The Declining Dollar and What It Means for You

Monday, February 18, 2008 by: Barbara L. Minton
Tags: financial news, health news, Natural News

(NewsTarget) Do you know that since the year 2000, the U.S. dollar has silently depreciated in value against other major currencies by a whopping 52 percent! This depreciation of the dollar goes a long way toward explaining why you feel like you are getting poorer every year even though you make more money.

A Short Dollar History

In earlier times it was readily accepted that fair and honest trade required an exchange for something of real value. First we had the barter system. Then gold became a universal attraction since it could serve as a store of value for those who wanted to save for a rainy day. The original paper dollars were certificates that entitled the holder to redeem them for a dollar's worth of gold. Gold was pegged to the dollar at $35 an ounce.

In 1913, the Federal Reserve System was created by Congress. This was the beginning of the end for U.S. sound monetary policy. The money supply was expanded to fund wars, manipulate the economy and take care of special interests. This was acceptable for awhile since the U.S. had political and military might, and because it had huge amounts of gold reserves.

Predictably, the Federal Reserve began to print money for which there was no gold backing. In the late 1960's the French demanded that the U.S. exchange one ounce of gold for each $35 they delivered to the treasury. It all ended in 1971 when President Nixon refused to pay out any more gold and, in essence, declared the U.S. insolvent.

Then, amazingly, the U.S. began to print money for which there was no backing by hard assets. U.S. authorities made an agreement with OPEC to price oil exclusively in dollars for all worldwide transactions. This meant that the dollar was now unofficially backed by oil. In return, the U.S. promised to protect the oil-rich kingdoms of the Persian Gulf. The radical Islamic movement became the result of this arrangement, as the influence of the U.S. in the Gulf region was highly resented.

In the short term, a country with a fiat currency (a currency not backed by a real asset) can gain economic benefits. As long as foreign countries accept dollars in return for real goods, the U.S. comes out ahead. But the end result of this is loss of manufacturing jobs, dependence on other countries, and a lack of self-sufficiency as foreign countries accumulate our dollars and lend them back to us to finance our consumption of their goods.

Our agreement with OPEC to price oil in dollars strengthened the dollar as the reserve currency of choice. This universal demand for dollars has soaked up all the dollars that fly from our printing presses. This is all great until the time comes when we have printed so many dollars that they become less enthusiastically accepted.

It appears that time is now. In 2000, Saddam Hussein demanded euros for his oil. This was followed by 9/11 and the rush to connect Saddam to the attacks through the idea of weapons of mass destruction.

In 2006, Iran opened an oil exchange. Of course, oil sales on the Iranian exchange are in euros, not dollars.

These initiatives mark the beginning of the dollar's loss of preeminence as the world's reserve currency. Until now, foreign countries have kept themselves well supplied with dollars so they could buy oil which was only sold in dollars on world markets. If the currency needed to buy oil is now euros, these countries have no need for dollar reserves.

Basic economics have always dictated that when the supply of something is expanding and the demand for it is shrinking, the value of it declines.

The Current Situation

Most people think the word inflation means rising prices. But the precise definition of inflation is an increasing supply of money which results in the appearance of rising prices. In real terms, prices have not gone up. It is only that the value of the currency has depreciated so that it takes more and more of it to buy something. An example of this is the price of gold which was 35 dollars an ounce in 1913. The value of gold has remained static, but the value of the currency has depreciated to the point where it takes almost 900 dollars to buy an ounce of gold in 2008.

As the dollar supply continues to expand, and the rate of that expansion increases, the value of the dollar will continue to fall, and more dollars will be required for each purchase.

There are several reasons to anticipate a continuation in the velocity of this expansion of the money supply. Money is needed to fund the war in Iraq, to bail out the banks and lending institutions for the sub-prime and other loans gone bad, to pay interest on the ballooning national debt, to fund exploration for alternative energy sources, to rebuild the infrastructure, to pay Social Security and Medicare benefits to the huge baby boomer cohort, to lend to consumers so they can continue to buy goods from China and other foreign countries, and to pay for the NAFTA superhighway and its electronic surveillance systems. Use you imagination to flesh out this list.

Adding to this outlook is the mushrooming trade deficit. Ships bearing cargos of goods cross the ocean to dock in the U.S. These ships return empty to their ports of departure, many of which are in China. The U.S. has little to sell on world markets, while other countries produce almost exclusively for export to the U.S. Dollars are leaving the country at a record rate. The Chinese and other foreign countries then lend dollars back to the U.S. in the form of their investment in the U.S. national debt. This works fairly well while the economies of these countries are emerging. But as these countries gain economic strength, more of their profits from exports will be needed at home to fund their expansions, and less will be available to continue to prop up the U.S. consumer.

This foreign investment in U.S. national debt has served to allow the U.S. to maintain low interest rates. However, citizens of emerging countries are now beginning to demand their own increased levels of consumption. Money will be needed in the emerging countries for buildings and infrastructure, improved diets, goods and services, and military might. As this happens, countries such as China will start to retain their export profits as Chinese companies sell to the Chinese instead of Americans. The result of this will be that higher interest rates will be needed to entice buyers to fund the U.S. debt. Much more money will need to be printed to pay these higher interest rates.

There is no end in sight for this money supply expansion. As the 2008 election debates have shown, Democrats will need more and more dollars to fund universal health care, tax cuts for the middle class, and increases in the amounts needed for social programs. Republicans will need continued growth in the money supply to fund wars, nation building, and national security programs. Only one of the candidates, Congressman Ron Paul, has revealed an understanding of this monetary situation and a willingness to do something about it.

What This Means for You

The U.S. government tells us that there is price stability, but a trip to the grocery store or the gas station tells us this could not be the truth. As the supply of dollars increases, expect and plan for significantly higher prices and an increase in the speed with which prices rise.

If you plan to travel abroad, you might need twice the amount of money as you thought. Hotels, restaurants, transportation, and entertainment expenses in Europe and other destinations will continue to rise as the dollar sinks. Two margarita's at the bar of the George V Hotel in Paris are now reported to cost over $100.

Planning to retire soon? You might need to rethink your financial position. The hard earned dollars you have saved or invested in retirement plans may buy only half as much or even less than you thought.

If you are pleased with the results on your investments, think again. The stock market gained a few percentage points in 2007, but the money supply increased at a much higher rate. You may have more dollars but they will buy less. If you are a holder of bonds or CD's, your investments declined in value even more.

Of course every situation has a bright side. If you are in the business of catering to foreign tourists, your business is flourishing. Foreigners are flocking to the U.S. to shop, buying designer luggage sets when they arrive, and filling them with all sorts of goods. They report having the time of their lives in the U.S. Their currencies are so strong in relation to the dollar that to them America appears to be a giant fire sale.

About the author

Barbara is a school psychologist, a published author in the area of personal finance, a breast cancer survivor using "alternative" treatments, a born existentialist, and a student of nature and all things natural.