Saturday, August 04, 2007

In support Of The Dollar

1) Trade deficit represents demand for dollars since the rest of the world needs to net export to us to get'em. All dollars get created by US Federal govt spending. Since most govt spending goes directly to US residents - foreigners must get US residents to part with dollars by selling us stuff in excess of what they buy from us to get some.

2) Dollars get created when Federal govt cash spending exceeds Federal govt taxation. As doggy pointed out, net deficit spending will be the lowest in four years as measured by net additions to Federal govt debt held by the public. So a falling deficit means supply of new dollars is shrinking.

what happens when demand is increasing (rising trade deficit as % of GDP) AND supply is falling (falling budget deficit as % of GDP) for a given commodity (US Dollar)?

Rising demand and falling supply doesn't sound like a recipe for a falling dollar to me.

More likely, it sounds like deflationary pressures via a superstrong US dollar. You may get your wish for falling stock market indices, but unfortunately for you it will be accompanied by falling gold and silver


I'm saying that in today's monetary framework - its Federal cash spending in excess of Federal cash receipts (ie taxation) that is the main driver of the supply of dollars.

Its neither a short-term nor long-term prediction -- rather I use the data to demonstrate the relationship. I actually never did what you did - ie examine Mar-May periods to see if the dollar rises due to "seasonal" budget surpluses -- although that was interesting. Thanks.

For a longer term view of a similar relationship - look at the 1998 - 2001 period. The Federal budget went into a sustained surplus and the dollar as measured by its price in gold, or vs. CRB index, forex rates (weighted avg) strengthened undeniably during this period.

What I'm trying to do is to show that there is more of a relationship of the dollar to the state of the Federal budget than there is to trade deficits or interest rates.

If this is true then persistent Federal budget deficits are the natural order of things because as the economy grows (and it tends to be growing almost all the time) it needs increases in fiat money. This fiat money gets created by cumulative deficit spending that over time roughly matches the growth in the economy.

A surplus or even a balanced budget would suffocate the private economy because the private sector would be giving back to the govt equal amounts of fiat money through payment of tax obligations as would be created by Federal spending. If this went on long enough - dollars would become scarcer relative to the economy's growing demand for them and that would bring on monetary deflation.

Prices for goods and services obviously reflect demand and supply characteristics for that particular good and service. Prices can fall because of oversupply or falling demand -- that is not monetary deflation. The key here is that the price for that good or service is quoted in dollars and dollars have their own supply/demand curve. If prices are generally falling/rising due to the change in the value of the dollar -- that is true monetary deflation/inflation.

If the private economy isn't getting enough new dollars due to deficit spending - eventually prices fall due to a rising dollar. This is what started to happen in 1998-2001.

What we've seen since is a regression back to the norm as the Federal budget has reverted back to deficit mode and the dollar reflated back to a normal range. BTW, surpluses are unsustainable for exactly this reason -- they lead to deflation, which suffocates the economy - leading to falling wages, asset prices and, ultimately tax revenues - which forces the system back into budget deficits. This is why I say that budget deficits are the normal order of things and why we run them practically every year.

Some people on this board have focused on the trend since 2001 and drawn a straight line through it expecting it to continue straight to a dollar default. They're flat out wrong - even with this reflation -- net Federal debt held by the public as a % of GDP is still 10% lower than it was ten years ago and lower than almost all of the other G-7 countries.

The fact that Buffett has taken a hedge on his huge dollar position has also been misinterpreted as a one-way bet against the dollar. This is also wrong, IMHO, as Buffett would be the first to admit he has no particular insight into macroeconomic decisions and is merely human in this regard.

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