Dollar Meltdown
Fiddling While Home Burns
By John D. Turner

“The decline of the dollar, symbol of US global hegemony for the best part of a century, may have become so entrenched that some experts now fear it is irreversible.”
–The Independent, 17 Nov 2007

It is astounding to me that what may very well turn out to be the single most important problem to face our country in the past 60 years is being pretty much totally ignored by presidential candidates on both sides during this election cycle. That is, the potential imminent collapse of the U.S. dollar, and the ramifications that will have on each and every one of us here in the United States. The news article I quoted in the Independent above goes on to say:

“After months of huge and sustained turmoil on the money markets, lack of confidence in the world's totemic currency has become so widespread that an increasing number of international traders are transferring their wealth to stronger currencies such as the Euro, which recently hit its highest level against the dollar.”

This article is by no means an isolated one, nor is it one penned by some fringe group bent on smearing all things American. Indeed, the strength of the dollar or lack thereof, is a topic of discussion around the world.

There are those, such as Iran, Venezuela, and Russia who rub their hands together gleefully at the thought of the dollar’s demise, and the damage it will do to the United States. These three oil-producing nations are collectively doing all they can to hasten that day. At a recent OPEC meeting both Iran and Venezuela have pushed hard to change the denomination of oil, which is currently priced in dollars the world over, to a basket of currencies, of which the dollar is only one; a move which Prince Saud Al-Faisal, the Saudi foreign minister warned could cause the dollar to collapse. (It's not necessarily that Prince Saud Al-Faisal is particularly bothered by the concept of the dollar collapsing, he just doesn't want it to happen right now.)

According to the article in the Independent, Iran, Venezuela, and Russia are already putting their money, or rather, the money of those who buy oil from them, where their mouths are, demanding payment in euros for their oil rather than dollars, with Iran “insisting that Japan should make all its payments for oil in yen, rather than dollars.”

A recent on-line poll in the Wall Street Journal revealed that that most respondents would prefer to be paid in euros, followed by pound sterling; not the U.S. dollar. Of course, this is not a scientific poll, nor did the report where the respondents came from; however it does point to a certain loss in confidence in the dollar abroad. This is critical, as the dollar is only of value as long as people think it is of value. It isn’t really backed by anything material.

The head of the Treasury, Secretary Henry Paulson isn’t worried though. The dollar has been the world’s reserve currency since World War II, and he doesn’t see any reason why that should not continue indefinitely into the future. “We are the biggest economy in the world.” he told reporters recently, “We are as open as any economy to investment.”

Perhaps Secretary Paulson hasn’t noticed, but things are quite different in the world since World War II.

At the end of the Second World War, much of the world’s economy was in shambles. Of the major industrialized nations, only the United States emerged unscathed. Europe, Russia, and Japan were devastated by the war. Korea and Taiwan were still economic backwaters. Most major world currencies were still backed by gold and/or silver, and the bulk of the world’s gold reserves were in the United States. Our economy was still geared up from the war effort and the world was open to a flood of American goods.

They didn’t even have to be particularly good goods. There wasn’t much in the way of competition. The dollar was the currency to own because it was the one that was the most stable, belonged to the mightiest economy in the world, and was backed by hard assets. Dollars printed in 1957 still stated they were redeemable in silver at any bank. Up until 1965, US coinage was minted in 90% silver.

In 1965 we debased our currency. Only the half dollar still contained silver, and the content was down to 40%, disappearing entirely after 1969. The year 1963 saw the printing of the Federal Reserve Notes, and the Silver Certificate (and its promise of redemption for its face value in silver coin) became history. The dollar was still king, even though now it was only backed by the full faith and credit of the U.S. government; that was enough. America was still the world’s economic powerhouse, and despite a consistently unbalanced budget, the dollar was still strong. I remember as a kid growing up in Germany, where my father was stationed, the dollar being worth more than 4 marks, and being able to spend American currency, even pennies, as freely on the German economy as I could on base.

Despite ups and downs, the dollar remained the world reserve currency of choice, primarily because that “full faith and credit” in the U.S. government had not changed, and because there really was no alternative. Dollars were “good as gold” and accepted everywhere. “Sound as the Dollar” was a term that indicated something that you had absolute confidence in. No other country had a national currency that could compete with the dollar, because no other country had an economy that was able to compete with the United States.

This began to change however, with the creation of the European common market, which created a combined economy which could compete with the United States, and solidified with the creation of the European Union, and the adoption of a common currency, the Euro.

The EU has its problems. And the Euro is by no means a perfect currency (any more than is the dollar). It does however provide an alternative; something that heretofore has been lacking. All that is required is a catalyst to spark the change. Businesses tend to be conservative; the term “business as usual” came from somewhere after all! They won’t willingly abandon the dollar without good reason. Likewise, if they do abandon it, don’t look for them to return from whatever alternative they embrace any time soon. If the dollar falls, and is no longer the international currency of choice, then we can look as our model at every other country whose currency has suffered the same fate for where our future position in the world will be.

And what might that catalyst be? How about increasing inflation, runaway debt (government, consumer, and trade imbalances), a sluggish economy, and huge business losses here in the US? Estimates of the ultimate cost of the credit crunch precipitated by the collapse of the sub-prime mortgage market and the resulting meltdown in the housing industry, run from Fed Chairman Ben Bernanke’s “rosy” estimate of “only” $50 billion to $100 billion all the way up to the recently released estimate by Goldman Sachs of $2 trillion, including $400 billion in losses tied directly to mortgages.

All these, and other issues as well, point to problems with the “full faith and credit” of the U.S. government, and faith in the value of the dollar. This is reflected in the daily lows it is posting against the Euro, and in the increasing unwillingness of those abroad to hold dollars, trade dollars, or get paid in dollars. This is not helped by the fact that while a weaker dollar makes our exports “cheaper” on the world market, it also makes our imports more expensive.

And, unlike the heady days of the post World War Two era, we import more than we export. This, coupled with the fact that one of our major (and increasingly expensive) imports is oil, which has ripple effects through our entire economy, has led to an economic slow-down as people and businesses have less money to spend; money that doesn’t seem to stretch quite as far as it used to.

The usual remedy for a sluggish economy that the Federal Reserve has used to good effect for the past 20 years no longer works because it is dependent on, if not a strong dollar, at least not a weak one. That is, stimulating the economy by lowering interest rates. This has the effect of dumping billions of new dollars into the economy, stimulating growth.

Unfortunately, at this point, such stimulus has the undesirable effect of weakening the dollar even further. The reason? Inflation. Increasing the money supply is essentially the same as printing more dollars. And with the value of the dollar only supported by the “full faith and credit” of the U.S. government and economy, and with that economy increasingly under strain and the government increasingly seen as having a money problem they cannot solve, the support for flooding the world economy with even more dollars is not there, as was evidenced by the drop in the dollar, the rise in the Euro, the huge sell-off in the stock market, and gold posting new highs the last time the Fed tried it. People don’t want the dollars they have now, much less more of them. The result is that the more the Fed tries to stimulate the economy by lowering interest rates and increasing the amount of dollars in circulation, the less those dollars are worth. It’s a case of “the faster I run, the behinder I get”. The ultimate end of all this is for the dollar to collapse and become truly worthless.

And yet, if the Fed doesn’t stimulate the economy, we may fall into recession. If that happens, government revenues will go down (less tax money) and outlays will increase due to more people being out of work. Government debt, already unacceptably high, will increase.

The Fed seems to do OK when it comes to handling a single problem. But when faced with multiple, conflicting problems, it really doesn’t have a clue, much less a plan, much less a viable plan that will actually work and solve the problems without making things worse overall.

As bad as all this may seem, things have taken on yet a new dimension with the entry of China’s economic expansion on the world scene. Not so much in terms of its currency, which like the currency of most Communist countries, isn’t really worth much on the world market, but rather in terms of its growing economic output, growing consumer market (four times the size of ours), and its incredible capacity to absorb dollars like a sponge. The latter is particularly troublesome. It means that if China sneezes, the dollar had best stock up on Claritin. And if China decides that it doesn’t like the value of its dollar portfolio dropping through the floor, and switches to the Euro, or gold, or something else instead, the world will be awash in dollars that nobody else wants either and which will have the potential, for the first time since the Revolutionary War, to not be worth “a Continental damn.”

If you think $100/barrel oil is bad, what will you do when the dollar is worth 1/100th its current value, and oil, which will then be selling in Euros, will cost you, being paid in dollars the equivalent of $10,000/barrel?

Park your car; you won’t be able to afford to drive to work. Of course, it won’t be a problem as the place you work probably won’t be able to pay its electric bill, or quite possibly have any meaningful cash flow, and so won’t be open for business anyway.

On the silver lining side, the nice thing about hyperinflation is that it will make it easy to pay off your house mortgage in dollars that are suddenly worthless. On the dark cloud side, you probably won’t be able to pay your property taxes without a job, so you will probably lose it anyhow. Can you say “depression?” I bet you can.

And finally, don’t forget to throw into the equation the fact that we are in an election year cycle. Even though none of the candidates seem to have picked up on this as a campaign agenda item, if things noticeably begin to slide (to the point that people become aware that they are individually affecting their economic position), you can bet that the Democrats will. And the Republicans will throw out all kinds of ideas to fix the problem, most likely with tax cuts leading the pack.

Unfortunately, if the economy is bad, people tend to focus on and vote their pocketbooks. They are unlikely to be kindly disposed to a party that got them into this fix, and unlikely to respond to the argument “yes, we messed things up big time, but wait until you see my (pick your favorite Republican candidate) plan to fix the mess our party made!” They really didn’t respond well to that argument back in 1980 when Jimmy Carter tried it, and I can’t imagine they will respond favorably to it in 2008. If the country is having economic problems come election time (which, despite all the hoopla going on is still a year away), don’t expect to see a Republican in the White House, or a controlling Republican interest in the House or Senate when all the dust settles.

And we all know what the Democrat plan to deal with an economic crisis that is piling up huge Government debt will be, don’t we? The same plan Democrats have when we are having an economic boom and they still don’t have enough money to spend on all the new programs they want to usher in to buy your vote – higher taxes!

I have yet to see higher taxes successfully grow an economy out of recession, but who knows? Perhaps this time will be the first…

I look at the candidates spending their millions in order to be crowned by the populace the next President of the United States, and I think, why? Who would want the headache? None of them appear to see this crisis, none of them are talking about it – I can only assume that none of them have a plan to avert it, or even see it as a potential problem. And who knows? It may not come to pass. I certainly hope it doesn’t anyway!

But if it does, the next president will likely serve but a single term, and go down in history as the most unpopular president since Herbert Hoover.

Additional sources and supporting/related articles

• Dollars no good for the Taj Mahal - BBC News, 16 Nov 2007
• OPEC Interested in Non-Dollar Currency - Breitbart.com, 18 Nov 2007
• Japanese shift cash out of U.S. investments - International Herald Tribune Business, 22 Nov 2007 
• What's Sinking the Dollar? - Fortune, 13 Nov 2007
• Dollar sinks below 108 yen in N.Y. for first time since June 2005 - BreitBart.com, 23 Nov 2007
• Gold piles on gains amid dollar weakness - MarketWatch, 23 Nov 2007
• Hundreds of banks threatened by new subprime crisis
- WorldNetDaily, 20 Nov 2007

From the other side:
• Shrinking-greenback blues - Ted Byfield, WorldNetDaily, 17 Nov 2007

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