Strictly Monetary VI: Dollar Downward Spiral

In Advice, Criticism, Financial, Strictly Monetary: A Series on April 22, 2011 at 3:42 PM

In January of 2010 I pointed to the decline of the American dollar as being permanent. I spat at the idea that it was simply a slump. When the stock of companies like Apple and Google were at lows, I advised people that while they were good companies, there was no way I was going to hold anything in American dollars. This past week, Standard & Poors rating agency issued American bonds a negative warning, citing that it had serious concerns as to whether or not the American government will get it’s fiscal situation in order, confirming something we’ve known for years. So, what took so long?

Here’s the thing – I’m not in the business of making predictions. This is the most basic accounting exercise imaginable. I’ve been waiting for this warning since 2003, when the U.S. unnecessarily engaged in a war with Iraq, a fiscal tipping point that sent their budgets into a downward spiral. The Bush administration ignored warnings from their accountant department that such military action was unsustainable. If your accountant needs a 20-year plan to balance the budget and you respond by telling him that it’s okay because you can simply print more money, there will ultimately be consequences to that. Why then, did it take the worst financial crisis since the Great Depression for the entire world to change its view towards America?

The Conventional Wisdom (as John Kenneth Galbraith would say) was that we were living in America’s system. The free market ideas that once belonged to Adam Smith had been adopted and controlled, economically and politically, by the United States. They wrote the rules and they would ultimately ensure that the value of their currency would not only remain supreme, but that the economic welfare of all other nations depended on the strength of the American dollar.

As we’ve covered in Strictly Monetary, America has done its part to ensure that the world is vested in the strength of the American dollar. It was the world’s reserve currency for close to century. The world felt compelled to invest in American stock and real estate, and America was the key purchaser that helped developing nations grow. It wasn’t in anyone’s interests to scrutinize the ugly books and records of the sole nation holding up the world’s economy. There was the sense that the United States would eventually figure out how to reduce its debt before it spun out of control. Who else would you have batting in the bottom of the ninth in a losing situation? Who was willing to bet against these Yankees?

But catastrophic events such as the Great Depression and the more recent global financial crisis have a way of changing the Conventional Wisdom. Galbraith spoke of how influential John Maynard Keynes’ economic thoughts were, simply because they provided a solution to the greatest economic problem the world had ever seen in the Great Depression. He provided wisdom when everyone was all ears. In fact, most economists agree that Keynes’ ideas have been horribly misunderstood and extended far beyond their original intentions. Today, we are witnessing the emergence of a new Conventional Wisdom; one that says America will no longer be the central force behind the global economy. The States are still great in the bottom of the ninth, but there’s not much you can do when nobody else wants to play baseball.

Despite the speed of information, the Conventional Wisdom takes time to change because it has to do with changing our fundamental beliefs. There is so much information out there that we can easily find a fact or situation confirming that our line of thinking is valid. Take housing prices in Canada as an example. Housing prices have crashed in Canada before during the eighties. They have crashed all around the world more recently. Yet, ask first time homeowners about the value of their homes, and they’ll struggle to see how prices could possibly drop.

The condition of our thoughts hasn’t changed since Galbraith coined the term Conventional Wisdom in the fifties, but in the information age, a generation feels like a lifetime. I’ve only been waiting for this to happen since 2003, but others called for this decline as far back as the 70s, citing America’s situation as being unsustainable. The difference today however, is that the world’s view is changing. The new wisdom says that America, while staying relevant, has lost its dominant. There is a ridiculous amount of information to confirm this idea.

United States budget is in political disarray, it refuses to touch military spending – the largest portion of its budget along with social security, it’s engaging in wars without the budgetary approval of Congress, it’s proposed to slash spending and increase taxes that might spawn another recession, it can’t seem to decrease unemployment…all these things simply confirm the new and emerging Conventional Wisdom, that America is in line for sustained economic stagnation. Gone are the years of world leading growth. Now America is just a louder and less stable version of Canada.

But since I’ve had this belief for years, I need to search for evidence to disprove this downward spiral theory. To date, the strongest dis-confirming idea I’ve found is this one:

America has, and will, continue to lead the world with innovation and ingenuity. America’s unique free market system and free wheeling financial infrastructure will yield rewards in ways that are unimaginable, because the smartest and brightest people go there to create the advancements of the future.

I have no argument against this. I wholeheartedly believe in the power of free markets solving problems organically better than the central planning methods of a nation such as China. But proponents of this theory are wrong in thinking this will somehow produce miracle growth on the balding head of the eagle.

In fact, the global economic machine has been designed for China to profit from America’s ideas. China has shown very little respect toward any intellectual property rights. Their specialty is, in fact, to copy and mass produce everything. That’s the essence of their wealth. The world enjoys cheaper prices because of China’s role in the global assembly line.

America has permanently given a share of its future profits to China even before comes up with the idea. The very free market system that America has promoted and profited from for generations will now, in an ironic twist, prevent America from regaining its world dominance. Americans will continue to attract the brightest brains of the world, but those ideas can’t be exploited without China’s cooperation.

This is a large and unshakable phenomenon in the global economic system. This dramatic shift in power is happening and it’s not going to wait for us to believe in it.

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