Monday, May 19, 2008

Bring Back King Dollar

Another friend has entered the blogosphere. I had a long and thorough answer to this post and it never showed up. Instead I will try to recreate my thoughts here.

He is absolutely right that the weakness of the dollar is related to the increase in the price of oil. Whichever came first, the weak dollar and high commodity prices (don't forget the more critical prices of wheat, corn, and rice) are related. All these other commodities are priced in dollars, so as the dollar weakens, all the prices increase.

I will have to disagree about the cause of the fall of the dollar. Iraq has nothing to do with it. Congress has been spending like drunken idiots, but the largest growth of spending is entitlement spending. There is no excuse for that, especially under a Republican Congress. There is no home for conservatives in either party right now. (As a side note, several Democrats have won special House elections by running CONSERVATIVE candidates. Guess what? Conservatism wins.) The Republicans probably deserve the trouncing they will receive in November for diluting their brand of fiscal responsibility.

Another cause of the fall of the dollar is the household debt. (Surprise, the prophets are right about something else. We should live within our means.) The household debt is mirrored by the trade deficit. If we want to improve the trade deficit, we should encourage more savings and investment. Sorry to break it to the liberal-left, but that means lower capital gains taxes. Improving the trade deficit will strengthen the dollar. Otherwise, the dollar will continue to weaken to approach a trade equilibrium.

Here's how that works: dollar decreases, American goods become cheaper internationally. Cheaper American goods sell more. Exports increase. Weak dollar buys less imports. Imports decrease. Trade deficit balances. I like the other solution more. We need high investment to increase US productivity so we increase output for higher salaries. Thus, household income increases and so do exports.

The key to all of this is an economy that is not too hot and not too cold. When the economy is just right, it is called Goldilocks. Too much growth will result in inflation. Too little growth, on the other hand, yields unemployment. Other than after Gulf War I and the dot-com bust and 9/11, the US economy has been growing at the perfect rate. Those two recessions lasted about 9 months each. The recent slow down has resulted in media stories of soup-line-America.

Much to their chagrin, the recent quarter showed positive growth. It was about 0.6%, but it was still growth. Shouldn't the economy actually shrink in a recession? All the economic indicators seem to say that the economy is about to get back to Goldilocks status. Of course Congress could wreck this by hiking taxes. (Especially if they double the price of fuel. The "solutions" to global warming are the same as tax increases; they just hit the poor most. Global warming nuts love high fuel prices.)

Another threat to the current economy is high tariffs. Despite what Lou Dobbs says, outsourcing is good for the economy. No one talks much about the amount of insourcing that happens. Ever noticed how many Toyota plants are in North America? The purpose of the free market is to put the factors of production (land, labor, capital, and entrepreneurial skill) where they are most economical. One of the reasons for the strength of the Euro is that those factors of production move across Europe more efficiently that when they all had separate currencies.

Before someone gets in a tizzy about my "outsourcing is good" statement, let me elaborate. I want the high skill, high paying jobs to stay here. If we raise all these artificial trade barriers, that won't happen. It is good when simple jobs are sent overseas. That frees us up to do the more lucrative stuff. But it also has the benefit of increasing the standard of living overseas.

We need the innovation and capital to stay here. That increases productivity. Increased productivity makes foreign investors want to invest here. That increases demand for the dollar, increases its value, and solves the international price inflation of oil and food. Again, that requires low taxes.


Brian Was Here said...

I found this recent article very interesting. It dives into statistics about unemployment, GDP, and the CPI.

cougartex said...

That contains some good information. I would agree with a few items. Consumer debt is a huge problem. In fact, it may be one of the biggest problems.

Social Security payments, mortgage payments, and interest rates are all at risk because of the high debt ratio. I heard in DC in February that consumer debt is something ridiculous like 130% of GDP. That is not sustainable. That is why drastic measures need to be taken to incentivize savings and investment.

Social Security is a disaster. When the retirement age was set at 65 in the 1930s, the life expectancy was close to 65. Now we have the retiring Baby Boom generation that is larger than the generation that followed it. It will shortly be impossible to pay anyone unless benefits are cut and the retirement age is raised.

I don't see anything in that article that disproves my diagnosis. When economists look at the state of the economy today, they know all that stuff. I know about inaccuracies in the CPI and whatever. Inflation is definitionally difficult to track.