We don’t necessarily see it on a day-to-day basis, but the value of the dollar is a variable thing.
Once upon a time, that value was based on gold, then when there wasn’t enough gold to back our money, silver became the standard. But in 1933, FDR took the dollar off the gold standard, where our money was backed by physical gold in the vaults of Fort Knox. The final nail in this coffin was pounded home in 1971, when then-president Nixon announced that the US government would no longer convert dollars to gold.
What this means is that the US, like the currencies of many other countries, only has value because we all believe it has value. In essence, the dollar is a product and the value of it goes up and down according to how much of a demand there is for it.
This is one of the more essential functions of the financial markets, centered on Wall Street in New York City, Bond Street in London and other financial centers around the world.
Yet the value of the dollar is clearly dropping. It has dropped over six percent this year, with an expectation by some that it will drop another 20% before the end of the year. Such a loss in value could have serious repercussions, both for the nation and for us individually.
On the most basic level, the value of the dollar is calculated based upon how much people are willing to pay for it on an international level. All currencies are valued based on this exchange rate, comparing the value of one country’s currency to another.
In most cases, they are compared to the US dollar, as it has been the world’s reserve currency since the end of World War II. On the other hand, the dollar’s value is in comparison to other major currencies, like the Euro.
Threats Against the Dollar
The fact that the dollar is the world’s reserve currency is mostly due to the strength of the US economy.
Not to malign anyone who fought in the war, but it was US industrial might, more than anything, else, that led to the winning of World War II.
At the end of the war, we were the only major global power left standing, economically speaking. That’s what led to the dollar becoming the world’s reserve currency and the currency of international trade.
But things have changed since then. The other countries involved in that war have rebuilt, in some cases with US aid. In the process of rebuilding, they have striven to go far beyond where they originally were, growing their economies. Today, some of those countries are our biggest trading partners.
When the European Union was formed in 1993, one of its prime purposes was to create a joint economy that would allow them to compete better in the global market. While their combined GDP is still about 40% lower than the USA, they are working on closing that gap. At this time, their joint economy is third in the world, after the US and China and they are one of the world’s biggest trading blocks.
This has led to the Euro slowly gaining a foothold in taking over as the world’s reserve currency, with roughly 20% of international commerce taking place in Euros, compared to 60% for dollars.
But the EU isn’t the only threat on this particular horizon.
China and Russia have signed an agreement to trade in their national currencies, as have China and Japan.
This process of moving away from the dollar, called dedollarisation, is weakening the US financial position, as we are losing the advantage of having other countries need our dollars to do business. From the end of WWII until 2011, that has helped to prop up the value of the dollar.
Effects of the Pandemic
The COVID-19 pandemic, which swept the world, has had devastating effects on both our national economy and the world’s. With so many people staying home in response to government lockdowns, the demand for products and services declined as well.
This has been most devastating to small businesses, with millions of businesses have shuttered their doors for good; but it has also had a direct affect on the value of the dollar. With a lowering of product demand, there has also been a lowering of international trade by roughly 15.4%.
That has reduced the demand on the dollar, one of the prime factors in driving the price of the dollar.
While we should see a recovery of the demand for the dollar as the pandemic ends and people return to their normal lives, there’s no guarantee of that. An awfully lot depends on what the “new normal” is going to look like and how closely it will match the normal that existed before the pandemic.
We’re already experiencing somewhat of an economic recovery from the pandemic, most especially in the housing market. People are now spending the money they were saving during the pandemic, especially on large purchases.
The housing market is booming, to the point where it has created lumber shortages, driving up the cost of lumber so much that the average cost of a new home is $35,000 more than a year ago.
But we are yet to see just how the international trade markets will shake out.
There’s currently a lot of anti-Chinese sentiment in the country, due to the way that the Chinese government handled the pandemic and suspicions that it was an intentional act against us and the rest of the world.
More and more people are leaning towards accepting that the virus came out of a Chinese bio-laboratory and are having a hard time accepting the idea that it could have been accidental.
At the same time, US businesses are struggling to recover from the pandemic, with many retail outlets shutting down stores in an attempt to avoid bankruptcy.
Small manufacturers are suffering as well, unable to take up the slack. We are literally in a place where we need China’s trade goods.
We’re Out Own Worst Enemy
Perhaps the biggest part of this though is contained within our borders. More specifically, it’s housed within the halls of Congress. All those stimulus checks that everyone was happy to receive have come with a price; that of over four trillion dollars.
Congress went on a spending spree, creating several trillion dollar plus “relief” bills, which included much more than relief to those who suffered from the devastating effects of COVID on the economy.
Unfortunately, this has taught Congress something that they had merely suspected before; that they can spend massive amounts of money with impunity.
While the various COVID relief bills did contain money for relief and economic stimulus, much of it was pure pork, pet projects for one political party, powerful lawmaker or another. It was disguised as help for the average person or small business; but it was really about getting money to their friends; crony capitalism at its best.
Billions were sent abroad from those packages, to pay for pet projects in other countries. Other billions were given to cities to cover their financial shortfall, disguised as “Coronavirus reparations” but actually covering poor policy decisions that had put those cities in financial straits before the pandemic started. I could go on, but there’s no sense in raising my blood pressure.
There are three clear results of creating all this money out of thin air. The first is that Congress is on a spending spree, looking to see how many other trillion plus dollar packages they can vote into law. The second is that they have led to the expected inflation.
Somehow our lawmakers have never learned the lesson that you can’t create money out of thin air, without watering down the value of existing money. That’s the true cause of inflation, not greedy companies raising prices.
We are currently facing the highest inflation that we’ve seen in over a decade. All through both Obama and Trump’s presidencies, inflation has been hovering around one percent, sometimes lower. Yet we are now facing inflation of nearly five percent, the highest in over 30 years.
International markets have taken note of this and are concerned about the US economy in general.
The good news about the coronavirus vaccine has actually added to this inflation, as well as lowering the pressure on the price of the dollar, helping it to go down.
With the vaccines now available, there is increased hope that economies around the world will recover. That has, in turn, reduced the need for international investors to buy dollars, as a hedge to protect their money.
While the dollar is always seen as a secure investment, there are other places where they can invest their money and expect a better return on that investment.
Should We Be Concerned About All This?
All of this is actually very concerting. Not only does it speak of the US economy becoming more shaky; but we can expect the cost of goods to increase due to inflation.
That will continue the upwards push on inflation, which may very well stick around for a while.
We’re already seeing major increases in the cost of some items, like the aforementioned lumber, as well as gasoline.
Overall, energy prices have gone up, as well as the cost of food. We can expect these things to continue climbing, as well as the cost of housing.
Overall, the buying power of the consumer will decline, as well as the amount of disposable income we have available to spend.
Less disposable income means less money for buying what are considered non-essential purchases, such as clothing, new cars and new televisions. While people will still be buying those items, they will also be hanging on to them longer, rather than replacing them. That reduces the sales of those categories of goods, affecting jobs.
Basically, what this all boils down to is that we’re heading into another recessionary period. The Federal Reserve Bank is doing everything they can to stop that, with the prime interest rate at 3.25%; lower than it was even a year ago. But any action the Fed takes doesn’t have a visible effect on the economy for several months; sometimes over a year. So it may be some time before we see things turning around again.
As long as Congress keeps spending money like kids in a candy store, we can expect the value of the dollar to keep dropping and inflation to keep rising. But there doesn’t seem to be any desire to change that around in Washington, with Democrats pushing a two-trillion plus dollar “infrastructure bill” that has little to do with infrastructure and President Biden proposing a six-trillion plus dollar federal budget, by far the largest we’ve ever seen.
Just like a parent who looks at their teenager’s spending habits, when that child asks for more money, the world’s financial markets are going to see the trend in irresponsible spending in the halls of Congress.
As long as it continues, they’re not going to be any more interested in giving us money, through buying US bonds, than that parent would be in giving their child a hundred dollars of their hard-earned money to blow.