¡@2006

Why¡¦d USD depreciate?

Since 2002, USD has fallen from 120 of USD Index to a little bit lower than 80.5 in early 2005, then it retraced back up to about 90 in early 2006.  Starting from February 2006, USD has gone back to the downward trend. In 2003, George Soros and Warren Buffett disclosed that they built massive positions of shorting USD since 2002. Warren Buffett is still holding the short position till now.

The 2005 retrace back up is mainly due to the US corporation tax policy, inflow capital to US, and increase of interest rate. 

The background for the story of USD depreciation in 2006. USD is not a healthy currency, it¡¦s crippled. US is the country which owns the largest debt. More importantly, US hasn¡¦t invested the money they borrowed into something productive. US is having negative budget and it becomes larger and larger, especially the trading deficit. Does US have enough competence to repay the debt? Probably not. Thus, what will the consequence be? Depreciation of USD.

US is like a man who has negative income and a huge debt, over 300% of what he earns every year before all expenses. In 1929, the debt was a little bit below 300% of its GDP. The most critical problem of US is that the trading deficit because it worsens the competence of the US corporations and that of the US workers.  Thus, US government¡¦s first role is to balance the trading deficit.  To do that, they need to increase the saving rate of the whole country.

In the early 1980s, the percentage of GDP accounted for by gross saving fell rapidly and was reflected in a widening gap between the supply of saving and the demand for domestic investment.  The declining share of saving had broad consequences: the economy accumulated less capital and therefore grew more slowly and paid workers lower average wages than it would have if the share had remained . Inflows of capital from abroad partially filled the gap and permitted domestic investment to exceed saving. Those inflows also created a trade deficit, allowing domestic consumption and investment to exceed domestic production.

Anybody who has taken a macroeconomics class remembers that national income accounting tells us that in an economy closed to international trade, savings will always equal investment. Similarly, once the economy is open to international trade the relationship is modified to where a country¡¦s net savings (the excess of investment over domestic savings) equals the net sales of goods and services (the trade balance)"

The depreciation of USD does help to balance the trading deficit but not really a huge factor. The depreciation of USD is more a consequence of balancing the trading deficit than a factor of it.

There are two savings which sum up to be the total investments, they are public savings and private savings.

Therefore, if US government wants to balance the trading deficit, it needs to increase the saving rate in order to reduce the consumption of import goods and increase the export production by increasing the domestic investments for improving the competence of domestic corporations and job markets.

The goal of the FED seems to be focusing on keeping the paper money, DJI, as high as possible rather than stabilizing the financial market and keeping the growth of US real economy (GDP growth). Is this the right direction to go? At least the ex- Chairman of FED, Alan Greenspan and Chairman of FED, Bernanrd both think it is. They are doing whatever they could to prolong the rise of paper money.

Ex-Chairman of FED, Alan Greenspan, has learnt how to play with the monetary policy to prolong the DJI since 1987. One of our human natures is  ¡§one mistake every three steps¡¨, Alan Greenspan is also human, thus, he made a mistake in 2001 that he kept on increasing the interest rate. Some people from Wall Street already warned him but he didn¡¦t listen. However, as expected, he started decreasing the interest rate while the market started falling but the market is always one step before him.

Alan also had effects on the US fiscal policy. He always suggested and did decrease the tax rate of corporations which will certainly let DJI stay at a higher level. Another effect of decreasing tax rate of corporations is that someone else has to pay more to cover what is paid less by the corporations. Guess who paid more then? The poor US residence! This is really not good to the whole US, the only advantage of this policy is to keep DJI staying at a higher level but the real competence of US is worsened. This is a very important reason of the increasing of US debt.

Chairman of FED, Bernand tends to follow Alan Greenspan and is afraid of deflation and he thinks that a proper amount of inflation rate is good to the economy.  This implies that he is not afraid of printing more & more money with the control of interest rate.  He might think that the control of interest rate can give him enough power to balance the amount of money he prints out. 

Thus, it is obvious that USD will depreciate and it has been depreciating since 2002. US government seems doing this on purpose and they planned for it. Take a look at US¡¦s gold reserve, you can tell. US is holding gold of over 70% of their reserve. Other countries seem not having such vision just yet, or we should say they can¡¦t because of structural problems.

Our world is currently lacking of a healthy enough main currency for 20 years, USD is over its value for a long time, that¡¦s why EURO is welcomed by many countries but EURO is not a too much healthier currency than USD.

EURO will not exist no more after a period of time although we don¡¦t know when. In fact, since 1970, Europe United(EU) has tried a few times to build a single currency but all failed. Until 1992, EU has finally succeed to build EURO. 12 of the 15 members of EU signed the Treaty of Maastricht. The problem here is that the financial and economic status of these 15 members are all different. Some of the countries are debtors and some of creditors, some of their currencies are weak and some of their currencies are strong. If we try to unite all these, tight them altogether with a single currency, it is impossible. The Treaty needs the members of EU to maintain the budget must be lower than a certain percentage of their GDP, otherwise, they need to pay. Thus, some countries are working on their financial statements with some creative accounting methods. These countries include France, Germany, and Italy!

For EURO, the only way to survive is to have every country using EURO to manage their finance and economy correctly. But it is impossible to have all 12 members to do it altogether at once.

If we look back the history of how US is united and built, we can provide a better way for building EURO. US was being united step by step conservatively, not altogether at once although this will take 10, 20 or even more years to accomplish.

In difficult times, there are only two ways for a country. A country can either borrow money from another country or print more money. According to the Treaty, EU members cannot print out money unless permitted. Therefore, most of the EU members are having more and more debts. Then, I wonder how EURO could exist any longer when there¡¦s no more creditors for them? This may not happen in a few years or so but it¡¦ll finally happen just like USD.

Actually USD has already been to the depreciation stage after the huge debt stage. In this stage, stock market will go up, economy will go up, everyone will have more money, and everything will do well TEMPORARILY. We only need to pay for it afterwards, by then we may all die, who knows? But the next generation will need to pay for it even if we don¡¦t.

We now have a choice of short term prosperity and long term depression or short term depression and long term prosperity. FED has chosen the former one. Which one do you prefer?

However, the consequence is that we¡¦re lacking of a healthy and strong enough main currency, USD can¡¦t, JYP can¡¦t, EURO can¡¦t, YUEN can¡¦t be it just yet.  The only choice left for the next decade maybe gold if China is not doing well enough

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Roy   20th May, 2006