Contrary to Fed policy, the only thing investors can't see in a bubble is when it will burst...
THE DOLLAR'S SLUMP is of great and immediate concern, writes Addison Wiggin of The Daily Reckoning.
Because while the Dollar had been slipping only gradually in the recent past, the rate of decline has picked up momentum. And a Dollar crash will have disastrous implications for global financial markets.
At the end of 2001, the Euro was worth $0.89, but it has been on a steady upward march since then. By the end of April 2008, the Euro had hit a high above $1.60 – the apparent "line in the sand" for European policy-makers fearing for their economy's exporting power.
How do all of the trade surplus countries play into this falling Dollar picture? Remember, former Fed chairman Alan Greenspan observed that in economics, the sum of all surpluses equals the sum of all deficits.
So when a surplus country stops investing that surplus in US Dollars, its currency will increase against the Dollar. This realization has profound implications.
Not only does the Dollar continue to fall against other currencies; as it does so, it accelerates the undesirability of pegging currencies to the US money, or investing surpluses in Treasury bonds and other US debt instruments.
In other words, it becomes less and less viable for foreign investors and central banks to fund ever-growing US debt.
This is not just a problem of US consumer debt trends. We may be addicted to shopping, but we have codependents and enablers around the world. Just as the US consumer is addicted to spending excesses, foreign exporters have become addicted to selling goods to Americans. The problem is with sellers, as well as buyers.
The governments in those other markets are as concerned about the US Dollar's fall as Americans are (or should be). Why? Because the fall of the Dollar is the same thing as a rise in other currencies. So the competitiveness of foreign export economies is damaged more and more as their own currencies increase in value.
Just as a falling Dollar hurts the buyer (Americans), a rising currency hurts the seller (foreign economies) to the same degree. The United States is only one side of the problem.
As the consumer in today's surplus-deficit world, American Dollars have tremendous influence throughout the world – if only because so many central banks (e.g., China's) have pegged their currency to the Dollar. At the same time, many exporting nations are seeing their currencies going up in value, making it untenable to continue exporting at the same rates as in the past.
So we have, through trillions of dollars of debt accumulation, created a de facto Dollar standard in much of the world economy.
The debt is based, however, on a worldwide bubble economy, perhaps the biggest bubble in world history. The whole theory behind this comprehensive "bubblization" (a new word for you, referring to the combination of federal deficit, trade, mortgage, housing, dollar, and credit bubbles all working together) has grown out of the economic theories of the Federal Reserve.
Alan Greenspan was the chief culprit behind the theory that spending is good...more spending is better...and the most spending is best. But we can't pin the whole thing on him. Like the US consumer, he had enablers and codependents everywhere. His helpers include an array of bankers, corporate executives, and investors – all buying into the Greenspan version of the US economy and how it just might work.
Now Ben Bernanke, who happily puts himself out there as the leading economic forecaster and wise man of our age, also contends that bubbles can't be recognized until they burst. That's like saying you can't tell that your house is on fire just because smoke is billowing from the windows; you have to wait until it actually bursts into flame.
The truth is, bubbles are easily recognizable well in advance of bursting. What we cannot know is when they will burst. The Dollar bubble is going to burst, and that is inevitable. The effects on the economy of that burst are going to be serious.
As long as investors, consumers, and business managers continue to base their financial decisions on assets of inflated and unrealistic value, we are denying this inevitable outcome. The more we depend on those inflated values, the more damage we will suffer when the bubble bursts.
In the case of Japan over the last 20 years, its pattern was somewhat different from the US pattern of today. Japan's deficit budget spending went into business investment, which in turn expanded productivity and trade profits. Spending on business equipment and plans, commercial buildings, and other production – based infrastructure had a specific effect: when Japan's economy slowed down, it merely came to a halt and has remained chronically slow ever since.
In comparison, US deficit spending is overwhelmingly going into consumer spending, with very little business investment or consumer savings to offset that trend. Thus, the US trend in GDP is led by consumption and not by investment.
So the use of deficit spending has everything to do with the consequences of deficits, and ultimately with the effect of a Dollar crash. Unlike Japan's economy, which merely flattened out as a consequence of deficit spending, the US economy is likely to see a more devastating change in the entire economic landscape – with the accompanying price inflation we have to expect as an outcome.