The Future of the U.S. Dollar

The future of the U.S. Dollar

Saleem Chatoor

Studentnummer 0746775

Introduction

In recent years the U.S. public debt has taken an enormous leap towards extreme heights. The current total debt of the U.S. is considered to be unsustainable by many economists and politicians. At this moment the total debt of the U.S. is 80% of its GDP reaching to a staggering amount of 13 trillion dollars. Given the expenses and obligations taken to save the U.S. financial system this figure will only rise in the coming years.

It is my own belief that the debt of the U.S. will sooner or later result in economic default of the world's greatest super power. Thus the result on the U.S. dollar will inevitably be one of cataclysmic hyperinflation.

In this paper we will discuss what the causes are of the deficit, and what are its implications. Also we will look at the total debt of the U.S. and the economic measures the nation is taking regarding interest rates, the stimulus plan and quantitive easing. To conclude I will elaborate my opinion as to which future scenario is most likely.

Current circumstances

Current Account

Having a deficit does not necessarily lead to an unsustainable or problematic situation. Often after a war or economic recession a countries governmental spending exceed its income. Some economist (for instance Daniel Griswald, director of CATO, http://www.cato.org/pub_display.php?pub_id=4367) even believe it to be a sign of trust and strength of a country. They say "would you rather be a country that attracts money or a country which lends outside of its own economy". So in case of foreign investments having a deficits it's not considered at all to be an unhealthy situation.

So why is it such a hype in the world today. The U.S. just came out of a recession and also has been engaged with war against terrorism for quite a while. In a time of recession the private sector saves money and economist such as Paul Krugman believe that the government should spend in order to save the economy. The first and foremost reason for economists to get upset is the sheer size of the deficit. Every year since 1975 the current account has been colored with red ink and the last couple of years the deficits have sky rocketed to more than 800 billion dollars per year.

The current account of a country mainly contains of the difference between money flowing out from import minus money flowing in from export. Basically we can say that it is a cash flow statement of a country. As we all know the U.S. currently has a major deficit in its current account.

There are 4 main reasons of the U.S. trade deficit.

• The U.S. consumption

As we will discuss later on, the U.S. consumers have been stimulated to spend more money. By tax and lower interest rates consumption is stimulated, unfortunately for the U.S. there is a relatively a stronger yield between consumption and import.

• Decline of competitiveness

The U.S. is in a currency war with China, because it is losing ground on competitive prices. However here it must be noted that exports are rising and productivity of the U.S. is highest in the world. But the wages in U.S. simply cannot compete with the wages in other countries.

• Dollar relatively high with regard to the deficit

The U.S. have a high account deficit. When a country usually has a deficit the currency inflation rises. This happens because deficits are made securities so that other countries can buy them. Money is pumped into the economy. However the amount of goods and services produced in a country remain the same and that causes inflation. Although this is not a pleasant event, it brings balance to an economy and makes export cheap. In the case of U.S. the dollar is relatively strong and did not devaluate as much as assumed because of several reasons. (dollar safe heaven)

• Governmental spending

The U.S. government itself is spending huge sums of money on the war against terrorism. But also pension and healthcare cause the U.S. government to borrow money from other countries. Because of the recession the country has also launched two stimulus plans in order to jump-start the economy. However, mostly these stimulus plans have been paid indirectly by the FED (quantitative easing), and so do not really contribute to the deficit.

Current Public debt

In the previous chapter we discussed the current account deficit of the U.S.. In this chapter we are going to look at what the deficit in combination with other factors has led too. Having deficits every year, plus additional spending by the governments on operations such as war on terrorism can only be financed by large private investors or other nations. The United states at this moment are highly financed by governments of other countries. China ofcourse being the biggest lender. China as a lender has 35% of the marketshare in U.S. bonds. 50% is in the hands of U.S. private lenders and about 15% is for the rest of the world. In relation to its GDP, the United states of America has lended 94%. This means, in theory the nation would need to work 1 year to pay off their loans. With a total sum larger than 13 trillion dollars, it's the biggest loan the world has ever seen. In comparison to the second largest debtor

U.S. measures to bring balance and stimulate the economy

Strong factors of the U.S. economy

As we are coming out from a recession, some believe that soon the U.S. will get its grip back on the deficit, the domestic market of the U.S. is still the most strong in growth and productivity. This are two very strong characters of the U.S. economy. There is one downside however, recent studies* have shown that the yield between the economic growth in the U.S. and buying goods from outside the U.S. is stronger than an average foreign country. This means that a growth in GDP will have a negative impact in the balance of payments, thus also the deficit will increase. Although this does negatively influence the trade deficit, having the highest GDP (measured in PPP) shows a high level of stability.

Also as said the productivity in the U.S. is as said the highest in the world, it makes the U.S. products cheaper because the ability to produce more per hour then other countries can. Therefore if a country can produce more goods in the same amount of time, the price per product decreases, thus the export rises. This also is a strong points of the U.S. economy at this moment.

The last strong factor of the US economy is ofcourse the "dollar" which is still the global reserve currency. Also many other countries are pegged to the US currency. This gives US a unique advantage over other countries. What it comes down to is that no country or economy will not be hurt if the US economy collapses. The willingness to trust in the US therefore will be very high.

Measures taken by the U.S. Government

The recession caused great damage to the U.S. economy, although the deficit problem already existed before this recession, things got ugly much more quickly. The US government and FED reacted very decisive and issued a plan to get the U.S. economy back on track. Monetary policy of the U.S. has been very focused on increasing expenditure of the private organizations and consumer markets.

• Low Interest rates / excessive money supply

Interest rates are basically like prices for goods and services, also the result of supply and demand. The supply in normal conditions is based by savings in a country and the demand comes from investors and those who are in need. The banks have a central role as they are responsible for the market between supply and demand. The Fed, however can manipulate the interest rate. Because the Fed can create money they can decide their own interest rates for lending money to the banks. And by lending out money to the banks in the U.S. at a very low interest