The Dollar Devaluation Debate
Sharon L. Secor
October 28, 2007
Dollar devaluation, while always a subject of contention among economists, has become even more controversial in recent months. Today's economic climate, with the current upheaval in the housing and credit sectors, has brought the issue to the forefront once again, as economists debate the best course to follow to enable economic recovery from these events. While dollar devaluation has been happening at a slow and steady pace for a good many years, over the past decade that pace has accelerated, a change that many economists feel is a reaction to increases in the money supply.
The prevailing monetary policy of the United States in recent years has been one of increasing the money supply through credit creation, resulting in an economy that is largely based on debt rather than income. As the money supply is increased in this fashion, the value of the dollars in circulation decreases.
While some sectors have seen a temporary benefit from the current trend, dollar devaluation can affect many other sectors of the economy adversely. Such is the debate between opposing camps of economists, arguing where economic priorities should lie.
The Pro Devaluation Position
Current monetary policy is favored by economists who consider the US trade deficit as the most critical problem in today's economy, with many stating that a substantial devaluation of the dollar against the currencies of our trading partners is necessary to bring the trade imbalance under control. Normally, this is a process that would take place naturally in the market, with the currency of the nation holding such a long term and significant trade imbalance losing value against that of their trading partners, correcting market balance.
However, U.S. currency was protected to some extent by its standing in the global economy. Despite the massive trade deficit held by the US, demand for the dollar remained high, as it is used by many countries in international financial transactions and as the reserve currency in many central banks world wide. Another factor that has protected the dollar from rapid devaluation is foreign investment. With widespread instability in many other economies and booming economic activity in the US in the late 1990's, overseas investors sought to protect their assets by investment in U.S. stocks and bonds.
As U.S. corporate mismanagement and accounting scandals hit the headlines all over the world, this trend began to change. Foreign investors began to pull away, no longer placing their trust in U.S. financial markets. Even American investors began to move money out of the U.S. economy, with a sharp increase in oversees investment. These developments resulted in a downward slide in the value of the dollar as compared to foreign currencies.
The U.S. dollar has lost more than a third of its value against the Euro and half its value against the Brazilian real since 2002. During this time, U.S. exports rose to $138 billion in August, setting a new record. The weaker dollar inflated the earnings of American companies that earn a significant portion of their revenue overseas, such as the S&P 500, which in turn inflated the stock market. The rising stock market is cited as a means of preventing, or at least delaying, economic recession by counteracting the effects of plunging home prices.
The Price Stability Argument
On the other side of the dollar devaluation argument are economists that believe price instability is a more pressing economic ill than the U.S. trade deficit. These experts are against the current monetary policy of lowering interest rates and money creation, favoring a policy of raising rates to slow the devaluation of our currency.
Among the many detrimental effects of dollar deflation on the economy is higher commodity prices around the world. As of August 2007, energy and agricultural commodities saw double digit increases as the Federal Reserve has flooded the market with cheaper dollars, and Texas crude traveled upwards in price by $19 dollars a barrel. Gold rose 18 percent to $765 per oz, its highest in 28 years. These increases mean that prices for the basic food and energy needs of the average consumer have risen sharply in the U.S. and other countries.
During this same time period, foreign investors have fled the U.S. market in record setting proportions, dumping U.S securities to the tune of to the tune of $163 billion. $69.3 billion in long-term securities, such as notes, bonds, and equities were sold off, an all time high. $29.7 billion in Treasury bonds were unloaded by foreign central banks in August 2007, compared to just $6.9 billion in July. $40.6 billion in U.S. equities were sold by foreign investors in August as well, due to recent Federal Reserve rate cuts that have the potential to drive the dollar lower at a sharply accelerated rate, spurring investors to move capital out of the country to avoid losses.
Adding fuel to the fire for the U.S. economy is the tightening of monetary policy in Europe, shifting the international interest rate differentials in their favor, further devaluing the U.S. dollar against foreign currency. In actions directly opposite of the U.S. Federal Reserve policy, European officials are moving to control consumer price inflation by combating growth in the money supply.
The basic difference between these two opposing economic viewpoints is in priorities. For those that favor allowing the continued devaluation of the dollar, the priority is placed firmly in favor of business interests. These economists believe that international trade balance and healthy stock market activity is the road to a strong economy. Economists on the other side of the debate feel that tighter money policy is the key, slowing the rate of currency devaluation. This method would offer more protection to the average consumer against surging inflation rates, while slowing growth.
Today's economic climate has placed the interests of business and those of the average consumer in direct opposition. Recent monetary policy has consistently favored business interests and Wall St., a trend that shows no signs of changing in the near future, as evidenced by the Federal Reserve interest rate cut of half a point in September 2007. With this policy in place, consumers will bear the brunt of the current U.S. financial turmoil, as dollar devaluation continues at its current accelerated rate, lowering the standard of living of the average American.
The prevailing monetary policy of the United States in recent years has been one of increasing the money supply through credit creation, resulting in an economy that is largely based on debt rather than income. As the money supply is increased in this fashion, the value of the dollars in circulation decreases.
While some sectors have seen a temporary benefit from the current trend, dollar devaluation can affect many other sectors of the economy adversely. Such is the debate between opposing camps of economists, arguing where economic priorities should lie.
The Pro Devaluation Position
Current monetary policy is favored by economists who consider the US trade deficit as the most critical problem in today's economy, with many stating that a substantial devaluation of the dollar against the currencies of our trading partners is necessary to bring the trade imbalance under control. Normally, this is a process that would take place naturally in the market, with the currency of the nation holding such a long term and significant trade imbalance losing value against that of their trading partners, correcting market balance.
However, U.S. currency was protected to some extent by its standing in the global economy. Despite the massive trade deficit held by the US, demand for the dollar remained high, as it is used by many countries in international financial transactions and as the reserve currency in many central banks world wide. Another factor that has protected the dollar from rapid devaluation is foreign investment. With widespread instability in many other economies and booming economic activity in the US in the late 1990's, overseas investors sought to protect their assets by investment in U.S. stocks and bonds.
As U.S. corporate mismanagement and accounting scandals hit the headlines all over the world, this trend began to change. Foreign investors began to pull away, no longer placing their trust in U.S. financial markets. Even American investors began to move money out of the U.S. economy, with a sharp increase in oversees investment. These developments resulted in a downward slide in the value of the dollar as compared to foreign currencies.
The U.S. dollar has lost more than a third of its value against the Euro and half its value against the Brazilian real since 2002. During this time, U.S. exports rose to $138 billion in August, setting a new record. The weaker dollar inflated the earnings of American companies that earn a significant portion of their revenue overseas, such as the S&P 500, which in turn inflated the stock market. The rising stock market is cited as a means of preventing, or at least delaying, economic recession by counteracting the effects of plunging home prices.
The Price Stability Argument
On the other side of the dollar devaluation argument are economists that believe price instability is a more pressing economic ill than the U.S. trade deficit. These experts are against the current monetary policy of lowering interest rates and money creation, favoring a policy of raising rates to slow the devaluation of our currency.
Among the many detrimental effects of dollar deflation on the economy is higher commodity prices around the world. As of August 2007, energy and agricultural commodities saw double digit increases as the Federal Reserve has flooded the market with cheaper dollars, and Texas crude traveled upwards in price by $19 dollars a barrel. Gold rose 18 percent to $765 per oz, its highest in 28 years. These increases mean that prices for the basic food and energy needs of the average consumer have risen sharply in the U.S. and other countries.
During this same time period, foreign investors have fled the U.S. market in record setting proportions, dumping U.S securities to the tune of to the tune of $163 billion. $69.3 billion in long-term securities, such as notes, bonds, and equities were sold off, an all time high. $29.7 billion in Treasury bonds were unloaded by foreign central banks in August 2007, compared to just $6.9 billion in July. $40.6 billion in U.S. equities were sold by foreign investors in August as well, due to recent Federal Reserve rate cuts that have the potential to drive the dollar lower at a sharply accelerated rate, spurring investors to move capital out of the country to avoid losses.
Adding fuel to the fire for the U.S. economy is the tightening of monetary policy in Europe, shifting the international interest rate differentials in their favor, further devaluing the U.S. dollar against foreign currency. In actions directly opposite of the U.S. Federal Reserve policy, European officials are moving to control consumer price inflation by combating growth in the money supply.
The basic difference between these two opposing economic viewpoints is in priorities. For those that favor allowing the continued devaluation of the dollar, the priority is placed firmly in favor of business interests. These economists believe that international trade balance and healthy stock market activity is the road to a strong economy. Economists on the other side of the debate feel that tighter money policy is the key, slowing the rate of currency devaluation. This method would offer more protection to the average consumer against surging inflation rates, while slowing growth.
Today's economic climate has placed the interests of business and those of the average consumer in direct opposition. Recent monetary policy has consistently favored business interests and Wall St., a trend that shows no signs of changing in the near future, as evidenced by the Federal Reserve interest rate cut of half a point in September 2007. With this policy in place, consumers will bear the brunt of the current U.S. financial turmoil, as dollar devaluation continues at its current accelerated rate, lowering the standard of living of the average American.
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