HowWealthWorks.com

[Dave]

The Inevitable Falling Dollar
You've heard that the direction of the dollar can't be forecast, but it can. The dollar is falling, and it's going to fall a long way. And the reasons are so easy to comprehend, it's surprising we don't read more about it in the mainstream media.

For 60 years, the US has enjoyed the privilege of issuing the world's reserve currency. This status allows the US government to spend more than it takes in tax revenue. Because the rest of the world accepted dollars in trade for their goods and services, the demand for the dollar in the global economy was continually expanding. First by Bretton Woods, and then by the petrodollar trade, demand for US dollars grew. This enabled the great disinflation of 1982-2001, in which the supply of US dollars expanded exponentially, and yet the dollar rose in value. If you've ever wondered why the US is the world's sole superpower, look no further than the dollar. The reserve currency status of the dollar allowed the US to spend far far more than it took in tax revenue, enabling vast military adventures that would leave any other country buried under a pile of worthless currency and debt (a la the Weimar Republic's disastrous hyperinflation).

The world is now beginning to repudiate the dollar, and other currencies, a basket of them, are in ascension. The dollar is falling against almost all major currencies, and will continue to do so for the foreseeable future. If someone tells you “there's no way to know whether the dollar will rise or fall,” don't you believe them. But so what?

As the global market for dollars shrinks, those dollars are going to make their way back to the US to purchase assets. This is a story we've been covering here for years as the "squanderville" story.

Think for a minute how this is going to work: our creditors are trading their ever less valuable dollars for our assets-- and who is selling? US entities. Many of those dollars will make their way into the economy, causing prices to rise.

Dollar Gains Reserve Currency Status
In case haven't heard, the US dollar has fallen 74% against the euro since the euro traded at .86 cents. The US is the lone remaining superpower because it enjoys the privilege of issuing the world's reserve currency. It gained that privilege when it was the world's largest creditor nation, and largest economy, in 1944 with the negotiation of Bretton Woods.

All major currencies were to be convertible into dollars, and in turn, the nations issuing those other currencies could convert their dollars into gold. This put the global economy on a dollar standard.

The world would accept dollars in trade for their goods and services, and could in turn demand gold for those dollars at the Federal Reserve gold window. Of course, the guns and butter deficits of the 60s and 70s resulted in debt monetization, and a run on the dollar, and ultimately forced Nixon to close the gold window.

After the Middle East Oil Crisis of 1973, global markets for oil were established that denominated oil exclusively in dollars, giving rise to the petrodollar trade, and providing some stability to the value of the dollar.

Dollar Loses Reserve Currency Status
In case you haven't noticed, the era of the petrodollar is passing, and the amount of goods and services traded for dollars in the world economy is shrinking, while the demand for alternate currencies is rising. This will not change. Creditor/producer nations are demanding the currency of the nations with whom they trade rather than the dollar. As the beleaguered US consumer rolls over, the demand for dollars will fall even more rapidly. Natural resources are being removed from dollar denominated markets and locked up in long term contracts, shrinking the supply of oil, gas, and other natural resources traded for dollars.

The US has issued $25 Trillion dollars that are held outside the US, and as the global trade in dollars shrinks, those dollars only have one place to go: home. We've seen the early effects of this in the huge foreign acquisition of US assets. Our creditors are in the process of divesting themselves of their excess dollars, and they are doing so by acquiring assets denominated in dollars-- US assets. Our global trading partners are buying, and US citizens are selling. I think of this as our assets going overseas as the dollars make their way home to our economy. And as the dollars flood in, prices will rise dramatically.

The value of a currency is defined by the supply of goods and service traded for the currency, as well as the value of the assets denominated in that currency. In case you haven't noticed, both are falling. The US stock market indices have been falling against gold and all other currencies since 2001, regardless of the increase in value in dollars. This means the real value of the stock markets have gone down since 2001 (Jan 2001 until now).

Inflation Can't Be Solved with More Inflation
The great irony of inflationary crises is that the public and politicians always clamor for more cheap money in response to the problems caused by too much cheap money in the first place. It isn't until the money begins to dramatically lose purchasing power that the will is found to decrease the money supply.

“Inflation is Always and Everywhere a Monetary Phenomenon” - Milton Friedman. Inflation is an increase in the supply of money and credit, relative the goods and services (and assets) tradeable for the money; and deflation is a decrease in the supply of money and credit.

The housing bubble was caused by massive inflation due to low interest rates. The giant expansion in the availability of mortgage money at low interest rates caused real estate prices to rise, and once they began rising, anticipation of future price increases drove the prices up further-- and money and credit expanded. That bubble became somewhat independent of central bank rates when investors wanted into to the game in the form of mortgage backed securities.

And now, in response to the real estate crisis caused by too much money, the government and Federal Reserve are riding to the rescue with more cheap money.

This has been tried many, many times in the past with the same effect: destruction of money purchasing power and inflationary disaster.
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Dave

Please feel free to agree with or critique the article excerpts and our comments. Alan Greenspan: Gold and Economic Freedom

[Dave]

FT: Falling US dollar threatens US power around the world

At the end of a year in which the dollar has endured a marked decline against other currencies, an unsettling question is beginning to be voiced: can the troubles of the US currency be confined to the financial world or are they set to undermine Washington’s place on the international stage?

“This is the neglected dimension of the dollar’s decline,” says Flynt Leverett, a former senior National Security Council official under President George W. Bush. “What has been said about the fall of the dollar is almost all couched in economic terms. But currency politics is very, very powerful and is part of what has made the US a hegemon for so long, like Britain before it.”

Along with some other commentators, Mr Leverett brackets the dollar’s recent fragility with related phenomena, such as the greater international use of rival currencies. He argues that if such trends continue, the result will be costly for the US.

“Americans will certainly find global hegemony a lot more expensive if the dollar falls off its perch,” adds Kenneth Rogoff, former chief economist of the International Monetary Fund, in an article published this month.

The tumble of the greenback – by more than 25 per cent against its trading partners since February 2002 when adjusted for inflation – may lead other nations to turn away from using dollars for their central bank reserves, international transactions or currency pegs, with expensive results for the US.

Indeed, central banks have begun to move in such a direction. China, which keeps the composition of its huge foreign exchange reserves a state secret, has hinted that it plans gradually to reduce the proportion held in dollars – some analysts put the current level at more than two-thirds.

“The US is extraordinarily fortunate in that its currency is also the international standard of value – if that would disappear, US leverage in many dimensions would also go,” says Benn Steil, director of international economics at the Council on Foreign Relations in New York.

Mr Leverett says the US could relatively soon become vulnerable to the kind of financial pressure that the strength of the dollar has allowed it to exercise in the past. In the classic example, Washington used the threat of a run on the pound to put pressure on the UK to withdraw troops from Egypt during the Suez crisis in 1956.

In future, that kind of leverage may belong to China. “Right now China wants to keep a close hold on how fast the renminbi appreciates,” he says. “But it’s increasingly likely that they decide their strategic interest to constrain the US at some point outweighs the economic considerations.”

Mr Leverett also points to what he says has been a series of unwritten but explicit understandings between the US and the oil producing countries of the Gulf that underpin the dollar’s role as the world’s leading currency by denominating oil contracts in dollars and linking local currencies to dollars in return for security guarantees.

“The arguments now on economic grounds are overwhelming that the Gulf Co-operation Council states, including Saudi Arabia, should drop the dollar peg” because of the currency’s decline, he says, alluding to many Gulf states’ worries that they are importing inflation because of the link to the low dollar. “Saudi officials will tell you it’s a strategic decision, not an economic one, that they are sticking with the dollar. That should be a real indicator to American policymakers and citizens that this is a real vulnerability.”

Indeed, at an Opec summit last month, Saudi Arabia headed off a push by Iran and Venezuela to price oil with reference to a basket of currencies rather than the dollar. In television footage apparently screened to reporters by mistake, Saud al-Faisal, Saudi Arabia’s foreign minister, argued that even mentioning the issue in the summit communiqué would weaken the dollar still further.
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Dave

Please feel free to agree with or critique the article excerpts and our comments. Alan Greenspan: Gold and Economic Freedom