| The Future of the Dollar: Is There One? |
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| Thursday, 15 October 2009 15:58 | |
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The DOW broke 10,000 this week for the first time in 2009. Is it time to celebrate? It does seem to bode well for the economic recovery. But where does the value of the dollar stand in the midst of this news? Back when the financial crisis looked the darkest, our panacea of choice was to funnel a mass infusion of U.S. tax dollars into stimulus packages. But is there another potential crisis looming – a growing lack of confidence in the U.S. dollar? If we allow this steady return to "economic normalcy" stunt our political will to fix the problem of deficit spending, what impact could it have on the dollar? Let's take a look at the current situation. There are huge trade and spending imbalances—the U.S. imports vast quantities of goods and services—far more than it exports. Our trade deficit in 2008 was the world's largest—a whopping $700 billion! Who's minding the trading store? Do they not realize that flooding international markets with dollars eventually decreases the value of the dollar? Yes, it's true that in the first quarter of 2009 this deficit did decline by 35 percent. Why? Because we're in such a deep financial morass, we couldn't afford to buy as many imports. Is that cause for celebrating? How can the U.S. afford to continue its deficit spending? Easy. It's all thanks to deep-pocketed Asian trading partners—China, Japan and Korea—who are willing to purchase and hold U.S. Treasury Securities that pay low interest rates. But now economic experts are beginning to send up warning signals. Paul A. Samuelson, Nobel Prize-winning economist predicts a global financial panic if China suddenly decides that the U.S. deficit makes further investments of Treasury Securities too risky. China has already voiced serious concern about the potential inflationary impact of the U.S. fiscal stimulus on the value of China's $1.5 trillion in U.S. government securities. Eventually asset holders around the world will think twice about whether the U.S. is credit worthy. The U.S. and China are locked in a delicate dance. Some experts note that China must continue to invest in U.S. dollar assets because if they were to diversify into other currencies, it would cause an immediate decline in the dollar's value, thereby quashing their ability to export goods to the U.S. On the other hand, China's continued purchases of U.S. Treasuries serve to subsidize U.S. consumption in the short term. At the same time they increase the trade imbalance and risk a long-term decline in the dollar that will further erode the value of their $1.5 trillion in dollar reserves. In other words, it's a case of being damned if they do, and damned if they don't. If the stimulus package was supposed to be the cure, in Warren Buffett's view, the cure could be worse than the disease. He recently wrote that the side effects of the fiscal intervention could be as dangerous as the financial crisis itself—in the form of inflation eroding the dollar's purchasing power. It's possible that over the next several years, the dollar will experience a gradual depreciation as currency markets adjust to reduce the massive trade imbalance. Despite the fact that, as we mentioned above, there was a 35 percent reduction in the trade deficit in the first quarter of 2009 because of the recession, the U.S. current account deficit is still projected to exceed $400 billion in 2009. Reflecting the size of the fiscal stimulus, the federal budget deficit (not the trade deficit; the federal budget deficit) is projected to be $1.6 trillion in 2009—the highest level since World War II—amounting to 11 percent of gross domestic product (GDP), a dramatic increase from 3 percent in 2008. Much will depend on changes taking place within China today. There is a growing realization that their export-driven model will never lead to sustainable growth. Because they have over-invested in fixed assets, such as factories and a manufacturing infrastructure, household consumption in China has never taken off. In fact, the current system has created boom-and-bust cycles that prevent, rather than foster, economic stability. Over the next five to ten years, the country will have to make the transition away from their current export-based economy to a consumer-based economy. This will require moving workers out of their repetitive manufacturing jobs and re-training them for service jobs that will require higher skills. With the massive population within China, and the potential for them to consume goods imported from the U.S. thereby helping to balance the trade deficit, we should do whatever we can to encourage China's transition, including offering assistance in retraining the workforce. Our interest and the value of the U.S. dollar will be served by economic stability in China. That may well be cause for celebration. |
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