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Author Topic: The Looming Dollar Crisis
David Ricardo
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This is an especially sobering piece from the Economist about the looming dollar crisis.

http://economist.com/opinion/displayStory.cfm?story_id=3446249

quote:
The disappearing dollar

How long can it remain the world's most important reserve currency?

THE dollar has been the leading international currency for as long as most people can remember. But its dominant role can no longer be taken for granted. If America keeps on spending and borrowing at its present pace, the dollar will eventually lose its mighty status in international finance. And that would hurt: the privilege of being able to print the world's reserve currency, a privilege which is now at risk, allows America to borrow cheaply, and thus to spend much more than it earns, on far better terms than are available to others. Imagine you could write cheques that were accepted as payment but never cashed. That is what it amounts to. If you had been granted that ability, you might take care to hang on to it. America is taking no such care, and may come to regret it.

The cost of neglect

The dollar is not what it used to be. Over the past three years it has fallen by 35% against the euro and by 24% against the yen. But its latest slide is merely a symptom of a worse malaise: the global financial system is under great strain. America has habits that are inappropriate, to say the least, for the guardian of the world's main reserve currency: rampant government borrowing, furious consumer spending and a current-account deficit big enough to have bankrupted any other country some time ago. This makes a dollar devaluation inevitable, not least because it becomes a seemingly attractive option for the leaders of a heavily indebted America. Policymakers now seem to be talking the dollar down. Yet this is a dangerous game. Why would anybody want to invest in a currency that will almost certainly depreciate?

A second disturbing feature of the global financial system is that it has become a giant money press as America's easy-money policy has spilled beyond its borders. Total global liquidity is growing faster in real terms than ever before. Emerging economies that try to fix their currencies against the dollar, notably in Asia, have been forced to amplify the Fed's super-loose monetary policy: when central banks buy dollars to hold down their currencies, they print local money to do so. This gush of global liquidity has not pushed up inflation. Instead it has flowed into share prices and houses around the world, inflating a series of asset-price bubbles.

America's current-account deficit is at the heart of these global concerns. The OECD's latest Economic Outlook predicts that the deficit will rise to $825 billion by 2006 (6.4% of America's GDP) assuming unchanged exchange rates. Optimists argue that foreigners will keep financing the deficit because American assets offer high returns and a haven from risk. In fact, private investors have already turned away from dollar assets: the returns on investments in America have recently been lower than in Europe or Japan (see article). And can a currency that has been sliding against the world's next two biggest currencies for 30 years be regarded as “safe”?

In a free market, without the massive support of Asian central banks, the dollar would be far weaker. In any case, such support has its limits, and the dollar now seems likely to fall further. How harmful will the economic consequences be? Will it really undermine the dollar's reserve-currency status?

Periods of dollar decline have often been unhappy for the world economy. The breakdown of Bretton Woods that led to a weaker dollar in the early 1970s was painful for all, contributing to rising inflation and recession. In the late 1980s, the falling dollar had few ill-effects on America's economy, but it played a big role in inflating a bubble in Japan by forcing Japanese authorities to slash interest rates.

This time round, it is a bad sign that everybody is trying to point the finger of blame at somebody else. America says its external deficit is mainly due to sluggish growth in Europe and Japan, and to the fact that China is pegging its exchange rate too low. Europe, alarmed at the “brutal” rise in the euro, says that America's high public borrowing and low household saving are the real culprits.

There is something to both these claims. China and other Asian economies should indeed let their currencies rise, relieving pressure on the euro. It is also true that Asia is partly to blame for America's consumer binge: its central banks' large purchases of Treasury bonds have depressed bond yields, encouraging households in the United States to take out bigger mortgages and spend the cash. And Europe needs to accept, as it is unwilling to, that a weaker dollar will be a good thing if it helps to shrink America's deficit and curb the risk of a future crisis. At the same time, Europe is also right: most of the blame for America's deficit lies at home. America needs to cut its budget deficit. It is not a question of either do this or do that: a cheaper dollar and higher American saving are both needed if a crunch is to be avoided.

Simple but harsh

Many American policymakers talk as though it is better to rely entirely on a falling dollar to solve, somehow, all their problems. Conceivably, it could happen—but such a one-sided remedy would most likely be far more painful than they imagine. America's challenge is not just to reduce its current-account deficit to a level which foreigners are happy to finance by buying more dollar assets, but also to persuade existing foreign creditors to hang on to their vast stock of dollar assets, estimated at almost $11 trillion. A fall in the dollar sufficient to close the current-account deficit might destroy its safe-haven status. If the dollar falls by another 30%, as some predict, it would amount to the biggest default in history: not a conventional default on debt service, but default by stealth, wiping trillions off the value of foreigners' dollar assets.

The dollar's loss of reserve-currency status would lead America's creditors to start cashing those cheques—and what an awful lot of cheques there are to cash. As that process gathered pace, the dollar could tumble further and further. American bond yields (long-term interest rates) would soar, quite likely causing a deep recession. Americans who favour a weak dollar should be careful what they wish for. Cutting the budget deficit looks cheap at the price.



[ December 07, 2004, 01:31 AM: Message edited by: David Ricardo ]

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Redskullvw
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Hurm, maybe you might want to see simmular remarks made by many economists in November of 1978.
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ed
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i feel i should point out that the author is assuming that the US deficit as well as the value vis a vis the euro and yen will continue to change at current rates. this is not however a reasonable assumption, IMHO.

ed

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WarrsawPact
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I think the dollar *should* fall.

Look folks, we've got an insane trade deficit here. Why is this?
A strong dollar makes our exports cost more and makes imports to here from weaker-currency economies cost less.
We buy up all this because we CAN: people will keep on investing in our country so long as the stock market holds its head high and keep investing in the dollar if it remains strong.
The benefit is it keeps consumer good s here nice and cheap.
The downside is we get the mentality that we can slide into debt forever. So we buy things, mainly manufactured goods, and the only place we have an advantage in our balance of trade is in services.

Hold that thought. We're buying manufactured goods, which cost less to import due to a strong dollar, but we're exporting less goods because it costs everyone else too much to buy our stuff.

This destabilzies everything. What do we do with all that debt? We have to borrow. We take loans from massive banks, we write up T-bills (the government's own Debt Machine that can't be managed down from the original issuance rate), we borrow from John Q Taxpayer over the long haul just to pay the interest on this staggering debt.

Why, when your debt is over $7.5 trillion, and your annual trade deficit is around $400 to 500 billion, do you want a STRONG currency? Why a strong currency when consumer debt is so bleeding high that everyone I know is up to their ears in it?
If you want to pay off debt, you weaken the dollar. And debt is our biggest problem here. It keeps on building whiel people live three steps ahead, buying things they can't even begin to afford even thoguh they're already in debt to support a lifestyle built on imported goods!

If you want to stabilize the way individuals and the government pay off debts, and you want to lower the trade deficit, you want the dollar to fall and fall far. It's that simple.
If you are concerned that other countries are holding us hostage by holding watertight onto such large reserves of dollars, make the dollars they're holding worth a little less to your economy so that if they sell them off, you've already got a manageable way of dealing with the debt and drop in "foreign investment".
If China doesn't have the dollar reserves (they've wathced 30% of the value simply disappear, and that hurts big time), they've got to manage their own currency like a real conutry does. The yuan will shoot up in value by an absurd amount and release the pressure valve on the Euro.

GWB is plagued by the prospect of a huge debt being propped up by a fat trade deficit. So his administration is weakening the dollar, and it's not entirely a bad thing. It has a few risks and it has a few downsides, but the upsides are massive.

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WarrsawPact
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And please note the effect on China: they won't be able to export goods so cheaply. It has a double-good effect on our trade deficit and on the Asian "tiger cubs" who will be able to pick up the slack and yet won't have such monolithic control over the potential of our economy. We won't have to bow to Chinese demands regarding Taiwan and the Korean Peninsula, because that elephant in the room will be gone and the other elephant will be our own might ("90,000 tons of diplomacy").

We're basically daring China and others to sell our dollars. We want them to. Prepare for imported goods to cost more, resulting in a non-tariff protectionist policy and less jobs leaving the country.

Well, that last part I'm not terribly happy about, because I think that low income, low skill manufacturing jobs leaving the country tends to be a good thing in the long run, leaving us to tend to those parts of the service, information and technology sectors that other people can't easily compete in. I like the idea of educating the country, taking people out of the workforce for extended periods of time to increase wages while maknig them productively unemployed (supply and demand for labor).

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WarrsawPact
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Then again, this requires that Americans actually start saving. But there's hope for that, especially since Bush's tax plans arefocused in that direction.

Read from Q&O:
quote:
The Bigger Fiscal/Tax Picture
Posted by: Jon Henke

By all accounts, the US is drowning in the Twin (Budget and Trade) Deficits. The effect on the dollar has already become obvious, and Paul Volker has suggested there is "a 75% chance of a currency crisis in the United States within five years". Heightened interest rates, recession, and the fall of the dollar as a world currency are being discussed as anything from distinct possibilities to probabilities.

The Democrats--partly because, hey, there are points to be scored--focus a great deal on the budget deficit, but economists are pointing to a the burgeoning US aversion to saving.

In 2000, former Fed CEO Bob McTeer said: "We are not saving enough domestically to finance our domestic investment". Indeed, things have only gotten worse, with the Personal Savings Rate in general decline over the past few years.

[and a picture inserted here]

As Laurence Summers noted in October, 2004: "At 1.5 percent, the national savings rate is about half of what it was in the late 1980s and early 1990s, when national saving was last a major item on the U.S. policy agenda. In fact, net investment has declined over the last four or five years in the United States, suggesting that all of the deterioration of the current account deficit can be attributed to reduced savings and increased consumption rather than to increased investment."

Clearly, Houston, we’ve been having a problem. The Economist defines it well: "America’s current-account deficit reflects inadequate domestic saving. Cutting it therefore requires that American saving rises or that demand in the rest of the world increases. A fall in the dollar would be a by-product of this adjustment. But without an increase in saving, even a big fall in the dollar would make only a small dent in America’s current-account deficit."

Since there’s no National Nanny to cut up our credit cards and reign in our rampant consumerist ways, it seems we’re left with three options:

1. An immediate reversal in governance, with the budget deficit coming under sustainable control and Congress no longer disposed to running up massive debts. [ha!--ed.]

2. A crisis, which forces us to find a more sustainable equilibrium. But....very, very painfully.

3. A voluntary increase in the savings rate.

If that last seems like the most agreeable course, then we’re on the same page. But however would such a thing happen? People, after all, are buying lots of stuff because they want to buy lots of stuff. They’re unlikely to change that because some geek releases a paper containing Warnings of Dire Macroeconomic Consequences!

Well, no. They’re not. But people do respond to incentives, and it strikes me that the current Bush administration tax policy may be pursuing exactly this course. From "The Economic Agenda" - a speech by Gregory Mankiw, Chairman of the Council of Economic Advisers....

quote:
A large scholarly literature in economics has pointed out that another way to strengthen the economy would be to reduce the tax bias against saving and investment inherent in the current system. This literature suggests that the optimal tax system would use consumption, rather than income, as the tax base. Under an income tax, a person who immediately spends all his wages pays lower taxes over his lifetime than his neighbor who earns the same amount but chooses to save and invest in order to enjoy a more prosperous retirement or to leave a bequest to his children. By contrast, under a consumption tax, these two families would pay the same tax in present value. Savers would no longer be disadvantaged relative to spendthrifts. The result would be greater saving, increased capital accumulation, and higher growth in productivity and wages.

At first, the idea of taxing consumption rather than income can sound like a radical change from the status quo. But the idea seems more natural when one realizes that the current tax code, while nominally an income tax, is actually a hybrid of an income tax and a consumption tax. Over the past several decades, Congress has amended the income tax many times to encourage saving. Policies such as individual retirement accounts and 401K plans exempt saving from taxation and, in doing so, move the tax base from income toward consumption. Similarly, last year’s Jobs and Growth bill lowered taxes on dividends and capital gains; by reducing the double taxation of income from corporate capital, that bill can also be seen as taking a step toward taxing consumption.

I’ve been writing, for as long as I can remember writing about it, that the Bush tax cuts were not originally intended to be a stimulus package...they were structural changes. This seems to back that hypothesis, and it gives me hope that the Bush administration’s tax policies will have some positive structural effecs on the US economy.

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WarrsawPact
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Looking forward to your response David. Others here are undoubtedly better economists than I.
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WarrsawPact
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http://www.economist.com/research/backgrounders/displaybackgrounder.cfm?bg=697972

The Economist has a good way of doing backround information on various subjects.

Here's their little take, as opposed to that lnog article above:
quote:
The American dollar's value has global repercussions. Sovereign debt is usually denominated in dollars, and a strong dollar can feed other countries' inflation by making dollar-priced imports expensive (a weak buck has the opposite effect). To mitigate these and other risks, some currencies, like Hong Kong's dollar (and formerly Argentina's peso) are linked to the dollar. Ecuador has even adopted the greenback entirely, trading the ability to control its own currency for stability.

During America's boom, demand for American assets such as shares helped keep the dollar strong. It remained so during America's recession—Japan's sickness kept the yen down, and the euro remained curiously weak. The dollar was probably overvalued then (as The Economist's Big Mac Index would have told you), and in early 2002 began to fall gradually, helped along by America's yawning current-account and budget deficits.

The Bush administration's apparent shift from a “strong dollar policy” in September 2003 touched off a steep slide that has continued in fits and starts. Nonetheless, the dollar will need to fall still further to correct America's current fiscal imbalances, a prospect that worries America's trading partners in Europe, Asia and North America. While a gradual fall could help worldwide economic recovery (though possibly not countries like Japan that keep their currencies weak to drive exports), a sudden plunge would be bad for everyone. After a buoyant start to 2004, the dollar seems headed for another tumble.

If we manage the fall of the dollar so that it doesn't happen too fast, it sounds like everyone wins except for the US's abiltiy to control macroeconomic policy for the globe.

Clearly we need a policy of reducing spending, paying down that debt and gradually weakening the dollar.

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Delirium Tremens
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quote:
Hurm, maybe you might want to see simmular remarks made by many economists in November of 1978.
This table of historical exchange rates puts the current value of the dollar in perspective. Compared to the DEM, FRF and GBP there were similar lows in the beginning of the 90's, beginning of the 80's and in the 70's. I don't know the numbers of those times, but if the budget & trade deficit are higher today, the problems are worse in a sense.

quote:
If you want to stabilize the way individuals and the government pay off debts, and you want to lower the trade deficit, you want the dollar to fall and fall far. It's that simple.
One of the consequences of lowering your currency is that intrest rates will raise and it will be even more difficult to pay off your debt. (I made already other posts where I described the positive and negative effects of a weak currency).

Another point: not only the US citizens have debts, also the US as a nation. How is the US as a nation going to pay off its debt? Reduce the budget for defense? Reducing taxes on dividends does not make the US richer as a nation (playing advocate of the devil: it's only a transfer of money from the nation to the wealty class if you want).

quote:
Clearly we need a policy of reducing spending, paying down that debt and gradually weakening the dollar.
That seems the best policy to me, but it will hurt. A president that actually implements such a policy deserves to praised.
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WarrsawPact
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Delirium - One way to start paying off the debt is to neutralize the massive trade deficit that's sucking capital out of this country. What we're getting with the weaker dollar are record-high exports and a better balance of payments. We're keeping jobs here.

And it helps to pay off the debt if those dollars you make overseas are easier to earn, if the new dollar earned there is lower in actual value than the one we borrowed.

What reducing taxes on dividends does is simple: it encourages saving and investment rather than consumption, which is exactly what we need at this moment. Just wait til China pulls off some of the artificial depression of the yuan over time and it's really going to hit us.
The same reasoning appplies to why it won't be a terrible thing if interest rates rise.

We'll all be a little bit poorer, but we won't be on the brink of disaster. Small price.

[ December 08, 2004, 05:58 AM: Message edited by: WarrsawPact ]

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Delirium Tremens
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quote:
And it helps to pay off the debt if those dollars you make overseas are easier to earn, if the new dollar earned there is lower in actual value than the one we borrowed.

Depends if you borrowed money in dollars or in another currency.

If you borrowed in another currency, it will cost you more. If you borrowed in dollars, those from who you borrow from will increase future intrest rates in order to compensate for the loss (you probably won't pay off your debt in 1 year).

That's why the best strategy is a gradual decline of the dollar.

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David Ricardo
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Warsawpact, have you studied international currency markets and currency crisis theory much?

The U.S. trade deficit is now close to 6 percent a year and rising. In theory, a very cheap dollar should improve the trade balance by making exports cheap and imports expensive. But it doesn't work out that way.

For one thing, many foreign producers, such as Japanese automakers, "price to market." That means that when the yen rises against the dollar, they just eat the cost in order to maintain their market share. So the dollar price of a Toyota doesn't change and the trade deficit doesn't improve much.

China, meanwhile, keeps its currency pegged to the dollar, so a cheaper dollar doesn't improve our trade balance with the Chinese either.

By continuing to increase the federal budget deficit, the current administration has simply compounded the problems. And there is a growing risk of a financial meltdown with the following elements:

First, as foreign confidence in the dollar keeps shrinking, so does the dollar. The Federal Reserve then has to raise interest rates defensively to make investments in U.S. securities attractive enough to foreigners, so they keep financing our ever-growing national debt.
.
But high interest rates slow U.S. economic growth, hurt the stock market, and would contribute to a long-anticipated crash of already-inflated housing prices.

We could face a serious recession with no easy cure, since the usual solution is to run temporary deficits plus low interest rates through a loose monetary policy. But in this case, overly large deficits were part of the problem in the first place, and higher interest rates would be necessary to prevent a total dollar collapse.

On the other hand, the United States is not just dependent on foreign central bank purchases of bonds. Because our budget deficit eats up so much domestic savings, our stock market and venture capital markets also are net borrowers from abroad. In the past we have counted on the fact that the American economy was so productive that foreigners, despite the trade deficit, saw the United States as a smart place to invest. But if the dollar is weak enough long enough, that investment starts drying up significantly.

The day will come when foreign investors simply say "no" to buying U.S. investments without getting a better return. That's when the dollar collapses, U.S. interest rates soar and the stock market plunges. Under such a crisis scenario, a U.S. recession would be all but inevitable.

For the average consumer, the dollar decline would mean lower values for their dollar-denominated investments, higher prices on imported goods and greater costs for foreign travel. And in some gloomy scenarios a sharp decline in the dollar could lead to an equally sharp spike in inflation, which would force the Federal Reserve to hike up interest rates drastically and erode home values.

How likely is this dire scenario? None other than Paul Volcker (Former Federal Reserve Chairman) has said that he thinks that the odds of a dollar crash in the next few years are something like three in four.

[ December 08, 2004, 09:20 AM: Message edited by: David Ricardo ]

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WarrsawPact
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No, David, as I said, I haven't studied economics much at all. I'm pretty new to all this, and I'm trying to learn.

China I mentioned as a country that we're just daring to sell their dollars and start treating their own currency like a real one. Some are speculating as much as a 13% rise in the yuan to be permitted next spring, though obviously there are critics.

And as for the debt, wouldn't that dollar crash just be the perfect opportunity, what with this Republican Congress and Republican President, to slash at costly programs like there's no tomorrow (because there won't be if we don't lower the deficit)?
What fits in with an "ownership society" better than saying "save and invest" rather than "borrow and spend"? Right now our policies are bending towards incentives that promote saving.

Wouldn't that be the perfect opportunity to press China and others to treat their currencies like real currencies and trade them more freely without artificailly seeking to control their value?

And the American economy IS productive, which is why I don't understad your point there. Our exports are higher than ever, and per-worker production is stunningly high. This is a product of all those unpleasant layoffs and fat-cutting from businesses adjusting to the dot-com bust.

I agree that the consumer would take a hit, but that's part of the engineered point. We're buying up all this stuff with consumer debt anyway. What happens when goods aren't so cheap anymore? Try to pile more on that credit card?

And as for home values, well, they need to go down already anyway. It's getting ridiculous.

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David Ricardo
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quote:
What fits in with an "ownership society" better than saying "save and invest" rather than "borrow and spend"? Right now our policies are bending towards incentives that promote saving.
WarsawPact, under the Bush Administration and the current Congress, the national aavings rate has gone down significantly.

As a practical matter, Bush Republicans have promoted a culture of debt much more than they have done anything practical to boost savings in this country.

Results count much more than idle words like "ownership society." And as far as results go, national savings will continue to plummet as they already have for the past four years.

quote:
And as for the debt, wouldn't that dollar crash just be the perfect opportunity, what with this Republican Congress and Republican President, to slash at costly programs like there's no tomorrow (because there won't be if we don't lower the deficit)?
WarsawPact, that would only be true if the Republican Party were the party of fiscal responsibility -- which it obviously is not anymore.

[ December 08, 2004, 09:33 AM: Message edited by: David Ricardo ]

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Delirium Tremens
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quote:
wouldn't that dollar crash just be the perfect opportunity, ..., to slash at costly programs like there's no tomorrow
Like the war on terror?
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WarrsawPact
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David - I share your assessment of the last four years except for where you say they've promoted a "culture of debt." They've promoted the debt itself, but the structural changes promoted by Bush's past and future policies seems to be geared at promoting investment and savings even in a weakening dollar climate by targeting consumption rates big time.

Yes, they need to do more to attack the deficit and nullify the entitelemtns and pork of the last four years. That's been disgusting. But it doesn't mean there's no hope. Now at least the President isn't trying to get re-elected.

And the Republican Party can still be fiscally conservative, but only in the right places. They'll accept cuts in funding for programs that were set to practically sunset next year anyway (they basically bought re-election by voting for tons of programs whose funding would be cut in early 2005), and they'll go on the attack against social welfare of all kinds. My only concern is how much this social security transition will cost short-term. Better sooner than later if the dollar is weakening, though.

Delirium - You can answer that question, can't you?

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Everard
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David-
I've previously blasted people for doing what you did in your post dec 8th, 8:46am.

Part of the content of that post is taken directly from a Robert Kuttner column. Please source when you do that, its plagarism if you don't.

I don't mind when people paraphrase things they've read, or talk about things they've read. But directly quoting, and not attributing the quote, is pretty low.

[ December 08, 2004, 04:21 PM: Message edited by: Everard ]

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Redskullvw
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David

Have you even bothered researching what economists and politicians were saying and projecting in November of 1978? I think this would be a great chance for people to do a bit of comparitive research, and compare the predictions then to the same exact predictions you have placed before us in the thread. Judgeing from you post noted by Everard as being suspect, I am forced to conclude that you are presenting another person's argument as your own, and therefor do not realize the limitations of the views that they originally presented.

Had you done your own work, or for that matter understood what you were reading, you would have undoubtably come across the earlier historical economic quandry that was represented by the United States trade, budget, and debt services, as well as a falling dollar, rising gold, and the co comitant collapse in valuation concerning the Yen, Mark, Lira, and Pound. Had you done your resarch, you would have not only recognized the repeat of an historical cyclical trend, but you also would have grasped the historical outcomes of such trends and realized your argument < or the person's argument you borrowed> has zero merit.

Your posting standards are slipping dramaticly. While your past performance in supplying gotcha threads, and flame thread attempts simply resulted in a degraded view of your arguments, plagerisim is now degrading your personal reputation.

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Richard Dey
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The Economist is looking at this from the standpoint of UK and EC holders of US public debt, the amount of which is held abroad today is startling -- but hardly anything to get upset about! We default. So what? Like no country ever defaulted on us? Like we never excused debts with the a political wave of the pen?

If America really cared, it would take note of where things are made. At best, the American woman (who buys >70% of our retail) notes the color, size, and price. American men (who account for >70% of our wholesale buying) are no more patriotic. We are pragmatic.

As Keynes said at Bretton Woods, "In the long run we're all dead."

Redskull: It's the rising price of platinum that's interesting to me; 3X the price of gold nowadays! Paying attention to ugly fashion CAN make money.

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Redskullvw
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Richard...

Its plagerisim which is concerning me...

ORIGINAL SOURCE FOLLOWS:

Robert Kuttner: 'The amazing shrinking dollar'
Date: Wednesday, December 01 @ 10:43:59 EST
Topic: Economic Policy


By Robert Kuttner, Boston Globe

I RECENTLY returned from Europe, where the dollar just hit a new low against the euro. The European Union's new common currency, widely disparaged in Washington as a bizarre idea that would never win acceptance, was worth about 90 cents in 2002. Now it costs you $1.33 and is rising. The euro has emerged as a worldwide rival to the greenback. It makes the United States a bargain basement for visiting Europeans, while Europe is staggeringly expensive for Americans.

What ails the dollar? Two things. Our trade deficit grows bigger every year, as does our budget deficit. Both deficits require foreigners to supply capital. The more capital they have to supply, the more nervous they get about the dollar. Lately, private foreign investments in US stocks and bonds have both declined, leaving the United States precariously dependent on two foreign central banks -- China and Japan -- to finance its twin deficits.


The US trade deficit is now close to 6 percent a year and rising. In theory, a very cheap dollar should improve the trade balance by making exports cheap and imports expensive. But it doesn't work out that way. For one thing, many foreign producers, such as Japanese automakers, "price to market." That means that when the yen rises against the dollar, they just eat the cost in order to maintain their market share. So the dollar price of a Toyota doesn't change and the trade deficit doesn't improve.

China, meanwhile, keeps its currency pegged to the dollar, so a cheaper dollar doesn't improve our trade balance with the Chinese either. High oil prices also worsen the trade deficit. Most oil transactions are priced in dollars. As the dollar's value sinks, oil exporting nations just raise the price of oil.

By continuing to increase the federal budget deficit, most recently with a plan to privatize Social Security, the Bush administration only worsens the problem. And there is a growing risk of a financial meltdown with the following elements:

First, as foreign confidence in the dollar keeps shrinking, so does the dollar. The Federal Reserve then has to raise interest rates defensively to make investments in US securities more attractive to foreigners.

But high interest rates slow US economic growth, hurt the stock market, and could contribute to a long-anticipated crash of housing prices.

We could face a serious recession with no easy cure, since the usual fix is to run temporary deficits plus low interest rates. But in this case, overly large deficits were part of the problem, and higher interest rates would be necessary to prevent a further dollar collapse. But won't the Japanese and Chinese central banks, whose economies rely so heavily on exports to the United States, keep buying American bonds? Perhaps -- it's a kind of co-dependency in which they willingly buy paper that is losing its value because the exports help develop their real economies.

On the other hand, the United Staates is not just dependent on foreign central bank purchases of bonds. Because our budget deficit eats up so much domestic savings, our stock market and venture capital markets also are net borrowers from abroad. In the past we have counted on the fact that the American economy was so productive that foreigners, despite the trade deficit, saw the United States as a smart place to invest. But if the dollar is weak enough long enough, that investment starts drying up. US financial markets have been quavering lately because foreign investment flows are dwindling.

How likely is this dire scenario? None other than Paul Volcker has said that he thinks that the odds of a dollar crash in the next few years are something like three in four.

The US trade deficit has been a problem for more than a decade, but the responsible fiscal policies of the Clinton years helped moderate it and also led to a healthier dollar, which in turn allowed for lower interest rates. In this virtuous circle, we enjoyed a period of sustained and balanced growth.

What's remarkable about George W. Bush's immense deficits is how faint are the voices of fiscally conservative Republicans and business leaders. The Concord Coalition got immense publicity and respect during the deficit crisis of Bush I and provided crucial business support for Bill Clinton's efforts in 1993 to win a tax increase to reduce deficits. The coalition still exists, but you hardly ever hear of it. It's as if business is enjoying its tax cuts so much that the consequences be damned. It would not be the first time that short-sightedness by a selfish financial elite helped sink the US economy.

Robert Kuttner is co-editor of The American Prospect. His column appears regularly in the Globe.

© Copyright 2004 Globe Newspaper Company.

Reprinted from The Boston Globe:
http://www.boston.com/news/globe/editorial_opinion/
oped/articles/2004/12/01/the_amazing_shrinking_dollar/

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David Ricardo
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I was too lazy to post the full quotations and source everything. This time, I was actually reading a "paper" article from American Prospect reprint and I just typed out relevant parts quickly.

Guess I am getting too lazy nowadays =P

Still, plagiarism is plagiarism. I was too busy to paraphrase, and didn't have the online link, but I should have taken the time, neh?

[ December 09, 2004, 10:15 AM: Message edited by: David Ricardo ]

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David Ricardo
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As of December 9th, here are the currency values for the dollar:

104.74 YEN to 1 US DOLLAR

.7546 EURO to 1 US DOLLAR

I will just let the currency numbers speak for themselves when you see those numbers continue to degrade (and I will update them periodically).

Call it a Dollar Watch, or whatever you will =P

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Everard
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"Still, plagiarism is plagiarism. I was too busy to paraphrase, and didn't have the online link, but I should have taken the time, neh"

Thanks for recognizing.

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Delirium Tremens
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quote:
Had you done your resarch, you would have not only recognized the repeat of an historical cyclical trend, but you also would have grasped the historical outcomes of such trends and realized your argument < or the person's argument you borrowed> has zero merit.
David's plagiarism left aside...

I see that current dollar rates occur roughly once in 10 years, which can easily be assigned to cyclical trends. 1978 is a bit before my time, but I know that different central banks did interventions during the '80s and '90s. Heck, they even intervened in 2001 when the euro was at all time lows. From what I read in the press, an intervention seems unlikely this time, which means the dollar can still fall 10 or 20% lower. At these rates , it's a bit trickier to use 'economic cycles' as an argument and the only comparison possible are the rates of the '70s. I don't think the economic situation in that period was very bright...

[ December 10, 2004, 07:51 AM: Message edited by: Delirium Tremens ]

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msquared
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Today .7555Euro = $1.

105.41 Yen =$1.

msquared

[ December 10, 2004, 03:55 PM: Message edited by: msquared ]

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