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It looks like a currency crisis is looming in the clouds of America with the U.S. current account deficit racked up to US$665 billion or 5.7% of GDP in 2004, which is historically high and its budget deficit for 2005 is estimated to be US$412 billion or 3.6% of GDP. In addition, the U.S. government is in debt by more than US$7 trillion. These and other factors have combined to put powerful downward pressures on the dollars. This reminds us of the Asian financial crisis in 1997, where the Asians have all learned a painful lesson – we were being punished for borrowing too much! In addition to the gloominess, Alan Greenspan, the confidence icon, is retiring in less than a year from now and we do not know who the next successor is.
Indeed, bad news for the dollar, which leads to bad news for interest rates eventually. It’s also bad news for everyone who depends on the American consumers for economic growth. According to the trade data, the U.S. is the largest trading partner for many countries in the world such as Canada, Mexico, China, Japan, Malaysia and etc. Hence, if there is ever a financial crisis, the outcome would be more severe than the Asian financial crisis!
Greenspan, the Federal Reserve Board chairman, 79, has helped steer the U.S. economy through the crash of 1987, the recession of the early 1990’s, the dot-com bubble and the terrorist attacks of September 11 th. He has the magic touch to instill the badly needed "confidence potion" to the Americans as well as to the rest of the World. In essence, all eyes are on Greenspan now to fix the ailing gargantuan U.S. economy. In my view, upon his retirement on 31 January 2006, if the U.S. current account deficit continues to worsen and the Bush administration continues to lavish on their spending on warfare and social security, I’m afraid the U.S. dollar will suffer a stampede cause by currency speculators and private investors who have lost confidence in the dollar.
In order to prevent a speculative attack on dollars, the Bush administration must show to the world that they are determined to cut down on the twin deficits. It’s a tough job indeed. In the past three years, with the interest rate was as low as 1%, the U.S. consumers ruined themselves by spending money they didn’t have on things they didn’t need. Asians, on the other hand, kept buying the U.S. public debt, the low yielding bonds, just to keep their "customers" happy, and to cover the U.S. current account deficit. It’s getting unhealthy for both parties, as one being suffocating with a mountain full of debt, the other running into default risk and currency risk.
The U.S. trade deficit with China has been increasing at an exponential rate. Back in 1988, the U.S. started with a humble trade deficit of US$3 billion with the Sino. By 2004, the U.S.- Sino trade deficit soared to a whopping historical high of US$162 billion, which has doubled from US$83 billion within 3 years since 2001. No wonder, the U.S. financial authorities have exerted tremendous pressure on the Chinese to revalue the Chinese yuan, in hope of slowing the tide of Chinese exports to the U.S.. However, the Chinese has no intention to revalue the yuan as the strengthening of yuan would hurt their exports which is the main driver for their economic growth. Also, the stronger yuan against the greenback would spell heavy losses for their dollar-denominated assets in their foreign reserves.
As much as the Bush administration stressed that they want to cut down on budget deficit, but the fact that he raises the budget for national defense has caused many mainstream economists spooked. The estimated spending on national defense for 2005 has soared by 42% to US$465 billion compared to US$265 billion under the Clinton administration in 1996. Where does the funding come from? From foreign borrowings, of course, as the Americans have poor savings habits, they save about 1% of their paycheck compared to 40% in China. Like what they said, the Americans are borrowing at the kindness of strangers – the Asian central banks.
No doubt that the Japanese and the Chinese central banks have amassed more than US$1 trillion in U.S. treasury bonds in their foreign reserves, which is a quarter of the US$4 trillion U.S. treasury market (with Japan over US$700 billion and China more than US$400 billion). But, Japan and China would not dump the dollars for two reasons. First, if they dump the greenback, their dollar-denominated assets in their foreign reserves will be affected immediately. Last year, Japan lost more than US$100 billion in dollar reserves as compared to holding euros. Second, Asia’s economies still depend heavily on exports to the U.S. for economic growth and employments. If the dollars depreciated too much, the U.S. Federal Reserve will have no choice but to raise interest rates at a faster pace to defend the dollars. And this will slow the U.S. investment and consumption spending rapidly which likely to initiate a sharp recession there and abroad.
Time is running out now, with the U.S. National Debt Clock clocking US$2.2 billion per day, and the Asian central banks are sweating on their assets held in dollars. The Asian central banks may not dump the greenback, but they may stop buying up the U.S. treasury bonds to protect themselves from further currency loss. According to Treasury Department data, foreign official net purchases of U.S. Treasury fell to US$7 billion in December from US$21 billion in November.
The Bush administration must device a credible plan to narrow its ballooning fiscal deficit, cut the unnecessary spending on warfare and social security. Opt for compulsory savings scheme like the Malaysian EPF scheme. Increase interest rate at a slower pace as not to overkill the declining U.S. consumption and investment spending. Provide incentives for export-producing sectors as they are likely to generate revenues necessary to pay back the rest of the world (to close the current account deficit). Discourage speculation on properties as they are more likely to cause artificial wealth which lead to overspending. Lastly, to announce the successor for Mr. Alan Greenspan as early as possible – but, I doubt it would make any difference now.