People continue to ask me for my opinion of what is happening with the budget deficit and debt ceiling. Why are food prices going up and the cost of gas surging? What is the economic future for our country? I wish I was smart enough to have answers to all these questions…because if I were I would probably be sitting on my own private island.
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First, a very quick history lesson. In 1944, after World War II, over 700 world leaders from the over 40 allied nations met in Bretton Woods, New Hampshire for the purpose of stabilizing and reorganizing the world’s economy. As a result of this conference a new postwar monetary policy was developed. It resulted in history’s first example of a fully negotiated monetary order intended to govern currency relations among sovereign states. The result was the creation of the International Monetary Fund (IMF), the World Bank Group, and the General Agreement on Tariffs and Trade (GATT).
At this conference each country agreed to a monetary policy based on the “Gold Standard.” They each agreed to maintain the integrity of their currency based on a fixed price related to one ounce of gold. They also agreed that the U.S. Dollar would become the reserve currency for rest of the sovereign states (which it still is today). In 1971, the U.S. left the “Gold Standard” and allowed our dollar to become “free-floating fiat currency.” Many debate if this was wise move, but it was largely done to grow our economy.
So around the world, many other countries’ central banks need to use the U.S. Dollar as the reserve currency and keep a supply of on hand. This also means that gold and oil are priced based on the U.S. Dollar. For the past 60 plus years the dollar has remained the dominate currency and allowed our government to freely issue debt and borrow against our economic strength.
But all that has been changing during the past few years and certain events are causing the U.S. Dollar to fall out of favor and literally fall in value when compared to other major currencies. This week the dollar hit a 15-month low against the Euro.
So, what is causing this falling dollar and why does it matter?
First, with our national debt ceiling at $14.2 trillion (and our deficit fast approaching this self-imposed borrowing capacity) our investors are getting nervous. Then just last week Standard & Poor’s (the rating service) downgraded the outlook for our sovereign debt to a negative outlook.
We now have key members of the G8 nations who have been openly discussing moving off the dollar as the reserve currency and instead moving to a global standard.
And, finally you have what was called the second round of Quantitative Easing (QE2) coming to an end. This literal printing of money by the Federal Reserve has pumped over $600 billion into the economy. This has the impact of making everyone else’s dollars worth less…or basically causing the price of goods to rise (think oil, food…).
But is this the cause of oil and gas going up? Historically an ounce of gold is worth about 15 barrels of oil. This correlation has held true for decades with some minor fluctuations (15/1 ounce/barrel ratio). Currently an ounce of gold buys roughly 15 barrels of oil and would support the theory that the real price of oil has hardly changed at all over the last 10 years. What has happened is that a weakened dollar is buying much less.
What does all this mean now and to the upcoming political battle over the U.S. Government debt ceiling? Many are saying if we do NOT increase the borrowing capacity of our government (and remember we currently borrow 40 cents of every single dollar we spend) we will have a Financial Armageddon and throw our country back into a massive recession. There may be some truth to this claim, but what failing to increase the debt ceiling would do is force a balanced budget on our government. They cannot spend what they are not authorized to spend. It would force congress to figure out how to spend the actual dollars they collect (wow, what a crazy idea…sarcasm added intentionally).
The next few weeks may be some of the most important in decades for our country. If the debt ceiling continues to be increased and Washington does not take some drastic measures to strengthen our dollar, our balance sheet, our fiscal position… we may wish another deep recession was the worst thing to happen. We may all learn what the word Hyperinflation means!!!