The US government uses a cash based system of accounting for its revenue and expenditures, which reported a 2005 budget deficit of $ 318 billion ("What's the real federal deficit?" USA Today)
Then there is another set of books: an audited statement based on accrual accounting, which is the required standard for all listed companies globally. Prepared by the accountants at the US Treasury Department, it matches revenues and expenditures and yields a 2005 budget deficit of $ 760 billion.
But even this understates the reality. It ignores big government spending programs like Medicare and Social Security. If those are taken into account (which is something proposed by an accounting board that oversees government accounting rules), then the deficit in 2005 would have been $ 3.5 trillion.
What does this mean? The US Government is following accounting rules that would be illegal for major corporations, and which understate current deficits. This is merely deferring the problem to later years, when the deficits will grow massively if things stay the same.
A study in 2003 by the Treasury Deputy Secretary estimated a minimum net present value (NPV) of total US federal liabilities at about $ 44 trillion (that's about $ 157,000 for each man, woman and child in the US) and represents 350% of US GDP. Report
What are the consequences of this? As Congressman Ron Paul (Republican, Texas) sees it, the US is essentially bankrupt. And it has to resort to printing money and issuing more and more debt to stay solvent. This will inevitably cause the US dollar to fall in coming years. Foreigners holding US assets will see a decline in the value of these assets due to US $ devaluation.
Dr. Eckart Woertz is the Program Manager Economics at the Gulf Research Center, based in Dubai. He questions why the Arab countries continue to support the US dollar through the currency peg that GCC currencies have with the US dollar.
He notes that Japan and China have largely stopped purchases of US Treasuries. He says that Arab countries are aggressively buying US debt, directly and through banks in the UK.
He believes that the US deficits are merely funding consumption and not investment. And as these deficits grow, the situation will eventually become indefensible for the "US dollar Ponzi scheme".
Eventually the US will either default on its loan obligations or "or, more likely, the dollar will be devalued by inflationary policies to such an extent that it will not hurt to 'pay' it back."
And it does not make sense from a trade perspective, as only 10% of GCC imports come from the US, while Europe and Asia account for one-third each. And even when the proposed unified GCC currency comes into being in 2010, it is still expected to be pegged to the US dollar.
He recognises that there are limited assets in alternate currencies relative to the US $ and global liquidity flows. The systematically entrenched position of the US dollar as the global reserve currency, its structured debt obligations and its use in pricing global commodities such as oil and gold make it the default currency of use. And political considerations may outweigh economic ones for GCC governments.
Since the health of the global economy depends on stability, no-one wants a precipitous decline in the US $. Nevertheless, he believes that the demise of the US $ is inevitable and that GCC countries must diversify into other currencies and gold. View his essay.
Since his essay, the Governor of the UAE Central Bank has announced that the UAE will allocate up to 10% of its reserves into gold. Russia has already announced an increase in its gold allocation from 5% to 10%, and Chinese and Japanese government have also suggested increased gold holding among foreign currency reserves. Central banks in Argentina, South Africa, South Korea and others have also stated the same.
Such buying by major Central Banks will take up a major percentage of global mining production and will have a meaningful impact on the price of gold in coming years. Individual investors should also seek diversification away from the US dollar and gold is the natural beneficiary of a decline in the US $.
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