Monday, December 20, 2010

The United States Dollar in 2011

I still believe that the long term trend for the United States dollar is downward. For the near term, for 2011, I believe that the United States dollar will remain relatively strong, at least against the other major currencies in the world.

My reasoning for the belief that the long term trend for the United States dollar is downward is based on the fact that the fundamental economic policy of the United States has been and will continue to be one of credit inflation. I explain this stance using the following chart.

The general trend in the value of the United States dollar reflected in this chart is downward. If one begins in March 1973 when the value of the index was set at 100, in November 2010, the value of the dollar declined by 27 percent.
The decline in the value of the dollar since the United States floated the price of the dollar internationally in August 1971 is even greater. Rough estimates place the decline in the value of the dollar from the time it began to float against major currencies until March 1973 between 15 percent and 20 percent. This would place the decline in the value of the dollar since it was floated through November 2010 roughly at 35 percent to 40 percent.

The underlying cause of this decline in the value of the dollar began in the early 1960s as the fundamental philosophy of economic policy in the government shifted to one in which a low level of unemployment became the over-riding goal of the fiscal and monetary policies of Washington, D. C.

The immediate results of this shift in economic philosophy was the destruction of the existing “fixed-rate” international foreign exchange system as capital flows opened up throughout the world and it became impossible to maintain fixed exchange rates in the face of independent national economic policies. A world of credit inflation became the norm.

There were two interludes, that of the Volcker monetary tightening in the early 1980s and the Clinton efforts to balance the government budget in the late 1990s. These periods, however, were just temporary diversions from the basic economic thrust of the policies of both Republicans and Democrats over the full 1961 to 2010 period.

I believe that the longer term trend in the value of the United States is still downward because the fundamental economic philosophy of the United States government has not changed. Credit inflation is still the basis of any policy being proposed by the government and this has been re-iterated over and over again by the economic policy spokesman of the Obama administration, Fed chairman Ben Bernanke.

I expect that federal budget deficits over the next ten years will total more than $15 trillion and the monetary policy of the government will just support the placement of that debt over time.

I don’t see any leader in Washington with the foresight or the strength to build a more sensible economic policy. That is, I don’t see anyone “in place” or on the horizon to pull off efforts at constraint like we saw in the early 1980s or the latter part of the 1990s. Thus, the basic fundamental economic strategy of credit inflation will continue to rule Washington, D. C. for the indefinite future.

The thing that will arrest this decline in the value of the dollar in the short-run is the situation in Europe. In a real sense the United States dollar is being protected in the short-run by the fact that the lack of leadership in Europe exceeds the lack of leadership being exhibited in the United States. One does not see this situation reversing itself in 2011. The value of the United States dollar will not deteriorate further against the Euro (and some of the currencies of other major developed nations) in the coming year.

Here the scale is reversed from the above chart. The Euro weakens against the United States dollar in the early part of 2010 as the sovereign debt crisis worsened in Europe. Around June in the year some confidence picked up as the European “bailout plan” for some of the perimeter European nations seemed to be coming together. As the summer wore on, doubts arose about the potential success of the effort. This backing off continued until the speech administration spokesperson Bernanke gave at Jackson Hole, Wyoming putting forth the idea of what is now referred to as QE2, Quantitative Easing 2.

The European financial situation once again came to dominate this foreign exchange market as the problems in Greece, the accelerating political and economic problems in Ireland, were coupled with downgrades to Portuguese debt and this has now expanded to potential downgrades to Spanish debt and other “non-perimeter” countries like France and Belgium. Confidence in the leadership within the European Union continues to fall: this chaos is seen as the dominating drama still to be played out.

So to summarize: in the longer-run, the value of the dollar can be expected to decline. The reason is that the political and economic leadership of the United States does not seem to have learned much over the past 50 years. However, this decline will be further interrupted for a while as European leadership continues to exhibit its greater incompetency.

There is one other development that I think it will be important to keep one’s eye on and that is the growing movement to conduct world trade in currencies other than the United States dollar. We see that Russia and China have moved in this direction. Brazil is also interested in moving in this direction as are several other countries that have not made a “big deal” out of it yet. The important point is that the “rest of the world” seems to be moving without the United States. This is just another example of the receding influence of the United States in world economic affairs.

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