Thanks Washington! Why dollar weakness will continue

October 21, 2009

The great Andy Busch of BMO Capital Markets effortlessly explains the link between the current anemic state of the dollar and America’s terrible fiscal situation:

The US fiscal deficit remains the major concern for US dollar reserve
holders and the situation is not improving. Granted, the peak of new
Treasury issuance occurred in August. However, there is no sign from
Washington that spending will be under control any time soon.

This is why you have seen this week US Treasury Secretary Geithner and
Federal Reserve Chairman Ben Bernanke all warn that the US fiscal
deficit must come down or risk disaster. They know that the US dollar
is weakening due to this red ink. 2009 fiscal deficit was an astounding
$1.4 trillion as spending increased from $3.0 trillion to $3.5 trillion
while tax revenue fell from $2.5 trillion to $2.1 trillion. The debt is
now at $12 trillion and is expected to grow by another $9 trillion over
the next decade.

Without any changes to health care, the CBO estimates spending for
Medicaid and Medicare is expected to grow $700 billion over the next
decade. With health care legislation conservatively estimated to add
another $900 billion to the deficit, the numbers are spiraling out of
control. Actually that phrase doesn’t do the situation justice. Maybe
the trailer for the movie 2012 is more appropriate.

Most disturbing is the combined level of federal, state, and local
government spending. According to the OECD, this totals up to 42% of
U.S. gross domestic product. Think about it: 4 out of every 10 dollars
of everything produce in this country is channeled through governments.
Quick poll: who thinks this is the most efficient way to run an
economy?

The point is that the US has embarked on a glide path of spending that
is making the currency weak and US dollar reserve holders knees weak,
too. The Federal Reserve appears to be the only one left in the
government who can do something about it by raising rates. With
unemployment expected to continue upwards, this is not expected to
happen soon.

This means that in the short term, the only change to the downward
direction for the US dollar has to come from outside the country. So
far, Brazil and Canada have acted. In the long term, the US has to act
to change spending or rates. Unfortunately, Congress is likely to
actually increase spending while the Federal Reserve is unlikely to
raise rates.

Therefore, the US dollar is likely to remain weak for a long period of time.

2 comments

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Very good article. As long as little Timmy is in charge, it’ll certainly get worse. American has been on top of the financial pile for many years, and it’s now time to let other countries have a go at it. Our economy has been reset to a lower standard, which is fine, and as soon as the government and wall street figure this out, we’ll all be better able to get on with our lives in the “new” America.

Posted by Frank | Report as abusive

I understand and appreciate the concerns about the dollar. But what I have difficulty with is why some folks want to defend the dollar by raising interest rates now, at a time when our economic recovery is still in a nascent and fragile stage. If the Fed started a rate increase cycle today, wouldn’t that raise the risk of a double-dip recession? And if so, why in the world would we want to do that?

Folks who are expressing their concerns about the dollar have an important message that all of us need to pay attention to. I just think taking action to fix that problem right now is premature. Lets get the economic patient healthy again before we address the side effects of the easy money medicine.

Posted by Bill, Fairfax, VA | Report as abusive