Saturday, December 01, 2007

Dollar Woes Signal Global Problems

The US Dollar continues to nosedive against European currencies, reaching new and troubling levels against both the British Pound and the Euro. While the decline in the dollar is being regaled by our adversaries in Iran and Venezuela, the implications of the weakening currency are global in reach. (Speigel Online: Why America's Currency Is the World's Problem.)

While it is popular among the left in the US to point to the war debt from our involvement in Iraq as the reason for the dollar's decline, the actual situation is far more complex and troubling. Truth is, we're now seeing an economic upheaval in the US similar to that which plagued the late Carter and early Reagan years. Gold topped $800 an ounce last week before retreating to $783 by Friday's close. Many economists are now pointing towards a recession that may be all but inevitable. The national debt has grown at a rate not seen since the early to mid 1980s. Capping it all, however, is the collapse of the housing market in the US.

The housing collapse certainly appears to be the catalyst, however that collapse is truly the inevitable result of long-term unscrupulous business practices primarily in the mortgage and banking industries. The relaxation of credit worthiness requirements and the ability to obtain sub-prime mortgages with no money down has lead to record numbers of foreclosures this year, and threatens to lead the nation into recession. Almost 40% of new home sales over the past two years were for second homes or vacation homes, with buyer exuberance fueled by the bait and switch tactics of a variable rate mortgage with a sub-prime entry.

We are now seeing the next ripple in the housing collapse as the world's top banks begin a massive debt write off due to the record number of bad loans on their books. The write offs are already taking their toll in Europe, and we are starting to see the wave crest over the largest banks in the US. Given the way they've handled the entire mortgage issue, I would find it hard to be sympathetic were it not for the toll the collapse will take on the American worker.

The collapse of the dollar is not entirely due to the mortgage issue, however. The average American has managed to run up a credit debt to rival the one our elected officials have managed to incur at the national level. Now, deficit spending has never hurt the US in the past, but this time around we have major foreign investors questioning our credit worthiness. As our national debt piles up, the value of our dollar continues to fall. With the decline in the dollar, we have energy prices rising astronomically, and that always translates into rising inflation. Deficit spending is now a luxury we can no longer afford.

To counter this wave, it appears the Federal Reserve is poised to lower interest rates again on December 11th, although it will be about as effective as handing someone a bucket to stop a tsunami. Lowering interest rates will do nothing to halt the rising energy prices, the rising rate of inflation, the collapse of the housing market, or the collapse of the value of the dollar. In fact, it could actually add to the problem by temporarily raising the overall value of the already over-inflated stock market.

About the only aspect of our economy benefiting from the dollar's decline is our ability to export goods and services. Unfortunately, we don't exactly manufacture goods the way we used to and are far more dependent on imports than we are on exports. A declining dollar doesn't do the American consumer much good when those items are imported from nations with a stronger currency.

There are some in Europe that believe the dollar's decline is intentional, and there may be some merit to that charge. French President Nicolas Sarkozy came right out and said as much, charging that the US is attempting to boost American exports while weakening Europe's ability to compete in the global market. He may be right. We certainly did just that in the early 1970s, and with our foreign debt at all time highs there is a perverse logic to weakening the dollar in the short-term.

What remains to be answered though, is what solutions to put forth. Sadly, the first solution we will need to accept is that the correction that is coming in the stock market must play itself out. There is very little substance maintaining a DOW average over 13,000. Corporate earnings certainly don't warrant that level, and the projected slowdown in economic growth does not justify the rapid rise in stock prices. Maintaining an artificially inflated market is only going to make the resulting crash much worse.

Secondly, we must hold the line on interest rate cuts. Attempting to stimulate the economy in that fashion does not address the heart of the problem and will be ultimately detrimental to the economy as a whole. In fact, what is needed to stimulate the economy is a reduction in the price of oil, and the only way that will be achieved is through strengthening the value of the US dollar. Interest rate cuts, and the cheaper credit implied by those cuts, is tantamount to giving someone a shot of whiskey to cure a hangover. It is going to add to the problem, not fix it.

Third, we must make the tax cuts implemented a couple of years ago permanent. While that will sound contrary to my next point, it's necessary. The American consumer cannot survive both a tax increase and a rising cost of energy, so like it or not, the tax cuts must be made permanent. Americans are already taking huge pay cuts just through their daily commute to work. With gas now topping $3.05 per gallon compared to $2.29 per gallon this time last year, the last thing the American worker needs is a rise in their income tax burden.

Finally, we must establish a positive budget, not even a balanced budget. We are no longer in a position to engage in the level of deficit spending that has worked well for the last 40 years. Our credit rating no longer permits it. The amount of glut in our national budget is staggering, and it's high time we put people in office that are willing to trim that fat. Now, before anyone here starts beating the "it's Bush's fault" drums, let me remind you that the budget is the sole responsibility of Congress. Remember that when you walk into the polls in November.

What goes without saying in all this is that we must hold our corporations accountable for the unscrupulous business practices that have caused at least part of this mess. There is a reason the banking industry was heavily regulated following the Great Depression. Unfortunately, we seem to have forgotten that history and we're once again allowing banks to do as they will. We saw once before that corporate executives were not responsible enough or ethical enough to be left to their own devices, and with the banking regulations being relaxed or eliminated now, we see once again that they have not changed. We need to put them back on a tight leash.

In the meantime, settle in for a rocky ride. The turbulence we are about to experience economically will be global, and it will take several years to work itself out. The remainder of this decade will be rough indeed.

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