Kurt Brouwer November 24th, 2007
The declining dollar has generated lots of anxiety even though this type of decline is nothing new. It has also drawn much speculation as to its origin, when in fact that should be quite obvious (see How Far Has the Dollar Fallen? And Why? and The Unloved Dollar) because our currency falls when short-term interest rates fall. With all the ink that has been spilled and all the pixels deployed in online media, this is one of the few articles that clearly spells out what is going on. The columnist, Gerard Baker of the Times Online, also succinctly ties in our much-decried savings rate and the phenomenal increase in U.S. household net worth. It’s quite a piece [emphasis added]:
The dollar’s in decline. Great news! (Times Online, November 24, 2007, Gerard Baker)
‘…Much has been written about the eschatological symbolism of the dollar’s fall and the financial problems that have accompanied it. The apparent consensus among commentators here in America and especially in Europe is that the US has become a kind of Third World country, awash in debt and sinking fast because of a collapsing housing market and a banking system in meltdown. And all this is supposed to reflect in turn a seismic shift in the balance of global economic power away from the US and towards Mighty Europe and Emerging Asia.
Let me take a moment in this season of cheer to raise a few objections. The first and most obvious point is that there are many reasons why currencies move against each other, often in quite dramatic fashion. Seismic, epochal, geopolitical shifts are not usually the best explanation.
Rather, more prosaic facts such as differentials in countries’ short-term interest rates, the rebalancing of temporary financial and economic imbalances and sudden changes in demand for and prices of commodities such as oil produced by particular countries — all of these help explain the dollar’s recent decline.
US interest rates are on a downward trend, while European rates are steady and might even rise. The US still has a vast trade deficit, which is being reduced by a continuing fall in the value of the dollar…
…For the historically short-sighted, let’s remember we have been here before. Between 1985 and 1995, the dollar declined by 43 per cent against the world’s big currencies — somewhat more than it has in the past six years. That period was also marked by dire proclamations of the end of US economic power. But it turned out that in those years the foundations were laid for the strongest period of US economic growth in the past 35 years…
Many people view the six-year decline of the dollar with fear and anxiety and that’s unfortunate. The dollar has fluctuated in a similar fashion in the recent past with no harm done. In fact, there are some tangible positive aspects of the falling dollar — then and now — most notable of which is the sharp reduction in the U.S. trade deficit.
And, do you remember thinking that the U.S. was in decline back in the late 1980s and early 1990s when the world’s other superpower, the U.S.S.R. was collapsing. Or, perhaps you remember those columns about how Japan was taking over our country, just at the point when the Japanese economy entered a long-term decline. Not exactly prescient were they. Baker continues:
…If you’re still sceptical, ask yourself this: is it probable that the shift in the relative value of the dollar and the euro represents a bet by the world’s investors that Europe — strike-torn, productivity-challenged, demographically doomed Europe — is the world’s economic future, rather than the US, or, let’s say, China? All right, but this is different, say the Cassandras. The US has been living on borrowing for years now. The world has finally woken up to America’s addiction to debt — all that growth has been bought on the never-never and now, at last, the bill has come due.
The first thing to be said is that the level of public sector borrowing in the US is very small. The fiscal deficit, at just over 1 per cent of national income, is smaller than in most major European countries. It’s true that America faces a large long-term fiscal challenge from an ageing population. But it’s a smaller challenge than that faced by most of Europe, Japan or even China…
Not only is our Federal budget deficit a very manageable 1.2% of GDP (which is half of the average rate for the past 40 years), but our national debt is modest as well. For more on this topic, see National Debt at $9 Trillion:
…So if government borrowing isn’t the problem, it must be the private sector that’s neck-deep in debt, right? The general view is that Americans have irresponsibly fattened themselves up on widescreen televisions and gas-guzzling four-wheel drives, all paid for with easy credit.
If you look at a simple measure such as the savings rate — the proportion of income that is saved rather than spent — Americans do look pretty spendthrift. It is close to zero in the US, compared with 10 per cent in Europe and much higher in Asia. But focusing on this one measure distorts the full picture of America’s household balance sheets. The reality is this: why save when the value of the investments you own is increasing at rapid rates? The total value of mortgage and consumer debt is indeed up by a massive $5 trillion since 2001, according to the latest figures published by the Federal Reserve.
But consider the increases in the wealth of Americans during that period. The aggregate value of houses alone is up $8 trillion. The increase in the value of stocks held either directly or through pension funds and other investment instruments is higher by another $8 trillion. That’s an increase in net wealth of American households of $11 trillion in less than six years. That’s about $90,000 for every household in the country. As someone once said, 11 trillion dollars here and 11 trillion dollars there and pretty soon you’re talking serious money…’
Many people who denounce our national savings rate do not realize that the savings rate statistic does not include most investments nor does it include assets in retirement plans or even home equity. For more on this, see $57.9 Trillion — American Net Worth.
I applaud Gerard Baker for a succinct and lucid column that beautifully lays out a historically-accurate point of view on the dollar and other current concerns. And, with him, I agree that we should be thankful for our economy, both for its strength,but also for its resilience.
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