Wednesday, April 8, 2009

Why the Value of the Dollar is Important, and why the Obama Administration Will Destroy It

By Phil Fraietta

In the midst of this recession it seems like it is impossible to pick up a newspaper and not see multiple stories concerning the economy. Interestingly enough, however, very few, if any, of these stories seem to discuss the matter of currency value.

It is an issue that has long lost interest in the United States. The policies of the Bush Administration substantially weakened the dollar, and the policies of the Obama Administration may very well end up weakening the dollar even further. But, while the issue may not receive much attention, it is one that is arguably the most important long-term issue facing the United States today.

Currently, Congress and the Federal Reserve are directed under law to make decisions in an attempt to attain short-term full-employment rather than in the best interests of the dollar. This is because according to Keynesian economic theory, the value of the dollar has little effect on the macro-economy and is only important to Americans who frequently travel or shop abroad. What the Keynesians fail to realize, however, is that the value of the dollar largely directs international investment into the United States.

But one may ask, what importance does international investment really have? International investment is of importance to the United States because it is what allows us to fund our budget deficit.

As most Americans know, we currently face a tremendous budget deficit that cannot reasonably be balanced for years to come. To make matters worse, the Obama Administration has determined that the deficit is not an important issue to face in these recessionary times and has continued to increase spending at the Federal level. Assuming the President does not retreat from his promises of tax cuts for 95% of Americans, it seems as if all of this spending cannot possibly be funded.

That is where international investment comes into play. In order to fund a deficit of such drastic proportions, without reducing government spending or increasing taxation, the Federal Government sells bonds to international investors. With doing so the government provides itself with the necessary income to fund its deficit.

But what people seem to forget is that these international investors must eventually be repaid. In this global recession, it is not crazy to assume that international investors would want to cash the bonds soon. After all, the tank of the stock markets has lost investors a lot of money and cashing in bonds would get these investors some of their money back.

So, assuming that foreign investors do suddenly begin to cash their bonds, how in the world could the Federal Government possibly pay? It seems the only way to do so is to simply print money. Obviously, printing money increases the supply of money internationally, which due to the laws of supply and demand, will cause the dollar to depreciate. If the dollar depreciates enough, we may very well find ourselves in a never-ending cycle of high inflation.

To explain, assuming the stimulus plan does work to stimulate demand and helps us escape the recession, foreign investors will be ready to invest again. However, if the dollar has depreciated sharply it will act as a disincentive to invest in American bonds because the investor will be repaid in with a weakened dollar. This means that the Federal Government will be forced to continue to print money in order to finance the deficit. Because printing money increases the money supply, it works to stimulate demand and thus creates inflation.

This is precisely what happened in Zimbabwe, where the Government turned to money printing in order to fund its deficit and now finds itself in a severe hyperinflation where prices are said to double every 24 hours. While it seems unreasonable that the United States could ever find itself in such a severe hyperinflation, it is not unreasonable to expect that printing money will cause inflation rates near 10% (an extraordinarily high number in an economy like the United States). It is now obvious why the value of the dollar is of such importance to the United States. If the Obama Administration continues to run the nation into debt and finances that debt with foreign investment, the dollar will be weakened. And, if we allow the dollar to be weakened enough, we may reach a point where foreign investors are no longer interested in investing in the United States. If this becomes the case, we can expect high inflation for the years to come.

This is not to say that we are hopeless. If the Obama Administration does act to balance the budget by reducing government spending, and the outdated Keynesian laws to strive to attain short-run full-employment are eliminated, we can avoid this fate.

To conclude, if the Obama Administration is concerned with the idea of hope, like the President claimed to be in his campaign, then this is the time to prove it.

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