FYI | Sep 24 2008
By Andrew Nelson
It’s a given, the Bush administration’s has a Plan to bail out the banking and finance sector and it is needed, but it’s also a given that the already ugly US federal budget will end up looking a lot uglier by the end of it all. This isn’t good news for the US dollar, with the last 20 years showing a distinct correlation between the US Federal debt and the performance of the USD.
TD Securities global strategist Stephen Koukoulas thinks that the increase in the US budget deficit over the next two years will be substantial, probably running into several hundreds of billions of dollars.
Add that to the several hundreds of billions of dollars of debt the US government is already sitting on and it’s not a pretty picture.
When you add the almost certain prospect of reduced revenues and additional outlays given what is looking like an extended period of very weak economic growth and the prospects for the US dollar look even worse.
Koukoulas points out that the pool of domestic savings in the US continually falls short of domestic investment, resulting in a chronic current account deficit. So when the government runs at a deficit, the funding must be sourced externally. This makes the USD vulnerable because it acts as a shock absorber for funding requirements, he explains.
True, a cheaper USD helps attract offshore funds, which go to cover the budget shortfall, but Koukoulas notes that this wouldn’t be needed if the government’s fiscal position was sound. He notes that during the years when the Clinton Administration was running fiscal surpluses, the US had no need to attract foreign funds. If anything, he points out, the fiscal surpluses added to domestic savings and all the while the USD kept rising.
But since the Bush Administration returned the federal budget to a deficit that is quickly approaching all time record territory, Koukoulas notes the call on foreign savings has been reignited and the USD has subsequently weakened.
On his numbers, if the FY09 budget deficit reaches US$750 billion (which he thinks is conservative at best given it’s already at $400 billion before the bailout) then by the end of 2010, the USD could be looking at EUR/USD 1.70, USD/JPY 95, USD/CAD 0.97 and GBP/USD 2.00.
Blow the budget out to US$ 1 trillion (again, easily within the realm of possibility) and the numbers go to EUR/USD 1.95, USD/JPY 85, USD/CAD 0.89 and GBP/USD 2.20.
Koukoulas doubts whether the USD will actually fall that far, especially given the rest of the world is looking at pretty tough times as well and there are some elements of USD that are becoming more attractive given current market turmoil. But taking a good look around at all of the impossible things happening in the market today, anything, he admits, is possible.
