World as I Think

A country interacts with its outside world by offering its products,services and capital and in turn enjoys them as well.Now if a country gets more products/services than what it can offer it ends in a trade deficit.We need to understand that products/services and capital are mostly counter flows.There is a outflow of capital when we get products/serices and vice-versa.The Balance of Payments(BOP) which is (capital account + trade account) is always zero, i.e the trade deficit is always funded by the capital Inflow (surplus) and vice-versa.

A country's government also interacts with its stakeholders like Households and Coporates.It has its own revenues(the taxing stuff) and the expenses (for the sweat of our government employees).If there is more expense than the revenue we end up in what is called the revenue deficit.Doesn't our goverment also do a hell a amount of capital expenditure towards infrastructure and the social sector now a days?.Yea, If we combine these two, we end up in something called fiscal deficit.Managing the fiscal part is what our finance is what our finance Minister does in the budget.

Now that we have so of much deficit, how do we fund it ?.There are two means of doing it, either do it through internal funding by allowing the RBI(the central bank) to print money or through external funding by borrowing from the global community,IMF and various organisations.Can we print money just like that?.There is a formality involved in it, the goverment issues soverign bonds promising to repay(Haaa haaaa) it back to the central bank.

The obvious question why don't we print money and make everybody rich in the country.There is the hitch, if artifical money is floated in the country, there would be more money chasing fewer goods/services and end up in artifical increase of prices (Law of demand, Is'nt it ?).What do we now do to prevent the prices going north and protect the poor.It's quite simple, hike the interest rate (the cost of money used to get goods/services).If the cost increases the, capital spending reduces and prices are now kept at an affordable level by reducing the demand.This is called monetary policy, this is what the central bank governor does !!!

Now if you got this in your mind, you are all set to understand why dollar would move south soon or later.

The United States has swung from being the world's largest creditor to the largest debtor nation(i.e its funding its operations by borrwing). At the end of 2004, it had net external liabilities of $2.5 trillion, or 22 percent of its GDP (around $10.2 trillion). The current account (goods and services, transfers, and capital income) is massively in deficit about $670 billion in 2004, or about 6 percent of GDP. If corrective measures (US fiscal adjustment and a further decline of the dollar) are not taken, the current account deficit will reach about 7½ to 8 percent of GDP by 2010, and net international liabilities will reach about 50 percent of GDP.

Now what should the US do to reduce its debt? Failing which it would become bankrupt,as it would be unable to pay it liabilties to the foreign countries.Just a clarification as to how US goverment is liable, most of the countries with trade surplus with the US like China (around $200 billion in 2005, approx 30 % of the total US deficit) invest their money in the US government bonds which need to be repayed one day when they want it back.

Do you want to know the easiest way out ?.Devalue the currency.To be short with an example, If we got to give back the $100 which was borrowed at an exchange rate of 50 Rs/$.Return it back when the it is 10 Rs/$.Now in term of Rupees, the liabilty has decreased from 5000Rs to 1000Rs which is awesome gain isn't it for the US.

Then Why doesn't the US wipe of the deficts by devaluing it now rather when it would be worse some years later?.There are two vital aspects involved in it

No American would accept to this for the simple reason that his standards of living would go down.An American who was earning about Rs 50,000/- in Indian terms ($1000 at an exchange rate of 50 Rs/$) ) would earn only Rs 10,000 ($1000 at an exchange rate of Rs 10/S).His earnings power has decreased he can lead a better by importing chaeap goods from China and India.

Dollar is still the reserve currency(more than two-thirds) of the world, Most of the corporates and country have their wealth in the form of dollar.What do you think would happen if dollar depreciates?.Their wealth is decrease phenomenally as the value of their financial assests would see abnormal loses.who would want this?.That's why they keep dollar at this artifical levels even when US is running record levels of trade and fiscal deficit and there are no signs of it fading away.

Onething is for sure, the rising imbalance will increasingly put the US economy and hence the world economy and especially developing countries at risk of a major crisis, as foreign investors lose confidence and US protectionist pressures mount. The longer the needed adjustment is delayed, the more wrenching it will be, triggering high interest rates, US recession, a greater decline in US households' living standards, and more damage to the global economy

The problem recently has been that both private wealth-holders and foreign governments have begun to fear that the unsustainable value of the dollar spells a decline in the currency that could sharply erode the value of their assets.

The only way out for the US deficit is by taking measures to control the fiscal and trade deficits, gradually devaluing its currency.The global money minters are already looking for other reserve currency options like the Euro.

1 Rs/USD, is it a myth ? Keep Thinking !!!