Gold News

The decline of the Dollar

In terms of the US Dollar, the trade deficit is the third rail of the US economy...

MOST OF US can relate to certain realities in the economy – the hard economic realities of how jobs and profits shift, for example. Most people can relate to why these things happen, too. The idea that higher-wage manufacturing jobs are being lost and replaced by lower-wage retail jobs, for example, is a reality that working people understand. They get it.

   But the same is not always true when we talk about trade deficits. Like the falling US Dollar itself, it's worth asking the question: How does it affect me as an individual?

   The US trade deficit – the excess of imports over exports – has a direct and serious effect on the value of the US Dollar. As long as we continue having big trade deficits, it means we're spending more money overseas than we're making at home. Our manufacturing profits are lower than our consumption.

   If your family's budget had a "trade deficit" of sorts, you'd soon be in trouble. If your spouse spent $4,000 for every $2,000 you brought home, something would eventually give way. This is what is going on with the trade deficit.

   In fact, the trade deficit is one of the most important trends in the economy, and the one most likely to affect the value of the Dollar. Combined with our government's big budget deficit, the trade deficit only accelerates the speed of decline in our Dollar's value.

   Speaking in terms of the spending power of the Dollar, the trade deficit is the third rail of the economy. Here is what has been going on.

   The United States used to produce goods and sell them not only here at home, but throughout the world. We led the way, but not anymore. The shift away from dominance in the production of things people need has allowed other countries (most notably, China and India) to pass us up, and now the US consumer has become a buyer instead of a seller.

   This international version of conspicuous consumption is financed not from the profits of commerce, but from debt. Let's think about this for a minute. If we were buying from domestic profits, the trade deficit wouldn't be such a bad thing. It would mean we were spending money earned from domestic productivity. But this is not what is going on. We are going further and further into debt to buy goods from other countries.

   Our wealth is being transferred overseas and, at the same time, we are sinking deeper into debt. This is taking place individually as well as nationally. Consumer debt (you know: credit cards, mortgages, lines of credit) is growing to record levels, and the federal current account deficit is moving our multi trillion-Dollar national debt into new
high territory.

   Sure, we should be concerned about retirement income from savings, investments, pension plans, and Social Security. But a bigger danger is that, even with a comfortable retirement nest egg by today's standards, what if those Dollars are worthless when we retire? What then?

   The big question today is, how long can this debt-driven economy continue? If you quit your job and refinance your home, you could live for a while on the money. The higher your equity, the longer you would be able to spend, spend, spend. But then what?

   This is precisely what is going on in the US economy and, at some point very soon, we are going to have to face up to it and change our ways. The trade deficit is the best way to track what's going on.

   Returning to the analogy of quitting your job and living off of your home equity, you may stay home all day and order an endless array of electronics, furniture, toys, other words, you could consume goods in place of working. But remember, you didn't win the lottery. You are financing this "new plan" with borrowed money. The lender will want that repaid. So this individual version of a trade deficit (the deficit between generating income and spending money) is what is happening on a national level in the United States.

   This is the problem that is directly affecting the value of the US Dollar, and the situation is getting worse. We know that the Dollar is in trouble because we see it depreciating against the floating currencies of other countries. We also see it depreciating against gold, as measured in terms of the gold price.

   America has a lot of wealth, but that wealth is being consumed very quickly. History shows that no matter how rich you are, you can lose that wealth if you're not productive. Meanwhile, the Dollar's value falls and – in spite of the Fed's view that this is a good thing – it means your savings are worth less. Your spending power falls when the Dollar falls, and as this continues, the consequences will be sobering.

   The Dollar's plunge has taken many people, currency experts of banks included, by surprise. For many of them, it is still impossible to grasp. Some talking head on CNBC said that he was at a complete loss to understand how such weak economies as those seen in the European Union could have a strong currency. For America's policy makers and most economists, the huge trade deficit is no problem. They find it natural that fast-growing countries import money while slow-growing economies export money. At least, that is the recurring theme.

   So Americans traveling abroad may continue to complain that "it has become so expensive to travel in Europe" as though the problem were somehow the fault of the Europeans. But in fact, it is the declining spending power of the Dollar that is to blame, and not just the French, the Italians, and the residents of the so-called "chocolate making" countries.

   This problem is pegged not to some speculative or fuzzy economic cause, even though the concept of currency exchange rates continues to mystify. A historically large trade deficit is at the core of the declining Dollar. Everybody needs to get over the notion that our economy is strong and other economies are weak, merely because this is America. In the United States, the reason for the trade deficit is not a high rate of investment as we see in some other countries, but an abysmally low level of national savings. We are spending, not producing.

   A second argument offered by some is that "capital flows from high-saving countries to low-saving countries, wanting to grow faster." Under this reasoning, a deficit country, looking at both consumption and investment, is absorbing more than its own production. But whether this is good or bad for the economy depends on the source and use of foreign funds. Do those funds pay for the financing of consumption in excess of production (as in the United States) or for investment in excess of saving? That is the key question that ought to be asked in the first place about the huge US capital imports.

   To quote Joan Robinson, a well-known economist in the 1920-1930s close to John Maynard Keynes: "If the capital inflows merely permit an excess of consumption over production, the economy is on the road to ruin. If they permit an excess of investment over home saving, the result depends on the nature of the investment."

   The huge US capital inflows (economic jargon for money coming into the country), accounting now for more than 5% of gross domestic product (GDP), have not financed productive investment. America's net investments are among the lowest in the world, meaning we prefer spending and borrowing over actual production and growth.

   The huge capital inflows have not helped finance a higher rate of investment. America has been selling its factories and financial assets to pay for consumption.

Publisher of Agora Financial, Addison Wiggin is also editorial director of The Daily Reckoning. He is the author, with Bill Bonner, of the international bestsellers Financial Reckoning Day and Empire of Debt, and best-selling author of The Demise of the Dollar.

Addison Wiggin articles

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

Follow Us

Facebook Youtube Twitter LinkedIn



Market Fundamentals