The Future of the Dollar and China - Radiant Asset White Paper

The Future of the Dollar and China:The Threat of Collapse and the MoveTowards a New Reserve Currency

Initially published October 27, 2009Revised April 22, 2010

Prepared by:David Justin RossChief Investment OfficerRadiant Asset Management, LLC

Radiant Asset Management, LLC P. 2

Introduction

In their important book,

This Time is Different,

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Carmen Reinhart and Kenneth Rogoff stress the roledebt plays in causing financial crises:[L]arge-scale debt build-ups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced. Debt-

fueled booms all too often provide false affirmation of a government’s policies, a financialinstitution’s ability to make outsized profits, or a country’s standard of living. Most of these

booms end badly.

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Debt has played an important role in the boom-bust cycles of the past decade. Both the stock marketboom of the late 1990s and subsequent crash and the recent housing boom and bust were fueled in partby a too-loose credit policy by the Federal Reserve that was only half-joking

ly called “the Greenspanput”.

After the stock market crash in 2000, interest rates were kept very low in part because the FederalReserve feared a deflationary cycle. Instead, the low rates fed inflation in housing prices and excessiveaccumulation of household debt. When the housing bubble burst and the worst recession in ageneration hit beginning in 2007, the Federal Government began a spending spree (and debtaccumulation) in an attempt to restore confidence. Today, that debt is fueling a slow crisis in the U.S.dollar. Each time, the seeds of the next crisis were planted by the efforts to ameliorate the previousone. And each time debt and credit played an important role.Today, public attention is increasingly focused on the burgeoning national debt. Some thinkunprecedented deficit spending on top of nearly one trillion dollars in stimulus money is essential toavoid a deflationary spiral and to lift the country out of the financial crisis. Others, growing in number,believe that the spending will lead to runaway inflation, a collapsing dollar, and a world-wide balance of payments crisis.Few commentators put the current situation in historical context or seek comparable periods for hints of what is likely to occur. Fewer still look at the investment strategies appropriate for the current era. Thispaper seeks to moderate the tenor of the current debate by putting the current spending in properhistorical context. Facts may be less interesting than opinion, but they are more useful for makinginvestments. To make good investment decisions in times of uncertainty, an understanding of what ishappening and why is required. Only in the context of information and facts can thoughtful decisions bemade.This paper looks at the current deficit in historical terms, how it affects the United States

’

globalrelationships, where there is hope and justifiable fear and, most importantly, the likely outcomes andhow to profitably invest accordingly.We look at the U.S.

government’s

true obligations, who holds U.S. government debt, and why they holdit. We discuss whether the debt holders are likely to continue to purchase the debt instruments and

1

This Time is Different: Eight Centuries of Financial Folly,

Reinhart, Carmen M. and Rogoff, Kenneth S., PrincetonUniversity Press, 2009

2

Ibid p xxv.

Radiant Asset Management, LLC P. 3what happens if they stop. We shall see that, second only to the U.S. government, China will determinethe future of the dollar, and through it, of the American Economy.

The Deficit and the Debt

“Debts are like children: begot with pleasure and brought forth with pain.” –

Jean-Baptiste Poquelin(Moliere)

Let’s start by looking at the

Federal budget during the past 70 years, with data from the CongressionalBudget Office.

Chart 1: The Federal Budget, Current Year Dollars

Chart 1 shows the budget in current-year dollars. It should be noted that two estimates of out-yearbudgets are presented: the 2009 estimate and the 2010. This graph shows exponential growth, butbecause it does not adjust for inflation, it has limited utility. Chart 2 adjusts for inflation.

Source: CBO,http://www.cbo.gov/ftpdocs/108xx/doc10871/historicaltables.pdf Data as of Jan 2010 and is estimated for 2009 and 2010 as indicated.