Is the Dollar Doomed?
As the economy attempts to recover from the crippling pandemic lockdowns, concerns are being raised that the dollar could be at risk of losing its value.
To prop up the economy, the government has exponentially increased spending and debt monetization. The United States is also operating with the largest trade deficit in the history of the nation due to fewer goods and services being produced domestically.
This combination puts downward pressure on the dollar's value that some fear may be detrimental for consumers and the currency.
Before the Federal Reserve started monetizing federal government debt, the treasury department would raise funds through taxation and issuing bonds that the real economy would purchase.
Under this system, the federal government had amassed around $9 trillion of debt leading up to the Great Financial Crisis in 2008-09.
Since then, the Fed has purchased most of the government debt with bank reserves through the primary dealer banks. This has enabled the government to vastly increase its deficit spending and widen its budget deficit. Today, the total government debt is over $29 trillion.
A big issue with the Fed purchasing government debt is that it increases the number of dollars in the real economy chasing goods and services. When entities in the real economy purchase government debt, there is no increase in the money supply.
Many of these extra dollars have been going directly to people through stimulus checks, tax credits, and rent forgiveness.
More dollars chasing the same amount of goods and services, or fewer goods and services, will cause the value of the dollar to depreciate against those goods and services. This leads to higher prices or consumer price inflation like we have already been experiencing in 2021.
Not only is the government spending more money than ever before, but the country is also operating with the largest trade deficit in history.
Trade deficits are achieved by importing more goods and services than the country is exporting. This is illustrated by looking at the country’s real manufacturing output which peaked before the Great Financial Crisis in2007 and has plateaued ever since.
This negative trade deficit brings more dollars into the real economy and places it on the balance sheet of non-bank entities (i.e., people). This put downward pressure on the value of the dollar against goods and services and other fiat currencies.
Looking at the same chart, it is interesting to note that the United States evolved into a net importer of goods and services in the early seventies. In 1971, President Nixon decided to take the U.S. dollar off the Gold Standard. Coincidence?
Are These Twin Deficits Permanent?
The U.S. dollar remains the reserve currency of the world’s financial system and the most widely circulated currency. However, the actions of the federal government and the Federal Reserve have put the future value of the dollar into question.
To try and understand what the future of the U.S. dollar looks like, we must consider whether or not these twin deficits will increase or not.
When the Fed introduced Quantitative Easing in 2008, it was sold as a temporary measure to stop some of the short-term economic bleedings. Since 2008, the Fed has conducted four different rounds of quantitative easing and is presently conducting what some have dubbed “QE infinity”.
Clearly, QE was not a temporary event and its effectiveness of reducing interest rates and driving more lending has recently been put into question. What it does do effectively, is artificially pump up the stock market and create a government and economic addiction to debt.
In 2020, the United States saw a trial run in Universal Basic Income, free child tax credits, and housing handouts that all helped increase the federal debt. If the government continues to pay people to not work, the country will produce fewer goods and services and be forced to increase the trade deficit by importing more goods.
Since interest rates are already near zero, the only way the Fed and the government can continue to prop up the economy is by monetizing more debt and spending more money.
If this trend continues, both the budget and trade deficits will grow larger, and the value of the dollar will only have one way to go. The dollar may indeed be doomed.