The financial and popular press has lately focused on the now obvious problems for the dollar created from our massive budget and trade deficits. Indeed, everyone now realizes that for the deficits to be brought into balance, the dollar must go down. It seems that virtually every financial pundit, though, still assumes that not only will the Asian and other foreign central banks continue to accumulate dollar assets forever, but that "those foreigners will never spend their dollars". However, very little is written about what will happen when all the dollars, built up as foreign central bank and private holdings, get spent. Indeed, we believe that not only will the dollars get spent, but this spending will have massive inflationary implications for America.
Up to now, foreign central banks - particularly the Asian central banks that currently hold over $1 trillion in dollar assets - have had every reason to accumulate as many dollar credits, in the form of U.S. treasury securities, as possible. Accumulating these dollar assets has cost foreign central banks nothing as long as they have a trade surplus and can print up more of their own currency for free and swap their free money for U.S. treasuries. Rather than spending their dollars today, America's trade partners are saving them so they can be spent tomorrow. Moreover, as long as our dollars are happily accepted by countries that produce oil, raw materials, and goods and services they need, America's trade partners can profit in the future in exchange for paying nothing today, simply by running mercantilist policies!
Another perspective on what is happening is if trade flows were currently matched, foreign countries would not be building up dollar credits; they would be spending dollars "taken in trade today"! This dollar spending would increase the demand for goods and services in America and raise prices, creating inflation. The very fact that foreign countries have not been spending their dollars now but are, instead, storing up massive dollar credits, means there is going to be a whole lot of dollar spending in the future. One can compare this to a huge dam filling up with dollar credits, but look out when this "dollar dam" breaks and the pent up dollar reserves flow out and flood America.
Sooner or later all currencies come home to their native country to be spent, but as long as the dollar is viewed as the international reserve currency, the process of massive credit and dollar inflation showing up is delayed. The fact that the dollar has been the world reserve currency simply means that the dam full of dollars has been allowed to fill up higher than anyone could have ever imagined.
Take China as a shinning example. China has amassed over $500 billion in dollar credits and is a developing country with 1.3 billion hungry, needy and politically restless people. The Chinese government has built up dollar credits temporarily, but as their citizens learn more about the good life - which includes electricity, heat, air conditioning, two cars and meat in their diet - the government may have to share some of its wealth with them. Not only is it possible for the trade deficit to swing into balance if this occurs, but all those dollar credits will get spent while they are still worth something.
What is on China's shopping list? Already announced are purchases of Noranda and Husky in Canada, the large mining and energy groups, as well as other significant investments in synthetic oil (tar sands). A major Chinese supplier of automobile parts has been buying up rustbelt auto part suppliers in the American Midwest. President Hu of China just came back from Latin America and announced plans to invest over $30 billion in Argentina and Brazil in order to build plants that are needed to extract raw materials. We expect that China's shopping list will continue to grow and they will start buying up the world with America's money!
How do our dollars finally get back home to our country? Well, if China does buy Noranda, the Canadians can invade shopping malls south of the border. If China also buys Latin American resources, Latin Americans can then buy the rest of Miami. As dollars get spent and move from country to country like a hot potato, eventually the dollars will come marching home because a dollar will always buy something in America, even if it isn't very much.
The fact that dollar credits will get spent will help pressure the dollar far more than is currently appreciated. There are reports that the average man in China is already willing to stand in a long line at a bank to convert dollars into the Renminbi; they have already dumped over $20 billion of U.S. dollars this year. How many Americans do you know are willing to wait in line to dump their dollars, other than Warren Buffet or George Soros?
The Russian President, Vladimir Putin, recently announced that his country will diversify foreign exchange holdings away from the dollar. Upon hearing that, every Russian or Eastern European gangster, drug-runner or plain old tax-avoiding businessman, should take the hint from Putin and swap old greenbacks for crisp new appreciating Euros, rather than consider holding on to our new pretty pink $20 and $50 dollar bills.
Think for a moment of all that cash in German Marks, French Francs, and Italian Lire that came out from under the mattresses to be converted into Euros. Now, consider that as much as two-thirds of all U.S. currency is still held outside the 50 states. Every foreign citizen who holds dollars should pray that their central bank will buy even more bad dollars at current levels so that they can get out without further loss.
The real problem for dollar investors is that as soon as it is realized that dollars will get spent - meaning significant dollar inflation - it is clear that the dollar can no longer be a stable store of value. So, even before our dollars come marching home anyone holding dollars can see there is a light at the end of the tunnel, but it's a train! He who swaps out of the dollar first, loses the least!
Foreign central banks hold about 75 percent of their total foreign exchange reserves in dollars, yet the financial markets have only vaguely acknowledged the problems associated with the spending of these dollar credits. As an investor, you should expect a further decline in the value of the dollar and the beginning of significant long-term U.S. inflation.