I don't know if you have been paying attention lately but the dollar has been falling like a stone. To hear the talking heads on the business channels, you would think that this is a desirable thing. After all, a weaker dollar makes our exports cheaper and thereby American products become more competitive in the market place. In truth, that is in fact what is happening to a modest degree. The export sector is about the only strong sector in the economy right now and the trade deficit has shown a decent amount of improvement in recent months.
However, this is not normal. The falling dollar is not a good thing. Even with the recent improvement, we are still running a trade deficit of about $50 billion every month. Our trading partners are beginning to figure it out. Figure what out? They are adding up the numbers and they are beginning to comprehend that America is never going to be able to pay off all their debt. So our currency is falling and in effect making their products more expensive. That's also why gold is going up - as a hedge against the falling value of the dollar. How many countries in the world have economies big enough to absorb all this debt that we Americans are producing? Like most of the world's currencies, the dollar is a fiat currency, it's not backed up by anything except the full faith and credit of the respective governments. It is just a paper promise.
So the question becomes how much longer will our foreign creditors let us get away with running up these trade deficits? Think about it. They give us oil, we gave them paper; they give us cars, we give them paper; they give us computers, we give them paper. Ultimately, they really don't want the paper; they want what the paper can buy - plus interest. However, they will only accept that paper as long as they believe that it has value. What America is doing by generating all this debt is destroying the relationship between the dollar and the goods and services America produces. Have you taken notice of the fact that America doesn't produce much of anything anymore? So how are we as a country going to pay off that debt? We probably won't. We have a trade deficit with virtually every trading partner in the world except maybe Albania.
The current situation is unsustainable and I don't think its going to continue much longer. Why would anyone want to hold U.S. debt and make, say 4% interest when the dollar is going down by 5% to 10% a year. It doesn't make sense and in fact, it's a stupid thing to do, at least economically. So what does it all mean? Well, a falling dollar means higher inflation as the price of foreign goods become more expensive. (Take that European vacation now). Further, it is likely we are going to see foreign investors come into the country and use their IOUs to buy U.S. assets, such as real estate and corporations. The falling dollar also has the potential to put upward pressure on interest rates as foreign investors want a higher risk premium for accepting the increasingly risky US debt (think higher cost for mortgages and carrying charges for credit card debt). Ultimately we may see the cost of commodities now priced in dollars be priced in more stable foreign currencies or even a basket of currencies of which the dollar might be one of several. This will cause the cost of all such commodities to increase. This is what we as a nation are facing as a result of the falling dollar. Ultimately it means a lower standard of living for all of us except our esteemed Congressmen and women, who always seem to have a knack for taking care of themselves on our dime. Guess what? This is the benign version of what are future is and it is the best situation we can hope for. This will happen at a minimum and only IF the value of the dollar erodes in a rational controlled manner. You want the scary version?
The scary version - think Germany in the 1920s, think Argentina in the 1980s, think either hyperinflation or severe deflation. They really are two sides of the same coin. If foreign investors ever come to the conclusion that the dollar isn't worth the paper its printed on, the recent decline in the dollar will begin to accelerate and it could conceivably cause a run on the currency as those investors try to sell their U.S. debt to recoup any value still remaining in the paper - and those investors know that the sooner the paper is sold, the more of their money they will recoup. It will be as if someone shouted (Fire!) in a crowded movie theatre. The currency would fall off the cliff, gold and interest rates would spike and the stock market would collapse. If you doubt that it could happen here, think again. If you ever watch a Congressional hearing with Fed Chairman Ben Bernanke, or Alan Greenspan before him, the dollar and the foreign debt topic will always be mentioned. The senators and representatives have concerns about the situation. They are not stupid (well at least not that stupid). They know the risk; you can tell by the questions they ask. Yet neither they nor the Federal Reserve Chairman ever directly or aggressively address the issue. Both sides realize that if they are too blunt and honest, the demise of the dollar will become a self-fulfilling prophesy.
In the history of the modern financial world, no currency has ever avoided a crisis or collapse with an annual trade deficit as large as that of our country. There is likely only one reason that collapse hasn't occurred -yet. Simply it is the fact that the U.S. dollar is the world's reserve currency and there are just too many countries in the world that have too much at stake if the dollar collapses. However, the markets are bigger than any one economy or even several economies. Trust me, if the US. keeps spitting out debt at the rate of $50 billion a month, the scary version has a real shot at happening .
