Analyzing the causality (relationship between events) between depreciating USD and its effects is confusing for a non-seasoned financial mind such as mine, but interesting none the less.
- Declining USD means that loaners (other countries like China, Japan, etc) want higher interest rates for a shrinking USD
- Rising interest rates means a decline in business activity and a decline in jobs (aka recession)
- Recession means decline in federal and state government tax receipts
- Declining tax revenue while federal and state spending is increasing means greater budget deficits
- Increase in budget and trade deficit means an increasing current account deficit, resulting in more debt
- Increasing debt means an eventual downgrade in US credit rating and/or lower confidence
- Poor credit rating means higher interest rates, higher inflation, a further downward US economic spiral
Now, Fed needs to worry about recession. It must therefore lower interest rates to increase economic activities.
- Lower interest rates means turning away international loaners, resulting in greater account deficit
- Lower interest rates means more cheap money within US
- Cheap money results in resulting in greater economic activities including M&A, IPO and business expansion/creation
- More business activity might result in placing wrong bets, resulting in huge losses (remember .com bubble anyone?)
- Cheap money also results in greater number of real estate transactions, resulting in higher demand
- Higher demand for real estate means dramatic price increase (aka bubble)
- This bubble bursts when economy is doing well and Fed has to increase interest rates to tame inflation
- Bubble bursts result in losses, which eventually might result in recession
- And the cycle continues, typically every 10 years
Well, here are some other implications of a depreciating USD
- Depreciating USD means higher prices for commodities like oil, gold, silver etc
- Depreciating USD with higher oil prices means increasing inflation in oil nations pecked to USD
- Increasing inflation results in increased pressure to move away from USD (eg Kuwait)
- This would mean oil will be traded in alternate currencies such as Euros, resulting lesser demand for USD, further increasing downward pressure
Interestingly, these events have fermented over numerous years, during which time Allen Greenspan chaired the Fed. I wonder how much of where we are today was an effect of Greenspan's policies. Apparently, I am not the only one ...
"During Greenspan's tenure, America was transformed from the world's largest creditor to its greatest debtor, from the world's mightiest industrial power to a second-rate service provider, and from a nation of responsible savers to one of reckless spenders," - Peter Schiffo
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