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The Economist: Are we headed for trouble?

Tucker Hart Adams //July 1, 2011//

The Economist: Are we headed for trouble?

Tucker Hart Adams //July 1, 2011//

The Duchess of Doom title gets old after awhile. Except for pointing out the dangers of the housing/debt bubble back in 2006 and correctly forecasting that it would lead to a recession by the end of 2007, I’ve been pretty upbeat about the American economy over the years. But I’m starting to get worried again.

I think we face two intertwined and very dangerous issues. The first is the dollar exchange rate relative to other major currencies. The second is our unwillingness to address our long-term federal deficit/debt.

The dollar is at its lowest level against the currencies of our major trading partners, after adjusting for inflation and weighting for each country’s share of foreign trade, since 1973. That’s when the dollar’s convertibility to gold was terminated, and it was allowed to float.

I’m certainly not an advocate of returning to the gold standard, an artificial construct sprinkled with fairy dust if there ever was one. Currencies need to float freely to enhance trade and adjust misalignments. That’s the source of the dollar’s problem.

It boils down to basic supply and demand. Our huge trade deficit causes us to flood the world with dollars, which must be used to purchase local currencies. Many governments buy up these dollars to keep their currency from appreciating and then use them to purchase assets in the U.S. Recently these governments have reduced these purchases, swapping their dollars for other currencies so they can diversify their portfolios by purchasing assets in other countries. Everyone tries to get rid of dollars; the price (i.e., exchange rate) falls.

This is occurring in the face of major uncertainties around the world, especially in northern Africa and the Middle East. In the past this would have triggered a huge flight to quality, which meant the dollar. It isn’t happening this time around. This apparent loss of confidence in the outlook for the U.S. economy is extremely troubling.

That leads to my second concern – our unwillingness to address our huge federal deficit and soaring debt. I spent several days in May at a large financial industry conference in Washington, D.C., where I had the opportunity to hear presentations by most of the senior government financial officials, both Democrats and Republicans. To a person the message was the same: While it is a mistake to cut spending and raise interest rates in the face of a very weak expansion, a creditable plan to reduce the deficit in the very near future must be enacted now.

Everyone nods his head, but politicians refuse to address Social Security, Medicare or Medicaid. Remember that when we point our finger at them, three fingers are pointing back at us. We don’t re-elect people who threaten those social programs, so anyone who wants to stay in D.C. leaves them alone.

But if you add up payments on those three programs plus the interest payment on the federal debt, it exceeds federal tax revenues, which were $2.21 trillion in 2009 and $2.39 trillion in 2010. We have no control over the interest payment on the debt. It is the result of the debt we have issued in the past and the new debt we issue each year (about $1.5 trillion in each of the last two years and into the foreseeable future) and the interest rates set by the market on that debt.

So even if we eliminate every other government program – defense, transfers to the states, agencies protecting workers and the environment, support for the arts and education, salaries, paper clips – we run a deficit! And the debt, currently $14.4 trillion dollars and growing at the rate of over $4 billion dollars a day, continues to increase. No wonder the rest of the world is losing confidence in the dollar!

I have great faith in our government and our voters to do the right thing in the face of a crisis. But we are running out of time. We need to keep that in mind when we head to the polls.

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