Money Money Money Money

Today I would like to talk about money, and the US dollar in particular. I have been reading the newspapers like the rest of you, but I am unhappy with what I have been reading. Let me explain.

Since the US dollar has fallen in value, also known as purchasing power, to other major currencies around the world, a number of business writers are writing about how this is good for business. True, a cheaper dollar makes our products cheaper when they are exported. And, it is true that this helps American businesses sell their products overseas. But, what happens to the American consumer? If you are working for one of these companies that sells their products overseas, you may be able to keep your job. But, I hope they give you a raise so you can afford to buy the items we import such as oil.

Not many people think about monetary policy and fiscal policy, and how these two policies work with each other. Newspaper writers come up with some interesting, but in my opinion, off base explanations as to why the cheaper dollar is good. Now I read that the Fed, who has cut interest rates because of our financial services industry crisis is not helping the US dollar by keeping interest rates low. This too is true, but this is not the whole truth.

Investors around the world would continue to buy our US Treasury debt even if interest rates were low, if they knew that the US dollar was maintaining its purchasing power. The problem does not start with low interest rates on US Treasuries. Low interest rate on US Treasuries means low interest rates all around. Remember corporate bonds and asset-backed bonds sell at a spread of so many basis points to US Treasuries. High interest rates impede economic growth, so what are these writer talking about? Business projects get postponed when interest rates are too high and the internal rate of return is not a high enough number to justify the investment in new plant and equipment.

So, where does it all start you may ask. It starts with a sound currency. Monetary policy in this country is not run for the benefit of the consumer, but rather for the benefit of commerce. What is wrong with that? We need to have a growth rate in the money supply to permit reasonable economic expansion. So, what comes first, the chicken or the egg?

I say the egg comes first. And this is my thinking. The US dollar and its integrity is what is paramount in my mind if I am running monetary policy because my populist instincts come down on the side of the individual and the family and their struggle to survive in a complex economy where the large corporation has the advantage.

So, you want to know who is the bad guy in this movie. Take a guess. There are three parts to the economy. The corporate, the consumer and the government. The government spends a lot of money on many many things. All kinds of government programs, some good and some quite wasteful. But it is the spending that exceeds the budget that causes so many problems. I can understand those that want a smaller government, but that is not the whole answer. A smart government knows how to filter out waste and not get bogged down in projects it can not afford or win.

I do not want to get too political because I want my readers to think about economics and see the relationship that political decisions and fiscal policies have on the economy. If you believe that spending $12 billion a month to pursue our policies in Iraq is the right thing to do, there is nothing I can say. Spending more money than the government is taking in requires for the government to borrow. And it is the borrowing and the importing that cause the US dollar to lose purchasing power and fall in value in relation to other major world currencies.

A monetary system that allows the printing of paper money requires discipline. The discipline will come one way or the other. Either the government exerts the discipline and grows the money supply at a reasonable rate for economic growth or there will be discipline exerted outside of government. When foreign investors do not want to hold huge reserves of the US dollar, they exchange them for other currencies. This is no more than supply and demand. Markets are constantly in motion. Prices change as supplies go up and down, and demand goes up and down. If the supply of dollars exceeds the demand for dollars, the price of the dollar in foreign currency terms falls. If there is a trend, the price of the dollar will continue to fall. Borrowing is just a piece of the equation. Importing oil is a piece of the equation. Importing products from China and other nations around the world that manufacturer cheaper than we do at home is a piece of the equation. When you add up all these pieces to the equation, you get a dollar that is cheaper for foreign buyers of dollars and an inflationary effect for the American consumer who must use dollars for their purchases.

What should become clear is that the currency markets and the laws of supply and demand will trump what the United States government does with its own fiscal and monetary policies. The investors outside the United States sees what is happening to the dollar on the currency exchange markets and acts. That is why the dollar is valued where it is at present. If the United States government made a change in its fiscal policy and borrowed less and imported less, there would be a corresponding change in the currency market’s psychology as it relates to the US dollar.

We need to have business writers from the newspapers to understand how currencies operate in the market and what causes money to go up and down in value. And, while we are at it, the same would be good for the politicians to understand this as well. Stay tuned.