How the Greenspan Guidotti Rule foretells a currency crisis?

Currency speculators have it figured out when a currency will default. This is the equivalent of a government going bankrupt. The US will be going bankrupt in 2010 and this little known rule is the leading indicator that will predict an external currency crisis. The rationale is that countries should have enough reserves to resist a massive withdrawal of short term foreign capital.

In a 1999 academic paper, Alan Greenspan and Pablo Guidotti, the Argentine finance minister surmised "To avoid a default, countries should maintain hard currency reserves equal to at least 100% of their short-term foreign debt maturities." PIMCO, the world's largest money management firm, explains the rule this way: "The minimum benchmark of reserves equal to at least 100% of short-term external debt is known as the Greenspan-Guidotti rule. Greenspan-Guidotti is perhaps the single concept of reserve adequacy that has the most adherents and empirical support." That is to say, if you can't pay off your foreign debts over the next 12 months, you're a diabolical credit risk. The traditional rule of thumb was to maintain reserves equal to three months of imports. In failing to meet this threshold, speculators will have you in their sights, target your bonds and currency, making it virtually impossible to refinance your debts. A default becomes a self-fulfilling prophecy.

This is How The Maths Works
2010 US financing needs:
- US$2,000 billion short term debt that rolls over - this is the equivalent of your bank reviewing, extending and guranteeing your overdraft limit - you are gambling they will not withdrawing support for you all at once
- 2010 budget deficit of US$1,500 billion
- Total of US$3.5tn (US$3,500 billion) that has to be met by selling Treasury bills at auctions to willing domestic and overseas buyers

Is this covered adequately by reserves?:
- The US has 8,133.5 metric tonnes of gold or 261 million troy ounces which at the 31st December gold price of US$1,096 is worth US$287bn.
- The US strategic petroleum reserve currently holds 726 million barrels as at 29th December which at a current oil price of US$79/barrel is valued at US$57bn.
- The IMF warrants the US has US$136bn of currency reserves
- This puts the US reserves at close to US$500bn

Thus the reserves do not cover anything near the US$3.5tn that needs to be financed in 2010. The fact the US$ is a "reserve currency" currently enjoying the status of the preferred currency for internationl trade may encounter stiff headwinds as overseas confidence in it is challenged.


Watch for signs of trouble in Latvia and Ukraine first. These have failed the Greenspan Guidotti test. Contagion is by its nature unpredictable. A series of events in Thailand in June 1997 triggered the Asian currency crisis.

Mindful of the speed bumps ahead...you can short the US$ ie. cast your vote of no-confidence in the US currency and protect against the decline in the pegged Hong Kong dollar by buying the ETF called UDN (PowerShares DB US Dollar Index Bearish Fund) as part of a defensive strategy.