The Disappearing Dollar

Those who follow financial markets may be familiar with the term “strong-dollar policy,” which is used by Bush administration officials and Federal Reserve Chairman Alan Greenspan himself. One might assume that such a policy entailed a course of action designed to strengthen the value of the U.S. dollar. However, if we judge Fed policy by Mr. Greenspan’s actions rather than his words, it appears we have a weak-dollar policy, a policy that erodes the value of your personal savings. The “strong-dollar policy” is nothing more than an empty political slogan.

The inescapable truth is that the value of the U.S. dollar has fallen over 30% in the past year, which to most people would not seem indicative of strength. There are several reasons for this decline, but the single biggest factor has been Mr. Greenspan’s relentless increase of the money supply. There are roughly sixteen trillion dollars in worldwide use today, five trillion more than when Greenspan became Fed chair. The law of supply is immutable: When dollars are abundant they are also cheap.

For much of our history a gold standard imposed discipline on U.S. dollar policy, since every dollar printed theoretically was redeemable in gold. Since the last links between the dollar and gold were severed in 1971, the dollar essentially has operated as an article of faith. Christopher Mayer, writing for the Ludwig von Mises Institute, states: “Faith that paper money itself was of any lasting value would have struck our forebears as patently absurd.”

The problem is that faith can be shaken, and the precipitous drop in the dollar shows how investors around the globe are very concerned about American deficits and debt. When government policies in a fiat system are the sole measure of a currency’s worth, the currency markets act as a reliable barometer of how those policies are viewed around the world. Politicians often manage to fool voters and the media, but they rarely fool the financial markets over time. When investors lack faith in the U.S. dollar, they really lack faith in the economic policies of the U.S. government. The Medicare prescription drug bill passed two weeks ago provides an example of this phenomenon – the day after the bill passed, the dollar dropped once again. Investors understand that the new entitlement will cost trillions over coming decades, trillions that will come from Treasury printing presses and further devalue existing dollars.

Ultra-cautious investor Warren Buffett is trading heavily in foreign currencies for the first time, demonstrating his lack of faith in the dollar. His predicament is simple: He holds billions of dollars, and cannot afford to sit by and watch the value of those dollars drop another 30%. By taking a position against the U.S. dollar, his actions speak volumes.

Unlike Warren Buffett, most Americans are stuck with their U.S. dollars. Average people, particularly those who depend on savings or fixed incomes to fund their retirement years, cannot abide the continued devaluation of our currency. A true strong-dollar policy would require constriction of the money supply and higher interest rates, both of which would cause some short-term pain for the American economy. In the long run, however, such a correction is the only alternative to the continued erosion of our dollars.