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U.S. could be hit hard if world loses faith in dollar

Updated: May 3, 2013 12:14PM



Originally published: June 19, 2003

I should have put my money where my mouth is. In February I wrote a column about hedging your bets on the dollar by purchasing foreign currency CDs at Everbank.com. At the time the euro was trading about one-to-one with the dollar. Today, it takes nearly $1.20 to buy one Euro. So when I leave for Europe today, everything will cost 20 percent more!

There are a couple of lessons here. No. 1 is that I’ll have to shop 20 percent less to stick to my budget. That’s what I get for not practicing what I preach. But since this trip isn’t a shopping spree, this column will stick to lesson No. 2: the importance of the dollar as a global currency and the need to maintain confidence in its value.

Lately the headlines have been full of talk about the “falling dollar.” It’s an abstract concept unless you’re leaving the country. But, in theory, a falling dollar means that everything we import should cost more because foreign businesses raise prices to offset the lower value of the dollars they receive in payment. And the stuff that American companies sell to foreigners should appear to them as a bargain, because their stronger euro will buy more U.S.-made products.

For example, if you’re in the market for a Mercedes, the price of your dream car should go up. That’s in theory. But in fact, German carmakers are desperate for sales to keep their factories going, so they’re accepting the currency loss and keeping prices stable. The impact of the falling dollar hasn’t hit Americans with higher import prices--yet.

Race to the bottom

Every country wants to keep its own economy growing. And since we live in a global economy, exports play an important part in keeping factories humming. Since cheaper currencies help make exports more attractive, we’re starting to see competing currency devaluations.

How do you make your currency less attractive? You can cut interest rates. That’s what the United States has done. And the EU responded by cutting interest rates in their markets. No one seems to be worried about rising prices of imports--inflation. In fact, most countries, including the United States, are more concerned about deflation. So they see cutting interest rates as a way to get an edge in the world of global trade.

The other way to cheapen your currency is not so benign, however. You can cast doubt upon the future value of your currency by signaling that you’re willing to print a flood of new money, to spur your own domestic economy. Who would want to hang on to money that is losing value every day? And that’s exactly what the United States is on the road to doing.

Last November, Fed Governor Ben Bernanke promised in a speech that the Federal Reserve would do everything in its power to keep America from sliding into deflation. And he specifically noted that if cutting interest rates didn’t work (of course, rates can only go to zero), then the Fed would use all its powers to inject money into the system by purchasing a wide range of assets, including foreign government debt. Those Fed purchases are paid for by creating “new money” that flows into the economy.

In effect, the Fed governor was promising inflation--a signal that the gold market and the currency markets understood immediately. Gold rose in value, as the one currency that cannot be created by governments. The dollar fell in value, because the global smart money realizes that creating new money devalues the old.

Astoundingly, two-thirds of U.S. paper currency is circulating in foreign countries. In fact, 90 percent of U.S. $100 bills are held abroad. That’s because those holders, frequently in the underground economy or drug trade, figure U.S. currency is the best store of value for their nefarious business dealings. If they were the only ones getting ripped off by a currency devaluation, no one would mind.

Trust in the dollar

But it’s the trillions of dollars that foreigners have invested in the United States, in our economy and in our stock and bond markets that’s really in jeopardy. If those investors stop trusting in the future value of the dollar, the impact could be devastating.

No country in history ever made itself wealthier by debasing its own currency. And that’s The Savage Truth. And it’s also my excuse for spending a few more dollars on my trip, because they might be worth even less at this time next year!

Terry Savage is a registered investment adviser and is on the board of directors of the Chicago Mercantile Exchange and McDonald’s Corp.



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