2008-10-06

Simple US Dollar behaviour

It's amazing. The US economy is in tatters and the US Dollar keeps getting stronger. What gives?

Well, we have to remember that oftentimes it is not about one thing getting stronger but other things getting weaker. With a deep recession now being factored into the market's mind, there is a drop in demand for all commodities linked to the US Dollar. Oil is dropping. Wheat is dropping. Iron ore is dropping.

And when all those things decrease in value, so will the US Dollar increase in value. So it's not a case of the US Dollar being a strange haven in the midst of crisis... it's simply a matter of the market factoring in normal drops in demand.

But wait. There's more.

The last two weeks in the US have seen the credit markets dry up. In other words, no one is willing to lend anything out. This means that money is suddenly being valued more highly than before. This, of course, has a deflationary effect, which should erase any inflationary pressures - assuming a dollar crash doesn't happen of course.

I'm still convinced that the US Dollar will crash if the US does not implement austerity measures within the next few months. In the meantime, the dollar is flying up and down and up in price. The current high level of the dollar has nothing to do with its inherent strength... it has everything to do with market volatility.

2 comments:

JD Walters said...

There's a very interesting article in Time by Niall Ferguson, an historian I greatly admire, that's relevant to your austerity argument. He says:

"Back then [during the Depression], conventional wisdom held that the government should try to run a balanced budget in a crisis, even if that meant cutting welfare spending and raising taxes. A generation of economists inspired by John Maynard Keynes taught us that this is precisely the wrong thing to do. Government deficits in a recession are good, the Keynesians argued, because they stimulate demand."

What do you think about that? What do you think of Keynesian economics in general?

One Salient Oversight said...

All things being equal this is a good idea. Running a deficit increases aggregate demand which helps an economy recover while running a surplus or merely balancing the budget may have a neutral or negative effect.

But the major problem with Keynsian "pump priming" (as it is called) occurs if the government in question has been fiscally irresponsible and has run structural deficits for long periods - a situation that the US is in.

Keynsian "pump priming" (governments increasing spending to encourage demand) works only if the government has also run surpluses during economic expansions.

Here in Australia the government has completely erased net public debt. This means that the government can run deficits to encourage demand because it has "room" to do so.

By contrast, US net public debt is approaching 40% of GDP - and that is before you factor in the current expenses associated with the bailout and drop in tax revenue.

Think of it this way. Imagine you had a credit card you could use in an emergency. But let's say you've been using it not for emergencies but to buy yourself better material goods. Suddenly an emergency arrives and the credit card you have is maxed out. That's the situation the US government is in with its levels of public debt.