Danger behind rescue

Sep 25 2008 by Peter Jackson, The Journal

SO everything is going to be all right now. At least that was the reaction of the markets last week after the US government announced its US$700bn rescue package for Wall Street, offering to buy the toxic mortgage-related debt.

Since then, there has been something of a reality check with the realisation that George Bush cannot just go running to the money fairy for the necessary cash. No, this must either be borrowed or raised through taxes, and, as the US taxpayer is not about to stump to bail out reckless bankers in the teeth of a recession, it will have to be borrowing.

Problem is, that has become something of a habit. When the Bush administration was sworn in in 2001, the US had a US$127.3bn surplus, but a combination of tax cuts, economic slowdown, anti-terrorism measures and a couple of wars have turned that into a US$459bn deficit which accounts for 3.8% of US GDP.

So the rescue package is going to make that situation a whole lot worse, which is bound to mean the dollar heading south, as it has been doing this week.

In fact, this is only going to accelerate a long term trend. The US balance of payments is also in the red and getting worse with high oil prices only worsening the problem.

The unknown is what banks, including central banks in China and he rest of the Far East will do. They hold massive reserves of US dollars and might, on the one hand, choose to offload what they will see as a potentially weak currency, prompting a run on that same currency. The Americans can truthfully say to the Chinese, “if we go, we’re taking you with us.”

Of course if you want to look on the bright side in all this you might consider a cheap holiday in the States next summer. Except with our own Government resolved to borrow its way out of trouble too, the pound might follow the dollar on its downward trajectory.