Globalist Analysis

The U.S. Dollar: From Greenback to Cheapback

What are the keys to avoiding an economic recession of unknown depth and duration?

Takeaways


  • International investors, recognizing the U.S. economy lacks competent helmsmen at Treasury and the Federal Reserve, are fleeing the dollar for the best available substitute — the euro and gold.
  • The Federal Reserve has direct regulatory responsibility for the large U.S. banks — and it is Ben Bernanke's job to require them to fix their business practices and resurrect the market for bonds backed by bank loans.
  • Continuous U.S. administrations have flooded the world with greenbacks, and global investors by now have little confidence in the management of the U.S. economy.

The dollar is trading at all-time lows against the euro and gold for good reasons. Continuous U.S. administrations have flooded the world with greenbacks, and global investors by now have little confidence in the management of the U.S. economy.

During the Bush years alone, the U.S. trade deficit has doubled. The deficit has exceeded $700 billion each of the last three years — and is more than 5% of GDP.

The Bush Administration's energy policy — which emphasizes incentives for domestic oil production and letting rising prices instigate conservation — has failed. Domestic crude oil production is falling, the price of gas has risen from $1.51 to $3.21, automakers have populated U.S. roads with fuel-guzzling SUVs, and petroleum now accounts for about $380 billion of the U.S. trade deficit.

As U.S. purchases from the Middle Kingdom exceed sales there by nearly five to one, the trade deficit with China is about $250 billion.

The Bush Administration has sought changes in China's currency policies through diplomacy — and has failed.

The remainder of the trade deficit is largely autos and parts from Japan and Korea, which through various means have kept the yen and won cheap too.

The huge trade deficit must be financed either by attracting foreign investment in new productive assets in the United States — or by printing IOUs. Investment has only provided about 10% of necessary cash, so each year the United States sells currency, bank deposits, Treasury securities, bonds and the like to foreigners. Those claims on the U.S. economy now total about $6.5 trillion.

That floods world financial markets with U.S. dollars and paper assets that function much like U.S. dollars — what economists call liquidity. And it evokes an iron law of the universe. If you print too much money, it won't have any value.

Until recently, most of that borrowed purchasing power was put into the hands of U.S. consumers by the large Wall Street banks. Essentially, through mortgage brokers and regional banks, those Wall Street banks loaned Americans money to buy homes and refinance their mortgages. In turn, the banks got the cash needed by bundling mortgages, as well as auto loans and credit card debt, into collateralized-debt-obligations — bonds backed by consumer promises to pay — for sale to fixed-income investors, hedge funds and others.

The bankers could get reasonably rich on this scheme — but got greedy. In the summer of 2007, we learned that the banks were not creating legitimate bonds. Instead they sliced, diced and pureed loans into incomprehensibly arcane securities — and then sold, bought, resold and insured those contraptions to generated fat fees, big profits and generous bonuses for bank executives.

Now investors ranging from U.S. insurance companies to the Saudi royals are not much interested in buying bonds created by large U.S. banks — and the banks can no longer make loans to many credit-worthy consumers and businesses. Without credit, the U.S. economy cannot grow and prosper.

The Federal Reserve has direct regulatory responsibility for the large U.S. banks — and it is Ben Bernanke's job to require them to fix their business practices and resurrect the market for bonds backed by bank loans.

Yet, Federal Reserve Chairman Bernanke has offered no plan to address these problems, or even acknowledged the urgency of the situation. And without a well-functioning banking system, the U.S. economy heads into recession of uncertain depth and duration.

International investors, recognizing the U.S. economy lacks competent helmsmen at Treasury and the Federal Reserve, are fleeing the dollar for the best available substitute — the euro and gold.

When George W. Bush was inaugurated, the euro was trading at 94 cents, and gold cost $266 an ounce. Now they are trading at $1.52 and $985 an ounce. That is a plain vote of no confidence by global models in the Bush—Bernanke economic model.

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About Peter Morici

Peter Morici is a professor of international business at the University of Maryland in College Park. [United States]

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