ALTHOUGH Americans are constantly being subjected to the economic theories of politicians and talking heads, we rarely hear about one ofthe biggest threats to the nation's economic future. Indeed, although the declining value of the dollar is often overlooked by the media, it is one of the most troublesome threats to America's economic well-being.
The primary cause of the dollar's declining value is America's huge trade deficit. Over the past several years the United States has increasingly purchased many more goods from abroad than it exports to other nations. Because of this, America now has a trade deficit valued at $500 billion. This trade imbalance has decreased the demand for dollars relative to other currencies and has caused the value of the dollar to fall.Federal Reserve Chairman Alan Greenspan echoed this point when he told an audience in Germany, "It seems persuasive that, given the size of the U.S. current account deficit, a diminished appetite for adding to dollar balances must occur at some point."
Because there is a much greater demand for other currencies than U.S. currency, the dollar would naturally lose value as long as an external source did not absorb the excess dollars. Ever since the significant declines of the U.S. stock market in 1999, the central banks of China and Japan have fulfilled this role by purchasing more than $1 trillion of U.S. currency in an effort to stop a decline in the value of the dollar. While this system was stable throughout most of the first half of this decade, the current declining value of the dollar, coupled with continued growth of the trade deficit, means that America could face a major economic crisis if the government does not take substantial action.
One possible scenario that could result from the falling value of the dollar is that the central banks of China and Japan could find themselves unable to afford continued purchases of U.S. currency. This could potentially cause a major run on the dollar, as investors lose confidence in the value of U.S. currency. Indeed, the former chief economist for the International Monetary Fund, Ken Rogoff, referenced the impact of the falling dollar to the Economist magazine on September 18, 2003 by saying, "The world is set to jump off the top of a waterfall without knowing how deep the water is below." Ultimately, a sudden fall in the value of the dollar would be disastrous because so much business is done in the dollar and because so many investors have a stake in it.
While the falling value of the dollar does have the potential to set off an economic crisis that would send unemployment and poverty skyrocketing, there are certain steps that the government can take to prevent this problem from spiraling out of control. Most immediately, the agents of the U.S. government must be in formal day-to-day contact with the central banks of China and Japan. By remaining in close contact, the U.S. government can help coordinate the actions of these three central banks, and will be more able to combat a potential financial crisis.
While this is a prudent step that government officials should take to address the immediate threats posed by a slumping dollar, the government must reverse America's trade deficit if the underlying cause of the dollar's weakness is to be addressed. One way of closing America's trade deficit would be to encourage saving by American households. This would cause Americans to buy fewer foreign goods, and give American corporations enhanced access to capital. America's central bank could encourage saving by raising interest rates and thus increasing the returns on savings and decreasing the amount of disposable income available for consumption.
Another possible solution to this crisis could be achieved by encouraging economic growth in China. Indeed, as China's economy grows, it will increasingly demand a larger amount of upscale U.S.-produced goods and, as such could instrumental in correcting trade deficit. Because of this, the U.S. Congress must encourage economic growth in China by continuing to permit open access to the U.S. market.
While all of this discussion is very abstract, its implications could touch the lives of every single American. Because of this, the government must take all possible steps to address this issue before it sends America plummeting into a painful recession.
Adam Keith is a Cavalier Daily associate editor. He can be reached at akeith@cavalierdaily.com.
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