Saturday, May 30, 2009

Is the US dollar Toast?

Not at all. The critics argue that the projected fiscal deficits will inflict severe long term damage to the US dollar and overall credit worthiness of the U.S. sovereign credit rating. With next year's projected fiscal deficit at a stunning 12 percent of GDP, the market is already forming an opinion. Some critics have also stated that outright hyperinflation is inevitable to America.

One only has to look at the US bond market, it is collapsing. Yields on long term US Treasury notes are quickly moving higher. Recent quote for US 10 year note at 3.75 percent is dramatically higher than the low in December 2008 at 2.1 percent. The market will put pressure on the US authorities to issue less notes, basic supply & demand. More expensive the rate, the less paper.

Further, what may happen to the US fiscal economy going forward? Simple, the Congress has the power to authorize spending. Today when compared to other industrialized nations, America remains a relatively low tax nation. The U.S. government has room to raise taxes. There are now for the first time in a long time rumblings in various mainstream US media publications about the possible implementation of a VAT consumption tax.

Canada, most of Europe already has a consumption tax. We argued on our USD currency review that America will ultimately have to bite it and implement a VAT which will likely bring in excess of $500 billion USD in revenue annually. A consumption tax will hit the underground economy, tax evaders, etc. Everytime one buys a toothbrush for example, bang, you get hit a few cents in a VAT consumption tax.

The politicians are playing a game of chicken, they know very well the market will not allow unrestrained huge deficits to continue, the cost of money will skyrocket, so will inflation. The market in time will force economic discipline and pain. The least painful way is to implment a VAT. Unfortunately, the politicians in power of the day know it is political suicide. They will keep delaying until the market forces it down their throat, play the game to the economic edge of the ledge of financial havoc. A VAT is the right thing to do, the question is who has the political charisma and leadership to sell it? Unfortuately, taxing the rich will not solve the fiscal shortfall, only a massive broad based VAT which will be needed to pay for the President's spending objectives.

So in our view, America will likely see a VAT and perhaps an amero currency in the next decade. Meanwhile, the USD will old its own. Expect to see higher interest rates, a lower standard of living, and a US dollar currency that will continue in a consistent bull/bear 7 year cycle. The USD is now entering its 2nd year in a bull cycle, expect a rebound shortly after the latest market sell-off over the last couple of weeks.

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