Saturday, November 27, 2004

I have been reading lately that there could be a US dollar crisis because of China selling off the dollar. This is a direct consequence from large budget deficits. The idea that "deficits don't matter" is dangerous specially when we rely on the money of foreigners, in the form of treasury notes and bills (aka savings bonds). What is a savings bond? It is literally buying a part of someone else's debt. So when you buy a savings bond from the US government, you now own a part of the debt of the US government.

What does this have to do with the fall of the dollar in currency markets? Well, the dollar is not tied to gold like it was before Nixon's administration so it is not tied to the cost of a brick of gold (which is now $445 a troy ounce, the highest in 16 years) but our gold reserves do play a role. It is traded on the global currency markets which means that a US dollar is only worth as much as someone else deems it is worth. Thus when they start losing confidence that people will buy our debt, they will start selling their dollars trying to make sure that they do not lose their investment. This selling will drive down the perceived worth of the US dollar. When the dollar loses this perceived worth then inflation starts because people do not value the US dollar as much as they used to so they must have more of them to sustain their value in their eyes. This all means that your credit card interest rates will increase and all of your other interest rates will also increase across the board. This causes the economy to slow because people cannot borrow money they need to buy a home or start a new business. Even established businesses will be effected because they cannot borrow the money they need to expand or even to exist at all or even if they do, they will be hampered by high interest rates so they will not borrow as much.

What does this all mean? It means that "deficits do not matter" is a fallacy. They do matter. The only thing that cannot be predicted is how fast this will all happen but it will. The red flags are all there. I would venture that if China dumps a huge amount of US dollars onto the market, the dollar crisis will begin. Otherwise, it will be a war of attrition and cause sporadic economic instability which could be even more painful in the long run (of course, Republicans are not worried about that right now, they are more worried about their "moral superiority").

Ok, that is enough of that. I am sure that I have completely bored the pants off of you. In other news, I had a few friend over last night and there is a huge amount of dishes to do but I am lounging around in my sweats trying to ignore all of it.

posted by Chris  #11:14 AM | 0 comments |