The implications of a swooning dollar

Andrew Jesaitis

Over the past several years a tremendous amount of destruction has been wrought to the U.S. dollar. Since its peak in 2002, the dollar has lost more than one-third of its value. What’s more is that this decrease took place right under the noses of Americans with hardly more than a flinch from some ex-pats in Europe who have been especially hurt by the dollar’s weakness.

Having given up the goal of a balanced budget, every dollar the U.S. spends sends the country deeper into debt. The U.S. is perilously approaching the tipping point where its debt will be greater than its entire GDP. For those keeping track, the U.S. debt just surpassed $9 trillion, while last year’s GDP was $13.1 trillion. After this point is reached, there is a real danger of a loss of faith in the U.S. dollar. Since faith and faith alone is what supports the dollar, this poses a real problem.

We can already see the subtle undercurrents signaling that the U.S. dollar is losing its place as the world’s reserve currency. Chinese officials have expressed desires to cut their U.S. debt holdings and Iran has slowly boosted the percentage of non-U.S. currency it accepts for oil sales. While there are obviously political messages wrapped up in these moves, the basis of action when it comes to money is ultimately greed. It is this greed that reveals the developing unrest with the U.S. dollar.

Ironically, greed is currently keeping countries like China in check by preventing them from dumping their dollar denominated debt on the market. Chinese officials know just as well as everyone else that a collapse in the dollar would spell destruction for not just the U.S. economy but also that of the world.

The Federal Reserve is in a difficult position with the recent collapse of the subprime market and subsequent freezing of debt markets across all tranches of credit risk. Whereas the old refrain for the past four years while the Fed eased rates up to their pre-September cut level of 5.25 percent was “concern over inflation,” now the Fed has to realistically worry about a recession. Unfortunately, inflationary fears are not disappearing with the possibility of recession.

The current situation is eerily reminiscent of the course of events that led to the “stagflation” of the 1970s. The parallels are uncanny: recent end of a war (hopefully), price of oil skyrocketing (albeit for different reasons), soaring gold prices and the Fed trying to inflate away a recession.

Should these similarities worry us? Possibly, but I am not losing any sleep because of one simple difference. Everyone is talking about these parallels today. This means that the Fed and money managers are well aware of dangers and have positioned themselves accordingly. When everyone is ready for some impending doom, it usually does not materialize.

It’s much more likely that we will see a wave of inflation sweep the country in the next two or three years, while the credit markets work off the current conflagration with a healthy dose of cash from “Helicopter Ben.”

But inflating our way out of the subprime mess brings us back to the original problem of the weak dollar. The more we inflate, the weaker the dollar becomes and the more nervous foreigners become about holding debt.

What’s the solution, if there even is one? Without keeping the money spigots open, the world could easily suffer a liquidity crunch. Thus, as unfortunate as it seems, inflation is a necessary evil.

The U.S. must become fiscally responsible. We need to trim our expenses and restructure taxes to balance the budget.

Bush has added $5.7 trillion to the national debt since he took office. It’s time to stop spending like it has no consequence. It’s time to balance the budget. It’s time to show fiscal restraint today for the sake of tomorrow.