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Wednesday, August 10, 2011

Long Term Impacts of US Credit Rating Downgrade

In the wake of US credit rating downgrade by S&P to AA+ from AAA, global capital markets tumbled in the panic. Investors’ interest in US treasury products and US dollar is waning.
Why not?
Then, USA President Richard Nixon (serving year 1969-1974), in the year 1971,cancelled the direct convertibility of US dollars into gold; and the move is one of the events which are reckoned as Nixon shock.
Lifting up of this convertibility made US government to print as much money as it can.
This move made US dollar a fiat currency, that means intrinsic value of the currency is almost 0, and whatever value a currency conveys is due to the law or government regulation.
This appears innocuous but its ramifications were lethal.
AS a result of the aforesaid move, money supply in USA increased multiple times- almost 13 times by the year 2005.
 US GDP was just $ 1.11 trillion in the year 1971 and by the year 2009 it was $ 14.12 trillion.
Increase in the money supply was supposed to cause extremely high inflation in the USA but this did not happen, and the reason responsible was dollar being the world’s reserve currency.
Majority of foreign trades are settled in the reserve currency, so there was no option left for foreign governments and global investors but to buy dollar.
Countries like China and Japan park their funds in US treasury products to make their local currency competitive as competitive local currency is favorable for exports.
US economy is in passing through its worst time, debt is as high as the national GDP, widening fiscal deficit and continuous bouts of quantitative easing to boost up the slowing economy.
US govt. spending is 25% of the national GDP while receipts are meager 15% of the GDP, and the difference is being meted out by printing money.
Now voices are being raised by many countries to dethrone the US dollar as reserve currency.
If such move takes place then foreign nations and investors shall start dumping the dollar and investing in safer havens like gold and Swiss Franc, as a result US dollar might get depreciated by even whopping 70%.
It is difficult to predict exactly when this might happen, but it shall be a wise decision for investors to stay bullish on the Gold in their investment portfolio.

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