Carlo's Think Pieces

Reflections of a Filipino in the Netherlands

Posts Tagged ‘Middle East’

Is US Dollar About to Fall?

Posted by butalidnl on 19 May 2011

The US Congress will have to raise the Debt Ceiling from the present $14.3 trillion by August 2, or else the country would face technical default. But the Republicans are demanding budget cuts be done first; and Democrats are demanding that measures should include increased taxes for corporations and the rich. Both sides are standing their ground, and there is a real danger that the country will indeed default by August 2.

Most probably, a deal will be made at the last minute, and the US can go on merrily increasing its national debt for a few more years. But the question remains: can the US dollar’s credibility withstand such a strain? Will the US dollar fall while Congress debates over raising the Debt Ceiling?

I think that sooner or later, within the next 5 years or so, the US dollar is going to “fall”.  The national debt limit is only part of the problem; the main problem is that the US has a triple deficit – of the budget, trade balance, and payments. And that it has accumulated a huge amount of “unbacked liabilities” in the world – to the staggering amount of $75 trillion.

All proposals on the table will help to reduce the budget deficit, but it will even not be enough to get a balanced budget.  Since there will continue to be a deficit in the coming years, the national debt will continue to grow. And then, there is the trade deficit which also grows from year to year. Thus, all plans now being considered will not improve the US’ capacity to repay its debt.

The world is getting impatient with the dollar, and it seems that US politicians are taking their time at solving it, not realizing that the problem is really urgent.

Signs of Trouble
The problems in the Middle East are all in the news. But the biggest problem with it lies not in Libya or even Yemen – but in the fact that the US dollar has not strengthened in the face of all these problems. Almost always before, when there is political turmoil somewhere, the US dollar gains in value, as money exits that country and goes to the safety of the US dollar. Now, the whole Middle East is ablaze, and the dollar, instead of strengthening, has weakened considerably.

Another sign of impending trouble is that the US, even with “QE2” (the program of the Fed for creating $ 600 B by buying government treasuries) and the extremely low Fed interest rate, faces rising commercial interest rates. QE2 was instituted in the first place to REDUCE interest rates. What will happen after June, when the QE2 program is over? Will interest rates rise substantially, resulting in a rise in unemployment? Will there be a double dip recession? If the Fed makes a “QE3” program instead, will this be enough to hold interest rates down? or will foreign fund managers dump US treasuries instead?

A third sign of trouble is the news that PIMCO, the world’s biggest holder of bonds, has entirely stepped out of US Treasuries. Even worse, PIMCO has resorted to selling US Treasuries short – which means that it even has negative ownership of Treasuries. This shows that US Treasuries are no longer attractive to the wiser international investors. I doubt that many hedge funds keep Treasuries in their portfolios either.

A fourth sign is that when Osama bin Laden was killed, he had with him 500 Euros. He had Euros, not US Dollars, which means that he considered Euros more useful in case he had to escape capture in Pakistan – Euros seem to be more useful in bribes etc. in Pakistan. This shows that even in the underworld, the US dollar is not considered a good currency anymore.

Roots of Crisis
The present crisis has its roots way back in the Bretton Woods agreement, made after the Second World War, to have the US dollar as the world’s reserve currency. Until 1971 the dollar’s value was pegged to the US supply of gold, keeping the US currency in “control”. In 1971 President Nixon let loose the gold peg, making the dollar itself as the only thing in reserve.

The US dollar as reserve currency meant that countries were willing to run a trade and exchange imbalance with the US, since this would mean that they would accumulate US dollars in their reserves. This meant that the US tended to have a structural trade and payments deficit with the rest of the world. This  effectively overvalued the dollar, making its imports cheaper than they otherwise should be. And this contributed to the very high standard of living in the US.

Over the decades, the US steadily accumulated a big debt burden. It is now at $14 trillion, or more than 90% of the US’ annual GDP. Among developed countries, it is only Greece and Japan which have higher debt/GDP ratios. Greece has had its debt crisis, and is now forced to undergo a strict program to get rid of its deficit. As for Japan, most of its debt is to Japanese citizens – and thus the impact of the debt is less than if it was held by foreigners.

The US debt is only part of the “US dollar overhang” in the world economic system; because the bigger part (approximately $60 trillion)  is simply the dollar reserves that countries have accumulated, due to the US trade deficit.  The national debt, in the form of US Treasury Bills, is the smaller part of the problem; but it is the more worrisome part of it, since the US has to pay interest on this.

Stumbling into Dollar Fall
The danger is always present that a country would decide to dump their US treasuries, leading to a chain reaction that sees other countries dumping treasuries, a spectacular rise in interest rates, and the dumping of US dollars from national reserves, and the fall of the dollar. This has not happened so far, since no country will do that consciously and devalue their own reserves. But we cannot depend on this not happening in the future. In fact, I think that the chance of this happening is getting bigger with time.

As more and more dollars are sent abroad, in the form of  US Treasury bills or simply “cash”, the danger that they will no longer be accepted by other countries increases. Already, many countries are calling for an overhaul of the international currency system. Countries have to continuously weigh the advantages of holding dollars against the cost due to the continued watering down of the dollar’s value.

Even if no country would willingly cause the dollar to fall by dumping it, a series of smaller events could push things so that even  minor players could accidentally cause such a fall.  The recent intervention against the Japanese Yen had the inadvertent effect of increasing Central Banks’ reserves of dollars. Central Banks all over the world had to subsequently find ways of restoring their dollar reserves to normal levels. The BRICS agreement to use their own currencies when trading with each other means that less dollars need to be kept as reserves. Eurozone countries intervention to support weaker Euro countries’ finances is another measure that strengthens the euro against a potential fall of the dollar. All these make the dollar weaker. A disruption of the scale of the 2007 sub-prime crisis happening now would surely topple the dollar.

Perhaps it won’t even be a single country or investor which would precipitate the dollar’s fall. It could be simply an accumulation of small steps that would push it over the edge. The US high unemployment rate has “forced” the Fed to keep the Fed Funds rate low, but this at the same time increases consumption and imports, and to further trade deficits.

The US dollar is undergoing something like a game of international “musical chairs”. US-based investors buy securities in other countries, effectively moving dollars abroad; Central Banks sell dollars to prevent their currencies from appreciating; the continuing US budget deficit means that the government has to issue more Treasuries;  foreigners buying US equities or Treasuries effectively returns dollars to the US;  too much incoming dollars could cause inflation, and increase unemployment. The cycle continues, and dollars are passed back and forth from the US and abroad.  A growing number of Central Banks are wary of keeping too much dollars, and this cycle would eventually break down at some point.

Tipping Points
There are a number of occasions or events which could push the dollar over the edge. The Debt Ceiling of the US has been reached, and by August 2 the US Congress has to agree to raise the limit. Not to do so will surely bring about a loss of trust in the dollar, and its subsequent fall.

And then will come the budget discussions later in the year. This is another occasion when confidence in the dollar may be critically damaged.  This will be followed by the Presidential election campaign and possibly a new administration.

At any time, Congress may pass a law imposing a tax on Chinese imports. This will cause Chinese countermeasures, including a stop to buying US Treasuries. And this will be enough to precipitate a chain reaction that will cause the fall of the US dollar.

The US dollar will fall within the next 5 years. While it will cause a deep crisis, it won’t be that bad, in the long run. I wrote a blog post about how it will be Two Years After the Dollar Fall

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Implications of Mideast Unrest for the Philippines

Posted by butalidnl on 18 February 2011

The crisis in the Middle East seems to have gained momentum. It has so far resulted in the overthrowing of the dictatorships in Tunisia and Egypt. Now, it is spilling over to other countries: Iran, Bahrein, Yemen, Libya and Algeria.  This seems to be a new trend in the Middle East – young people willing to risk their lives in the struggle for democracy, and succeeding beyond what people could imagine even a couple of months ago. I think this trend will continue for some time. In fact, I think this is THE new trend in the Middle East – to replace that “old” trend of Islamic Fundamentalism.

What does this all mean for the Philippines?

Overseas Filipinos. The unrest in Egypt has meant that some scores of Filipinos working there have had to go home. Some Filipinos in Bahrain and some other countries may also be forced to do so in the coming days or weeks. But the impact of the unrest will be bigger than that, especially if the young people are victorious in their struggle. Because one of the main issues behind the struggles is that people want more jobs created.  And this means that governments, even those who manage to survive the protests, will have to pursue programs to employ more locals.

A local-hire policy for Egypt will probably not displace Overseas Filipinos (OFs) there, but it may in countries which have a bigger migrant work force. The Gulf states e.g. Bahrain, have a lot of OFs.  If the governments in the Gulf countries institute local-hire policies, intensify the job-trainings for locals, etc., this could mean that less migrant workers would be hired. And that will include Filipinos.

There is, however, a “but” to all this. If the governments of countries like Egypt, Lebanon and Jordan manage to stimulate the economy and increase employment opportunities, their people will not have to go to the Gulf countries as migrant workers.  Jobs would then be available to others, including Filipinos.

So, it all depends…

Higher Wheat Prices. Another issue that governments in the region are sure to address is that of wheat prices. Wheat is very important for people there, and they have seen a very significant rise in prices recently. What many governments are already doing (even those without significant protests) is to increase wheat price subsidies.  They don’t want to be overthrown, so a “little bit” of subsidy for wheat imports is a small price to pay for stability.  Or, for countries with successful revolutions, this is one of the things that the people will demand, and get.

If countries in the Middle East would all increase their subsidies on wheat, the result will be an increased overall demand for wheat, which can only mean that the world price for wheat would go even higher. And this will be felt in the Philippines. Already, the Philippine government has turned back tax increases on wheat imports. But the price will continue going higher for some time to come – and may remain at that high level.

Thus, expect even more increases in the price of pan de sal ,Tasty and other wheat products…

Muslims in the Philippines. I believe that another result of the unrest in the Middle East will be the decline of Islamic Fundamentalism. The Egyptian revolution is a turning point, a trend break, in the Arab world.  Egypt has always played a leading role in such trends. Arab nationalism started with Egypt’s Nasser; Islamic fundamentalism also started in Egypt. Thus, I believe the new “facebook” inspired revolution is another Egyptian trend that will be adopted by the Arab world.

Islamic Fundamentalism is the ideology that has been attracting the youth of these countries. Now, the youth have a new call – one of democracy and progress –  which they can aspire for. If Egypt becomes economically successful as a result of their revolution, I think that Islamic Fundamentalism will indeed become a thing of the past, in a few years.

The strength of Islamic Fundamentalism comes from its appeal to the youth, and in the funds that it is able to raise. If the youth are attracted to something else, there would be less recruits to Al Qaida and other Islamist movements. If people have something else to donate to (i.e. the pro-democracy movements), they will not give as much money to Al Qaida. This is why I think that Al Qaida will soon be a thing of the past – if it is starved of youth recruits and money, it won’t last long.

What about Abu Sayyaf?  Abu Sayyaf these days gets money from Al Qaida and other such Islamist organizations. And they do this by staging terrorist attacks etc, making videos of them, and sending these to Al Qaida et al. They get paid by Al Qaida, in effect, for undertaking terrorist attacks. If Al Qaida runs short of funds, this will also mean decreased Abu Sayyaf activity.

It may also be that Filipino Muslims would have their own “facebook” revolt against their trapos. Political dynasties such as the Ampatuans etc rule their areas as if they were absolute rulers. If the Muslim youth get inspired by Egypt, it may mean the beginning of the end for these mini-dictators who have been exploiting them for so long.

Who knows, maybe the Egyptian revolution will inspire the full blooming of democracy and the economy of our Muslim areas.

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