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The big challenge as currencies face collapse

The Bank of Thailand is facing one of its greatest policy challenges ever: how it will manage its foreign reserves of around US$200 billion amid the global currency war. For Thailand's reserves - which back the baht currency and international transactions - are mostly backed by international reserve currencies that might become worthless. If the dollar or the yen, in the worst-case scenario, were to become worthless, our reserves would also become worthless. That would be amount to a repeat of the 1997 financial crisis when the baht crashed through the floor.

Let's examine the latest situation involving all the major global currencies. Kyle Bass of Hayman Capital Management said the yen is toast. At 24 times central government tax revenue, cumulative Japanese government debt has reached a level that ensures financial collapse. Recently he told CNBC that the yen would collapse over the next 18 to 24 months from a sudden swing in expectations. The Japanese government will not be able to rein in runaway debt and Japanese government bond bubbles against the impending rise in interest rates.

The euro has stabilised so far. But the fundamental sovereign debt problems have not been resolved. The Spanish and Greek banking systems have negative capital. Europe's banking system is worth about $46 trillion, while its gross domestic product is around $17 trillion. This implies that government money won't be able to bail out the banking system. The European Central Bank might end up printing unlimited money to spark off a euro crisis. Greece might seek an exit from the euro zone sooner rather than later.

And Germany now wants its gold back. Germany's total gold reserves stand at 3,400 tonnes, the second largest in the world after the US. It is seeking to repatriate its gold from the vaults of the Federal Reserve of New York, the Bank of England and the Bank of France. By doing so, Germany is sending an indirect signal to the financial markets that it is also preparing to exit from the euro zone too.

Germany knows that it can't bail out the entire euro zone. The gold shipped back home to Frankfurt could be used to back the Deutsche mark when Germany eventually reverts to its own currency. The question is whether the central banks still hold Germany's gold or only receivables. If Germany were to leave the euro zone, it would spark a euro crisis of galactic proportions.

The US dollar is also facing a crisis of confidence. The timing to watch is March onward, when the White House and the Republican-controlled Congress will negotiate the US debt ceiling of $16 trillion. Given the animosity between the Democrats and the Republicans, the conflict might spill over into the financial markets, resulting in a collapse of confidence in the US Treasuries market. If buyers of US Treasuries do not show up and the Federal Reserve can't compensate for all shortfalls, the dollar will tank. A dollar default looks increasingly possible.

The US's balance sheet looks ugly. The US debt is $16 trillion, equivalent to 100 per cent of the GDP. The US government's budget in 2012 was $3.8 trillion. Tax revenue was around $2.5 trillion, resulting in a budget deficit of $1.3 trillion. But the US off-balance-sheet debt is believed to exceed $80 trillion, which is by far higher than the world's GDP of $60 trillion. In fact, John Williams of Shadowstats believes that the US is creating $7 trillion in new debt every year. Since this is the case, the US Federal Reserve will have no choice but to monetise the government debt indefinitely. The dollar collapse is a matter of time.

Of the Bank of Thailand's $200 billion in reserves, 50 per cent is denominated in US dollars, 25-30 per cent in the euro, 10 per cent in Asean currencies, 5 per cent in the yen and 3 per cent in gold. This is my own estimate from conversations with BOT officials. If the major currencies of the world, such as the dollar, euro and yen were to crash, the Thai central bank's reserves would lose value in a hurry.

The way out is to walk away from the current global financial framework. How about putting half of the Bank of Thailand's reserves into a swap agreement with the Bank of China for yuan? The yuan will rise when other global currencies collapse. The central bank then can add more gold and other regional currencies to its reserves as a diversification of risks from the global currencies. Gold should have been accumulated earlier when its prices were cheaper.

There is not much time left to protect the country's reserves. But it is better late than never.


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