Some very big questions

With the USD fluttering around 76 on the US Dollar currency basket index, the USDX it's a good time to pontificate on its near term future, and longer term future. Gold's big rally since 2002 begs a lot of major questions.

The US is now flirting with an immediate debt of around $14 trillion (US Treasury bonds etc, and not including future liabilities like Medicare). The US now passes a key level of indebtedness considered to be a first stage of crisis. That puts US current debt at 100 pct of GDP. Just this week, the US needs to sell a record $130 plus billion of debt, for one week. The US is running a fiscal deficit of about $2 trillion a year, and for the total government budget that amounts to 40% of its budget. Imagine trying to run your own personal life that way.

US debt by several key measures

Clearly a turning point is being reached. The Chinese, who have now accumulated an astounding $2.2 trillion of foreign reserves, have been complaining all year that the US must stop the massive overspending. But, ironically, China, Japan, the EU, the Mid East, even Russia and especially the Asian exporters like Korea, Taiwan, etc have also banded together last week calling the fall of the USD a disaster for their exporters. They banded together to support the USD in the last two weeks.
When the USD fell two weeks ago below 77 on the USDX for example, the Far Asian central banks banded together to support the USD and it briefly went back above 77, and now is around 76.5. Message to the currency markets: don't plan on a big USD sell off yet.

However, if you were to then look at total current US debt, to include public debt like mortgages and credit cards, corporate debt, and also especially municipal and state debt (current debt is that which is paid every month with interest) the US debt to GDP grows to roughly 400 pct of US GDP. Interpretation: well if the US 'earns' $14 trillion a year, it has to service debt on the aggregate of $56 trillion a year. Clearly on that measure, the US is just on the verge of a financial default across the public and private sectors. If interest rates start to rise, look out.

In fact, the US Federal government had to issue a tremendous amount of new debt (treasuries etc) in the second quarter of 09, basically bailing out the entire defaulting world banking system. The US used a combination of quantitative easing, and actually buying its own debt for half of its issuance. The Chinese went ballistic immediately and have been warning the Fed not to do that or else. Treasury Secretary Geithner flew to China to explain. The US supposedly backed off buying its own bonds at that point. But the clock is ticking.

USD crisis when?

Now then, the question becomes what is the near term and midterm future of the USD. Will there be a big USD crisis sooner or later? The huge interventions to support the USD this year by the world export nations' central banks muddied the waters quite a bit. They are supporting the USD in the FX markets regardless of this massive new deterioration in US finances. Reason? They cannot tolerate a further collapse of their export economies. They are afraid of riots in China for example over that. China and Japan had a 30% drop in exports YOY in September 09. Supposedly, things have modestly improved.

The point is, that the rich export nations such as China, India, Japan, Germany all have a lot of skin in the USD game, and cannot tolerate a significant drop in the USD exchange rates which makes their exports more expensive. But alternatively, they also cannot tolerate the rapidly and seriously deteriorating US fiscal situation on all fronts.

Delicate balance

One gets the impression of a very delicate balance keeping the USD together for the moment, and the question is when will that balance fall apart?
I know we all have heard about the 'imminent USD demise' for decades, especially from 2002 to around 2007/8 with gold rising by a factor of over 3 times. And, if you have followed the USD story since around 1971, when Nixon took the USD off the gold standard, and the inflation that followed in the 70's, the 'imminent demise of the USD' story has been around for decades.
But this time is different, very much so, with a US fiscal deficit now at 40% of government expenditures.

But the USD has still hung in there. What is different this time? Could the USD merely have a 'controlled burn' and gradually devalue, and not see a catastrophe in the FX markets? Perhaps the USD falling over a period of several years to 40 on the USDX?

Or, is there enough fiscal pressure now for an accident, and a chaotic fall in the USD in the FX markets and an assured world currency crisis that follows? IE if the USD had a chaotic devaluation, the rest of the world's currencies, especially the Yen, would have heart attacks at the same time.
In other words, a chaotic USD collapse probably means a Yen collapse, and other currency collapses as well, and God only knows what kind of chaotic unwinding of carry trades?
And to add more to the mix, with the USD now becoming the new carry trade favorite, ala Japan with the Yen carry trade, how much more room is there for the USD to hold together???
Will that carry trade rally markets again for two more years, perhaps after a correction first in financial markets at this juncture?

Asking the right questions is the key for all researchers, a fact known to all sciences.
A last carry trade rally? A long question

Is the carry trade the way to reignite the old USD centric trade/export system? Even if only for a last gasp? And, then a new last gasp financial market bubble of mammoth proportions because the wealthier and fiscally healthier export countries such as China, Germany, (I have to kind of exclude Japan from the healthy category but Japan too, as I consider the Yen a USD sister currency and Japan always supports the USD) band together to support the USD till they figure something else out, which leads to another financial collapse of even greater proportions, perhaps leading to the final demise of the USD and a total collapse of all financial markets in the world, making the stock crashes of the Great Depression child's play by comparison... and causing such chaos and angst that the world then must adopt a new world currency merely to get food on the table?

Every major nation calling either for a new currency or a new world order

And, in the last year, every major nation has either stated that a new one world currency is desired and or also a one world government. How the hell did that consensus gather so fast? Previously, only about two countries even talked about that publicly; now they all are saying this at the same time? There are HUGE changes afoot. Then this dubious Copenhagen treaty which will create a quasi world government/economy with enforceable laws...

We continue to ponder the probability of a USD crisis with fast onset, or the alternative gradual USD decline which everyone hopes for. Regardless, the demise of the USD will change the entire world.
These are questions we are analyzing right now at PrudentSquirrel in our weekly newsletter. Stop by and take a look at our testimonials, and see for yourself.

Chris Laird is not an investment advisor/professional. This article, and the PrudentSquirrel newsletter and alerts, are general market commentary only. They are not intended as specific advice. You should talk to your own investment professionals for specific advice. Information here is deemed reliable but should be verified by you if you think it's important.