The Dollar Crisis

I've been reading a book called 'The Dollar Crisis', which talks about how a rising US trade deficit is unsustainable and is sooner or later likely to be reduced through currency devaluation and general reduction in consumption and import. This will lead to severe repercussions for all export-oriented economies given that they basically survive on exports to the US (the Asian economies are the leaders in this respect, but India will also be affected) as well as other nations, since the world's reserve currency is the US dollar.

A slowdown in US imports will lead to a global slump and perhaps even a recession, creating worldwide stock and property market crashes, among other things. The good news is that prices of goods and services will most likely reduce, but if you're an investor that might not be much to cheer about! Further, if you are one of the many immigrants working in the US, I need not explain how a falling dollar will affect you. The book talks about currency devaluations of the order of 50% or more!!!

Reading all this has got me thinking about the general direction of the Indian economy, as the book provides multiple examples of 'bubble' economies, all of which showed similar trends in the years leading up to the inevitable crashes. We are all most familiar with the dot-com bust and perhaps the Asian crisis, but similar situations have been happening on a fairly regular basis e.g. Japan's bust in the early '90s, from which it is only now recovering...

The 'Crisis' In a Nutshell

Till early in the 20th century, the world followed what was called the 'gold standard', in which their money was backed by gold and, hence, redeemable as such. In such a system no country could afford to have a sustained net trade deficit as that would cause their gold reserves to deplete till it reached a stage when they no longer had enough gold to sustain their economy. Once this stage was reached, their economy would go into a recession and prices and wages would fall till they were low enough for their exports to become cheap so the rest of the world would start importing from them again, allowing their gold reserves to build up once more.

Today's system has no such checks and balances. The international standard is a set of currencies that float in value against each other, with the US dollar as the de facto reserve currency of the world. In such a situation, and with a strong dollar, there is nothing stopping the US from sustaining a large trade deficit (i.e. importing more than it exports). And since it is to the advantage of exporting nations like India, China and the Asian countries to keep their currency values low, they cannot take the US dollars they get from exports and convert them into their own currencies, as that would increase the value of their on currencies and hurt exports.

Therefore, these countries invest them back in the US and state them in the form of national reserves. Thus, the US gets goods and services and pays for them in dollars, which it then gets back in the form of investments. These investments are pumped into the US banking system, which it then lends out, thereby allowing businesses and consumers to buy more things, most of which are imported! This cycle allows the US to continue with a rising trade deficit. Thus, in effect, the US has been buying goods on credit!

This huge US trade deficit has been financing most of the economic growth in the Asian nations and other export-oriented economies, allowing for increased lending and creating jobs and wealth that are leading to economic booms and rising asset values (stocks, property etc). Therefore, a slowdown in US consumption will hurt these economies badly, leading to a very severe recession.

Since the US deficit is underpinned by the willingness of the rest of the world to continue to hold their reserves in dollar instruments, it is only a matter of time before it has to be curtailed as countries begin to get uneasy about the credit-worthiness of the US (after all, it cannot repay infinitely large sums of money) and either withdraw their funds or at least reduce their annual investments. The other possibility is that the US consumer, already neck-deep in debt thanks to all the low-cost credit they have had access to, is no longer able to service increasing debt repayments and chooses to cut back consumption, thereby reducing the extent of US imports.

Both of these scenarios spell doom for the rest of the world, as the net result will be for the US to have to sharply depreciate the dollar against countries with trade surpluses (China, India and the Asian economies) in order to reduce, and eventually reverse, the trade deficit.

The next post will focus on India

How Much Could You Save?

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Series: Beginning Investing (4th post)
Section: Setting Your Goals
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Now that you know how much you spend sit down with your family and work out where you could reduce your expenses. There are usually some useless expenses that you can cut without feeling the difference.

A good place to look for saves is in utility bills like electricity and telephone. It might also be possible to reduce in areas like credit card late payments and interest expenses (just pay before the due date, take an instalment loan scheme on the card or transfer your balances to another) and some entertainment expenses (no, I'm not asking you to sacrifice it all - maybe you could just reduce it by, say 10%?)

Once you have 'cut out the fat', you are now in a position to determine how much you could save every month - your monthly income less your monthly spend. This should, at the very least, be a positive figure otherwise you are definitely living beyond your means. Ideally it should be around perhaps 20% of your income or better. I think that's the average savings rate in India.

Your monthly savings are pretty much all you have to count on when you set your financial goals so the larger the figure you can mange, the better!

Next Post on Beginning Investing: What Are Your Goals?

How Much Do You Spend?

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Series: Beginning Investing (3rd post)
Section: Set Your Goals
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Ok, so now have taken the first step on your journey to wealth and financial freedom and you know what you're really worth. And you're ready to start working out your goals and figuring out your financial plan, right?

Wrong.

Before you move on to all the cool 'banker' stuff, it is important to figure out how much you spend. Without this information, all your goals and planning will just remain utopian dreams, your financial plan will not deliver the results you want and you'll eventually be discouraged into giving up the whole thing.

Keep an Expense Diary

The best way to work out your expenses is to maintain a log of your spending every day for at least two to three months, ideally a lot longer. If you're married, have a family or are living with a partner, do this at a household level i.e. maintain a diary of all personal as well as common expenses for the entire family.

Basically, at the end of every day write down your expenses in a little notebook. At the very least, the notebook should have columns for date, expense description and amount (ideally also add columns for expense category and person responsible for the expense) and you should add up the amounts spent every week. It takes 5 mins every day and is well worth the effort.

[When creating categories, make sure you have enough to cover the entire spectrum of expenses in a manner that will allow for meaningful analysis i.e. not too many or too few. I would suggest you set up 7-10 categories as a good number]

Remember to add in credit and debit card expenses as well as spends made through other non-cash means such as food coupons (like Sodexo, Ticket etc.)

For non-monthly outgo such as insurance premia or one-time purchases (like appliances etc) either maintain your diary for a long period and record these as you incur them or make a conservative (implies you should take a pessimistic / worst case) estimate of your annual spends, divide by 12 to reduce it to a monthly value and add it into your expense diary as a 'virtual' expense in an appropriate category.

Analyze Your Expenses

If you're somewhat comfortable with spreadsheets, create one or download the one shown here from the Journey to Wealth group to help you create cool graphs and charts that show you just how your expenses break up by category, when the peak spending times are every month, what your average monthly spend is and how your expenses change over time.




Believe me, if you haven't done this before, it's really fun - not to mention it gives a really professional feel to this entire personal finance thing and gives you the satisfaction of getting something done.

If you aren't great with spreadsheets, just manually calculate your average monthly expenses because this is the basic information you need for financial planning.

Testimonial

My wife and I kept such a diary for almost a year. We started because we really needed to find out where our money was going as somehow we never seemed to have any at the end of each month!

It gave us a wealth of information on our spending habits e.g. we discovered we were spending a lot on electricity (the AC was on all the time), telephone bills (we lived away from our parents) and pizzas (that was me) and were able to reduce the spend in those areas significantly. The money we saved went partly into investments and partly into living the good life (a regular Saturday night out). Everybody won!

It is possible you'll read this and think you can already estimate your spends, but that's usually not good enough because you'll invariably miss out some regular (not necessarily monthly) expenses. If you're very sure, keep the diary for a short while but don't skip this step. I can almost guarantee you will be surprised when you maintain this record for a while

***I would like to acknowledge Prasanth for providing some of the material for this post***

Next Post on Beginning Investing: How Much Could You Save?

Addendum Squared!

Sorry about these repeated post-scripts, but I've just figured out how to use Google Groups to upload templates and other tools that you can use to jump-start / accelerate your journey to wealth.

Here's the link to an Excel template you can use to calculate your net worth. All data are fictitious, and intended to illustrate how the sheet can be used.

If you are not familiar with pivot tables (used in the template), please just create standard charts for your analysis. I'd appreciate it if you could send me across a copy so everyone can benefit from your efforts.

Thanks and hope you like this new feature. I'm going to use it as often as I can!

How Much Are You Worth - Addendum

This is to acknowledge some excellent inputs provided by Prasanth in his comments on the previous post.

To summarize:

• Remember to include your Provident Fund (or 401k or equivalent) and surrender value of insurance policies in the assets column
• If you have reverse-mortgaged your property (taken a loan against your property or used your property as collateral for anything, including top-up loans, home improvement loans) include the amount of debt you have taken on as part of your liabilities.
• Prasanth prefers not to include his primary residence in the asset side at all since it is not, strictly speaking, an investment (after all you need a place to stay) but I'd prefer to include it anyway. Not many of us will own more than one property and, if you've had the sense to make a good investment, you've earned bragging (and 'asset-column') rights to it!
• Both Prasanth and I agree on not including inherited property because we tend to favour wealth creation over wealth inheritance, believing that you should add to what your forefathers left you, rather than living off it. But that's a matter of personal choice

I hope you have completed this exercise (or soon will) because I'll soon be back with the next post in the series and then there'll be more 'homework'!