Kutner, Robert (2004) “The budget mess that Bush can no longer ignore” BUSINESS WEEK, 11/22 P. 36

Day after day, dollars are sold on the “spot” market. This market sells dollars for francs or the Canadian loon or any other currency in the world. For many years, the Canadian dollar was 66 cents to an American dollar. That meant that the dollar could buy more than the loon. However as this is being written, the loon is 88 cents and gaining on the dollar.

What this means is that banks, and monetary institutions around the world have less faith in the dollar. Why? Folks who trade in the “spot” market believe that the USA will not reduce their debt. Further, investors and/or buyers believe that in the future, the USA will continue to borrow. About a year ago, the dollar started to crash and banks in Japan and China bought dollars to keep our currency afloat. Today, roughly 50% of our dollars are owned by Americans and the other 50% by Japan and China.

If the dollar crashes again, there could be a “run” on the dollar as buyers of currency panic sell to anyone who will buy the dollar. If this is the case, what might happen?

First, America must raise interest rates. That tells the rest of the world that we will pay higher amounts of money if they will buy our dollar. Raising interest rates will slow down our internal economy.

Second, to avoid the collapse of the internal market, governments generally print more money. This means that as the dollar inflates, consumers believe that it is best to buy now rather than later when prices will continue to climb.

Third, as prices continue upward, those that can strike for more income raises will do okay. The rest of the population suffers.

Fourth, as prices and income increase, this creates stagnant growth based on inflation rather than productivity. This is called stagflation. On the whole, the economy starts to decline gradually.

Fifth, on the bright side, it is possible that goods from cheap labor overseas create higher prices so that Americans really do start purchasing cheaper American goods. In the meantime, the economy drifts and services such as meals for poor children at lunch time are cut or a new weapon is not constructed.

Supply siders do not believe that the weak dollar is a problem. Keynesians believe that it is a big problem.

Perhaps, the future will tell us who is right.