Thursday, October 11, 2012

Explaining the crisis to a non-believer

The crux of the problem is that US is adding roughly 1 trillion dollar external debt per annum. Read this article to understand the deficit numbers. The deficit in 1945 was internal and due to the war.

Contrast this with the deficit of Japan which is 200% but almost all is internal. Internal debt is not as bad as external debt.

India is in a much smaller external debt, but our currency is undergoing devaluations due to Balance of Payements problems. A look at the External debt of India.

The question is why does India suffer from the deficit, but the US does not. The answer is that Indian debt is not considered good while US debt is being taken in by some countries.

Lets see why US debt is so much in demand, and what we can project for the future. US Dollar is the reserve currency. So nearly all international trade happens in USDs. US is also the largest consumer. So the surplus countries get US Dollars. They cannot do much with it. So they have to give it to the US, and get Treasuries instead. This is how China, Japan have collected so much US Treasuries. We can say that the major export of US is US Treasuries, which costs nothing for US to create.

This obviously is not sustainable. US is continuing its high consumption, while China and other countries are providing the surplus to balance this out. Starting September last year, China turned around and started consuming the excess USDs it was getting by buying different commodities. China is on its way to becoming the largest importer of gold.

The year ending June, Japan was the major importer of treasuries. Now Japan is on the brink of a collapse. It is interesting that Japan has been giving so much money to US, but is still not able to balance its budget. The real problem is that Japanese have been trying to keep their currency low value by selling Yen and buying USDs. This is how they are getting the US Treasuries. But this does not help them.

China is spear heading a drive to get into Currency Swap agreements with different countries, in an effort to increase the distribution of its currency. The more Yuan there is in the world, the higher impact China will have in world affairs. It has achieved agreements with 20 countries including Germany, Japan, Russia, UAE, Brazil, etc. Lots of important countries.

Euro already has a decent distribution in the world. There are 3 important currencies in the world now, including the USD. The more these two currencies find acceptance in the world, the less use the world has for USDs.

The reason why the world needs to get away from USD, is the same problem as Japan is facing. They produce excess, but they have problems meeting their budgets. Slowly and slowly countries will move away from the US. The current US deficit is expanding. The QE3 introduced creates about 1 Trillion USDs a year. This is exactly equal to the deficit. Which means that the structural support provided by China for the last 10 years is gone. US is on its own now. Due to the QE3 USD has started to drop in Value, which is why we are seeing Gold rise again. Rupee is also rising but due to the various measures taken by our Govt.

The US govt will use these created USDs to bid for consumer items from around the world as it has been doing for the last 40 years. QE3 shows that this money is not being stored anywhere, so whoever gets them will try to get rid of those USDs as soon as possible by buying stuff from other countries. Since nobody wants the USDs the prices of stuff will rise quickly in USD terms. This causes inflation in USD terms. But this is only an international phenomenon. Now countries will be in a fix as their ability to export is diminishing, some countries will stupidly try to devalue their own currency in a bid to increase export. This starts a currency war devaluing all such currencies. This war is already being waged, it will intensify. The high prices in the international market will increase the prices in the local market in USA and other countries involved in the currency war. This quickly becomes a vicious cycle, and results in a hyperinflation in USD terms. Countries will slowly realize the outcome of this currency wars and will drop out of it.

Hyperinflations take a couple of years to unfold. Initially inflation lacks money printing, as has been happening till now, but soon with the loss of trust, it over takes the money printing, and then inspite of having a huge amount of currency, there is no liquidity. US will be forced to print faster and faster to create enough liquidity. As countries stop the war, the hyperinflation will be pushed back in the USA.

Since the whole world has been living on a mountain of debt, as the USD goes into hyperinflation, the debt will lose its value. And the whole world will plunge into the greatest depression yet. Several currencies with large debts will hyperinflate away their debt. While creditor nations will plunge into deflation. Effectively the depression will be a global phenomenon.

Due to the high inflation or deflation people will stop spending anything on non-essential items. Consequently only companies that produce essential items and those that produce items for the govt will survive. The govt is not affected by the high inflation as it can print as much as it needs. This is not true of the Eurozone as ECB will not be printing to fund the govts. So they are left with the option of deflation and austerity. This is what is happening in Greece, and moving towards other Eurozone countries. But countries that can print will print to maintain their lifestyles. And those that do not curb their lifestyle will experience hyperinflation.

People working in non-essential non-governmental jobs will lose their job. This will result in lots of people with very little money. They will sell their non-essential items at very cheap rates and there will be a glut of cheap second hand iphones, ipads, computers etc.

Reserve status of USD hinges on Oil. US has zealously guarded USDs exclusivity for oil. It attacked Iraq when it tried to sell oil, in Euros. Now it is attacking Iran because it is also selling oil in other currencies. The next country to do this will be Russia and China. They have an agreement to sell Russian oil in Yuan, by 2014. This is actually a preparation for a post USD world.

The USD hyperinflation is not likely to take more than 3 years. The over high inflation should be visible beginning the next year. Unemployment will probably rise precipitiously in another year. The period after that will be very bad with food riots, arson becoming very common.


  1. Thanks Anand! seems to me much simpler to understand than other blogs, thanks for putting it into J6P words. Cheers!