Quote:
Originally Posted by mackinac81
Hi!
New to the forum, with a burning question that's been on my mind for months. Why is the dollar losing so much value? And what determines the value of one country's currency vs anothers, like the euro?
If anyone can shed some light on this, that would be fantastic!
Mackinac
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The value of a given currency in relation to another is based on demand, and to a lesser extent, confidence in the government, the economy and the currency itself.
When I say confidence in the government, I don't mean whether or not you like the government, I mean are there smooth transitions of power, or is change effected through revolution or coup, or does the ideology of the government swing wildly?
Confidence in the economy is not whether the economy is doing "good" or "bad" it's based on the rule of law. Are contracts enforced? Are there property rights? Is there an unbiased judiciary (meaning is it separate and apart from the government), are their rulings consistent? Are they published? Do outsiders have access to court opinions and to the courts?
Is the currency consistent in its shape, size, color and denominations, or does it constantly change? And is the currency backed by anything?
The latter are subjective and hard (but not impossible) to quantify, but demand can be quantified.
Let's put all these things together and do some "myth-busting."
Does "inflation" affect the value of a currency? That depends.
What
kind of "inflation" are you talking about?
Are you talking about Wage Inflation? Rising wages result in rising prices. Why? Greed. Adam Smith first observed this phenomenon as Britain began to industrialize in the late 1700s, and wrote about it in his book
The Wealth of Nations. Every time the workers got pay raises, he noted that the shops and pubs across from the factories raised their prices. He attributed it to "the invisible hand" but it's really just greed. People know you can afford to pay more, so they charge you more.
Even though rising wages causes prices to rise, it has no affect on the value of a currency against other currencies. The last time the US experienced Wage Inflation was in the early 1970s. Nixon implemented a Wage & Price Freeze, which appeared to be effective (although I'm not a fan of such controls). Wage Inflation isn't particularly harmful, but it does prevent the Average Joe/Jane from every getting ahead in the game.
Are you talking about Cost Inflation? When there are shortages of commodities, prices rise but wages don't. That can be devastating. The declining value of a currency also causes Cost Inflation. When you have commodity shortages AND a declining currency, it is very destructive, and that's what's happening now. Note that Cost Inflation doesn't cause a currency to decline in value, rather it's the declining currency that causes Cost Inflation.
How about Fiscal/Monetary Inflation? When credit is too cheap or plentiful, it can inflate prices. That is caused by low interest rates. If the central bank (for the US that's the Federal Reserve) does not raise interest rates, then the government must raise taxes and/or cut government spending, and/or reduce the money supply. However, the rate of inflation for Fiscal/Monetary Inflation is only tenths of a percent. It isn't particularly harmful. Yes, over the long term prices will rise slightly, but then so will wages, even though there is a short lag time. However, where you have goods, services or commodities tied to interest rates, it can be very harmful. Look at housing. Housing is definitely tied to interest rates, and when you have low interest rates, it will cause the value of home to rise and become over-inflated, which is what you've been seeing over the last 15 years. Still, it has no effect on the value of currency.
How about Currency Inflation? It can affect the value of a currency, but that only happens when there is Hyper-Currency Inflation (Germany post-WW I is one of the best examples). Currency inflation will cause prices to rise, but wages also rise with prices. The US is not currently experiencing Hyper-Currency Inflation, so that can be ruled out as a cause for the falling value of the US$.
But what about normal Currency Inflation? Is it the cause of the declining US Dollar? No.
The rate of Currency Inflation for the Swiss Franc averaged about 0.50% over the last 25 to 30 years, yet the US Dollar has always been stronger than the Swiss Franc and even now, $1 = 1.01 Swiss Francs.
The rate of Currency Inflation for the British Pound Sterling since 1974 has been 6.3%, more than twice that of the rate of Currency Inflation in the US, yet over the same period, the British Pound Sterling has always been stronger than the US Dollar. Even now the rate is $1 = 0.49 Pound Sterling.
Remember I said one of the considerations is what backs a currency?
For the Brits and the Swiss, they have gold backing their currencies (a percentage of gold not a 1:1 backing), while the US doesn't, but we still have an incongruity as the US$ is worth more than the Swiss Franc, as well as being worth more than other currencies that are backed by a percentage of gold (like the Russian Ruble).
Obviously, there's another factor that has a great impact on the value of a currency, and that's demand.
For decades, almost everything on Planet Earth was bought and sold in US$: oil, natural gas, coal, timber, gold, silver, precious metals, metal ores, minerals, wheat, barely, sorghum, corn, rice, cotton, linen, flaxen, wool, sugar cane, coffee, tea, chocolate and many other things.
The Soviets/Russians were forced to sell their oil and natural gas in US$, Cuba had to sell its sugar cane in US$, New Zealand bought cotton from Egypt and paid in US$, India and China sold their tea in US$ and so on.
That created an artificial demand for US$ and so for decades, the value of the US$ was grossly over-inflated.
With the introduction of the Euro, that changed. EU members trading amongst themselves traded in Euros, not US$, which reduced demand for the US$, and it started to slide.
The former East Bloc countries (Latvia, Lithuania, Estonia, Poland, Cheha, Slovakia, Slovenia, Croatia, Serbia, Macedonia, Bulgaria, Hungaria, and Romania) all operated on a quasi-US Dollar economy. As they moved to join the EU, the switched to a Euro economy or a quasi-Euro economy (in the case of Romania and Bulgaria as they were waiting for entry).
During the Clinton Administration, the US$ slid 39 points against the Euro, from $1 = 1.24 Euros to $1 = 0.85 Euros on Election Day 2000.
Since Bush has been president, the US$ has slid another 23 points to $1 = 0.62 Euros.
And all of it because of reduced demand for the US$
More than 60 countries, and possibly more than 100 countries (we don't know since the US ceased publication of the M3 in March 2006), have dumped 100% of the US$ currency reserves and now trade almost exclusively in Euros, Rubles, or basket currencies.
Russia has dumped 100% of its US$ reserves and replaced them with Euros and gold. Russia now buys and sells all commodities on the world market in Euros and Rubles. Since the opening of the Moscow Exchange in July 2006, the Ruble has gone from $1 = 37 Rubles to an astonishing $1 = 22.6 Rubles.
Japan now buys oil from Norway in Kroners and Iran in Yen. China will soon be paying in Yuan instead of US$ for oil, and Iran's oil bourse opens soon and its oil will be sold in Euros, Rials and Rubles, not US$.
Indonesia left OPEC in May and will initiate its oil bourse soon, selling oil in Euros, Rubles and basket currencies.
Non-OPEC members Singapore and Malaysia are preparing oil bourses in Euros, Rubles and basket currencies.
OPEC Associate Members Angola, Algeria, Nigeria and Venezuela are seeking permission to switch from US$ to basket currencies.
Those 7 countries will cause the US$ to drop about 2 points each, about 12-14 points total, making the US$ worth $1 = 0.48 Euros over the next 24 months.
There is sufficient demand for the US$ from US exports, Canada and Mexico's sale of oil and natural gas in US$, and many Central and South American countries who trade in US$ or who use the US$ as an official currency (like Ecuador) to keep the US$ from sliding below $1 = 0.36 Euros.
However, if the US does not invade Iran and seize the oil fields in Kuzehstan, then the US will not be able to gain control of the Central Asian states (Kyrgyzstan, Kazakhstan, Turkmenistan, Tajikistan and Uzbekistan), and if Russia, China or the EU do, then the oil, natural gas and minerals there will be sold in Euros, Rubles and basket currencies, and the US$ will eventually decline over the next 12-15 years to $1 = 0.26 Euros.
So that's the story on the US$.
There is nothing the Federal Reserve can do to stop it, and for the rest of your life, barring a nuclear war or a cataclysmic event, you'll never see $1 = 1 Euro.
Even if the US invades Iran and ultimately gains control of Central Asia, the best case scenario is that the US$ would eventually stabilize at around $1 = 0.60 Euros.
Creating a North American Union and switching currencies to the Amero would have no effect. It'd be 1 Amero = 0.60 Euros (assuming the US controls Central Asia, if not then 1 Amero = 0.26 Euros). The reason is that the US$ is currently being buoyed by US exports and the sale of oil and natural gas from Canada and Mexico in US$.
As the US$ falls, commodity prices for Americans will rise, but not for the rest of the world. At $1 = 0.62 Euros, a bushel of rice might be 5 Euros, but it's $8 for Americans, and at $1 = 0.46 Euros, a bushel of rice might still be 5 Euros but it'll be $10 for Americans.
You might as well accept the new reality and plan accordingly as prices for commodities continually rise over the course of the next several decades.