debt, many countries around the world are questioning the position of the U.S. dollar as the reserve currency.
Cracks are beginning to appear; the latest sign is that China and South Korea have come to an agreement in which banks from either country are able to borrow funds from a swap line that makes loans available to companies for deals in local currencies. (Source: “China, South Korea to Boost use of Local Currencies in Trade,” Bloomberg, December 4, 2012.)
This swap line is currently set at $59.0 billion, and allows firms to settle deals in either the Chinese yuan or the South Korea won instead of the U.S. dollar. On the surface, this might not seem like a direct attack on the U.S. dollar’s status as reserve currency, because reducing transaction costs is inherently advantageous to corporations. However, the willingness by these nations to increasingly avoid the U.S. dollar is a problem.
Shifts in the reserve currency status take many years to develop. We’ve seen rising U.S. debt levels for years, and this is putting increasing pressure on countries to diversify away from the reserve currency nation that is becoming increasingly irresponsible in the way it handles fiscal and monetary policies.
Running up the U.S. debt levels over the short term might be seen as innocuous by American politicians; but over the long term, the sustained inability and ineptitude of politicians to properly manage government spending will lead to a lack of belief in the country … Read More
With the recent move by Mitt Romney to choose Paul Ryan as his running mate for the upcoming election, I believe this sends a strong message to the American people and the rest of the world that the U.S. is finally going back to its roots by getting on the path to reducing the budget deficit and preventing a financial crisis.
A financial crisis usually stems from a lack of confidence. If the lenders feel that a borrower can’t pay, they sell their securities and refuse to lend unless the rates are extremely high. This is how the financial crisis in Europe is unfolding, as the budget deficit for many nations remains high. They are continuing to spend more money than they earn. Running a budget deficit for a short period of time might be okay, if a surplus is eventually generated to reduce the overall debt. This has not occurred for many years in dozens of nations, including the U.S.
Ryan understands that the real victims are the American people if a budget deficit is continually generated. This puts the country at greater risk of a financial crisis, as investors begin to lose credibility in the nation as a whole. The U.S. is fortunate that so many other nations are also poorly managed, running up a huge budget deficit and cresting on the edge of a financial crisis.
One of Ryan’s ideas is reducing government spending by 2015 to 20% of gross domestic product (GDP) and a long-term target of 15% of GDP. Reducing government expenditures is a needed step in reducing the budget deficit. Such a move will … Read More