Yesterday I was on CNBC’s “The Call” discussing the negative impacts of a weaker US dollar with Melissa Francis, Larry Kudlow, David Gilmore and Steve Liseman.
There are several negatives to a weaker dollar. First, and probably most importantly, is that a weaker dollar reduces the purchasing power of the consumer. However, in the globally linked economy we live in today there are other implications. A weaker dollar is a deterrent to the attraction of foreign capital investment. If the dollar declines by 20% then foreign investors have to earn 20% on their investment just to break even.
Secondly, it weakens our position as the reserve currency in the world which jeopardizes our position of being able to sell our bonds to foreign holders. As a foreign government or business why would they want to conduct business in a currency that is declining in value?
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Third, it won’t meaningful diminish our trade deficit as 40% of the trade deficit is oil and that is priced in dollars.
Finally, a weaker US dollar impacts the price of goods that we import from our foreign trading partners making them more expensive (inflationary) and thereby reducing the real net income of the average American consumer. This is a double edged sword as well. As products get more expensive which results in a decline in purchasing power we are, in turn, forced to purchase less.
Most importantly, the debasement of the dollar is NOT a new thing. The decline, as shown in the chart, has been going on since the early 80’s. As the decline in purchasing power, combined with lower wage growth, has forced more and more consumers into using credit to maintain a standard of living this in turn has reduced the ability of the economy to grow.
As we have shown in A Structurally Manageable Debt Level, the amount of total credit market debt (of which consumers make up the majority of) rose above 150% of debt to GDP for the first time in the early 1980’s. The introduction of the “live on credit” society led to more consumption but less productive investment and savings which slowed economic growth over the last three decades. This slowing economic growth is a direct result of the continued decline in the US currency and is showing the real net effect of the destruction of purchasing power.
With total credit market debt at more than 350% of debt to GDP with will take a significant about of debt reduction (about $30 Trillion in total) to return the economy back to a level where an increase in savings can occur for the consumer and productive investment can once again lead to economic growth. Then and only then can we really expect to see a long term and sustainable trend of strengthening in the US dollar.