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The wave of the terminal crisis of US Treasuries, Dollars and Pounds, and the return of inflation

June 2009 (GEAB N°36)

The first BRIC Summit in Yekaterineburg on what to do with US Dollars and Treasuries reserves[1], China’s shrinking US T-Bond reserves[2], Shanghai Cooperation Organization’s[3] call for the creation of a new international reserve currency[4], the Fed’s incapacity to prevent US-Bond prices from falling[5] and resulting interest rates from rising, the growing concern surrounding all Treasury sales worldwide (issued by risky countries in particular, such as the United States and United Kingdom), the increasingly volatile variations in currency rates in a context of the steady loss in value of the US dollar, the European fear that the Euro jumps to levels incompatible with their exports, the general crisis in the UK affecting politics, finance, economy, currency,… these trends are many black clouds on the horizon of summer 2009. Moreover, according to LEAP/E2020, they represent the third wave (third component of those « three sisters » so dangerous for ships) entailing, at the end of this summer, two major events: the US debt default and the UK’s call for help to the IMF; and, at the end of the year, the beginning of the phase of global geopolitical dislocation.

 

GEAB 39 - 1

Government debt issues annually by the US, Eurozone and UK (2005-2010 projections) – In 2009, the UK will issue four times as much debt as in 2005 – 2009/2010 projections are based on official figures tending to underestimate the scope and duration of the crisis, as well as the decline in tax revenues (note by LEAP/E2020) – Source: CitiGroup, 06/2005

 

Indeed, this first BRIC Summit (which it is not difficult to imagine how difficult it was to organize), is the first sign of dislocation of the current international system. The US probably did everything it could to prevent it from taking place; moreover they were refused the status of observers inside it, indicating clearly that what was to be discussed had nothing to do with diplomacy. The main topic was not a military and strategic issue, but a monetary and financial one: what to do with the hundreds of billions of US dollars (in the form of US Treasuries in particular) accumulated by these four countries in the past few years?

Chinese and Russians have already noticed that their dollars are not always welcome in the United States, Europe or Australia when they try to use them for investing in “strategic” assets[6]. With the Brazilians and Indians, they have therefore entered into a large number of swap agreements in their own currencies (a trend that will gain momentum after this summit) and they are trying to buy everything they can with their Dollars as long as some countries are still ready to sell their riches for this currency. But all of them are aware that they have far too many Dollars to be able to spend them usefully now that the US economy is contracting and that the Fed has undertaken to print hundreds of billions of new Dollars. Now suspicion surrounds this currency and all related assets. For this reason, they have decided to buy each other’s treasury bonds, thus reducing their dependence on US T-Bonds[7]. At this stage, the aim is not yet to sell US T-Bonds, but it has dealt a severe blow to future T-Bond sales.

GEAB 39 - 2

Déficits budgétaires en % du PNB (2009) – Source : Casey Research, 06/2009

 

LEAP/E2020 believes that this Yekaterineburg Summit is probably the BRIC’s last attempt at a reconciliation before divorce[8]. If their requests concerning a rapid and profound reorganization of voting rights within the IMF and other international organizations are not accepted and implemented soon by the US, the Japanese and the Europeans, then the next BRIC Summit will be a summit of rupture, setting up independent strategies, or even some opposite to those of the USA/Japan/EU trio.

With US T-Bond issuance now exceeding 100 billion a month (as opposed to 10 billion at most formerly), the pace of rupture is naturally imposing itself. As anticipated by LEAP/E2020 in previous GEABs, it is at the end of summer 2009 that the unbridled borrowing needs of the US and UK (further increased by other countries’ needs[9]) and growing suspicion on the part of potential buyers, will combine and reach their moment of truth: borrowing needs will jump from USD 1,600 billion in 2008 to USD 2,600 billion in 2009[10]. This moment of truth can only take one form: the buyers’ refusal to keep purchasing US T-Bonds and British Gilts. In this sense, the decision by the BRIC nations to buy each others’ treasury bonds is a first sign that a « strike of US T-Bond purchasers » is swelling[11].

In this context, the first scenario is that the Fed and the Bank of England start purchasing massive amounts of bonds issued by their own governments (then their currencies plummet as money creation soars, while Euro, Yuan, Real… prices jump). In fact, the Dollar and related currencies collapse with the Pound Sterling against all the other international currencies. The devaluation many US leaders dream of (to absorb US public deficits and boost exports) thus happens. Moreover they claim to be the victims of those bad Chinese, Russians, etc… thus facilitating the adoption of protectionist measures in an attempt to boost US industry and jobs. Of course, in the course of this process, the purchasing power of US citizens will suddenly be halved, but it is not certain that anyone really cares about that in New York and Washington[12].

GEAB 39 - 3 

Budget deficits/surpluses in April in the US (1981-2009) – April 2009 is the first April budget deficit in 26 years (April is classically the month of the largest surpluses) – Sources: US Treasury Department, Casey Research, 06/2009

 

In the second scenario, Barack Obama, Timothy Geithner and Ben Bernanke must make a public statement on television that the US Dollar has lost 30 to 50 percent of its value against other currencies as a measure to address the fact that the US government can no longer repay US T-Bond holders[13] (remember that US Treasuries holders, like the Chinese, have undertaken to sell their medium- and long-term bonds and replace them with three-month notes). This scenario corresponds to the « new Dollar » option already described by LEAP/E2020 in a number of previous issues of the GEAB.

The BRIC countries have very different characters and interests. But what brings them together is extremely powerful: it is the project to increase their role in the system of global governance which they feel has more chance to happen if they operate together. They have now understood that Western countries, the US in particular, vitally need their money. This understanding can only feed a strategic approach where short term losses correspond to long-term gains.

GEAB 39 - 4

Emerging markets have become the exporters of capital  - Current accounts in % of PNB – Source : FMI, 05/2009

 

In this sense, for the European Union – supposedly more open to a changing world, it is a major failure to have not been able to take into proper account the concerns of these four regional powers in its own strategies. And for the United States, United Kingdom and Japan, it is a major failure to have not been able to prevent the emergence of a new geopolitical pillar –another indicator of their rapidly vanishing influence on the global system[14].

Our team believes that one of the main geopolitical consequences of this evolution is to increase the autonomy of a number of regional players who are regaining a breathing space that had disappeared after the « Cold War ». The instability of the most unstable regions of the world will therefore increase in the coming months, as each month gives further evidence of the fading away of US might. No doubt that this situation will have an upward influence on energy prices.

As a matter of fact, in a context of US and UK debt default and dollar collapse, USD- and GBP-denominated commodity prices will certainly rise, even if, compared to other currencies, they could stagnate or even slump as the recession worsens. This market will therefore be difficult to anticipate precisely, a situation not helping already faltering companies.

In the United States and United Kingdom, as currencies plummet and money printing accelerates[15] compared to a contracting economy, the situation can only result in soaring inflation (or even hyperinflation momentarily)[16]. Fortunately, due to the fact that their exports are non-strategic (contrary to commodities or energy), this inflation will not be exported to any great extent and, on the contrary, it can be largely compensated by the deflationary effect, in other countries, of other currencies’ increased value.

 

Notes

[1] Source: China Daily, 06/16/2009

[2] Source : China Daily, 06/16/2009

[3] A now adult institution. Source: Asia Times, 06/13/2009

[4] Source: RiaNovosty, 06/16/2009

[5] Holders of US Treasuries, long-term ones in particular, have lost between 20 and 30 percent in one year. Source: Seeking Alpha, 06/18/2009

[6] Source: Reuters, 06/19/2009

[7] Source: Bloomberg, 06/16/2009

[8] Chinese requests are more and more pressing concerning a US guarantee on their USD-denominated assets. If they are not given a positive answer (which seems impossible), confrontation is inevitable. Source: China Daily, 06/15/2009

[9] France also, though far less than the US and UK, will contribute to this excess in public borrowings in 2009 and subsequent years. Source: Le Monde, 05/18/2009

[10] Source: Financial Times, 05/18/2009

[11] Source: Bloomberg, 06/15/2009

[12] Significantly, an increasing number of Americans worry about their country’s internal prospects, and books like « Getting out: your guide to leaving America » meet growing success. Source: Amazon.

[13] Today they are touring the world begging people to purchase their Treasuries. Source: Europac, 06/05/2009

[14] Source: Telegraph, 06/02/2009

[15] An interesting analysis on money supply: AgoraVox, 01/27/2009

[16] Investors buy gold as fears of inflation rise. Source: Telegraph, 12/06/2009