money makes the world go ’round

I’ve been watching the slow decline of the US dollar with fascination. It’s got to be keeping the bankers and investors from sleeping at night, but anyone with a credit card may want to pay attention here.

What am I talking about? Our currency here in the United States has been dropping, relative to other important currencies like the Euro, for months. This has something to do with the truly disturbing amount of debt this country has (I find it hard to comprehend that this much money can even exist–we’re talking about seven and a half trillion dollars). Apparently our money isn’t worth so much when we don’t seem to have anything backing it.

The thing that I don’t think is getting enough press is that this issue affects a lot of things, from the federal goverment right down to each individual. The value of our currency can’t slide forever without other effects, and no one seriously thinks it’ll rise again without a reduction in debt at the national level.

In order to maintain the debt at all, there has to be some kind of incentive for lenders (mostly national banks in Asia, in our case) to keep letting us have that money. So the interest rate goes up, giving them a higher rate of return. But this also means that the interest rate on debt the rest of us are paying off will rise. Up goes your credit card payment, your mortgage payment, and so on. It’s all linked together. Currently the Federal Reserve is keeping that rise slow, but if the Asian banks that have been enthusiastically funding our deficit start to want out, it may increase much more sharply.

What else is happening as a result of this? A cheap dollar is good for American exporters. The cheaper the better, even, because it causes goods made here to be more affordable elsewhere, like Europe. Conversely, it’s very bad for European companies who want to sell their goods in the US, or anywhere both places might export to. It’s also bad for Americans who travel outside the country, or who buy imported products. Note that we import far more than we export, so we’re likely to feel the increased cost of imports more than we benefit from cheap exports.

At the moment, there isn’t a strong impact on trade with Asia. In fact, the whole reason they’re buying so much of our debt is to keep it that way. They depend heavily on being able to offer cheap exports, and if the dollar falls relative to their currencies, that advantage will dissipate.

One of the related issues that comes up in discussions about this whole thing is that people in the United States don’t save very much of their money. A lot of us are not only failing to save, but we’re spending more than we make (that debt thing again). This not only means that we’re succeptible to higher interest rates, but it causes larger structural problems. Instead of putting money into banks where it can finance other things, we’re borrowing. The creditors fund that with money from elsewhere, which does nothing to increase the size of the reserves backing this whole economic system.

There’s an alternative to higher interest rates, but it’s not any nicer. One of the reasons the Fed raises those rates is to control inflation. They could just opt to let inflation increase, which effectively reduces the value of the debt we’re struggling with. The problem is that it also reduces the buying power of your paycheck.

So, to summarize: gigantic amounts of debt are bad for everyone. There’s not much us lowly consumers can do about the federal debt (except attempting to get people in Congress who are equally horrified by it), but this may be a good time to pay off your own debts if you can.

The general belief is that the dollar still has quite a ways to fall to make everything balance out again. I want to see it happen, because it’s an interesting event when you live in the country with the money everyone else around the world banks on for stability, but I’m apprehensive about what else this might bring.

Most of my information on this subject is drawn from The Economist, which has been feeling rather concerned lately: see this week’s Buttonwood column for the latest. Any errors in what I’ve written are likely due to this being a complicated issue I’m still trying to figure out.

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