The Fate of the U.S. Dollar:
Talk is Cheap. It’s Action that Counts.

Ben Bernanke and Henry Paulson were simply doing their jobs when they made their latest comments about strengthening the U.S. dollar. The comments were designed to bolster the U.S. dollar relative to other currencies, the Euro in particular, by intimating that a Fed action may be forthcoming. And in the short run, the dollar has risen slightly ($.03), but when the markets come to their senses and realize that the Fed and Treasury departments aren’t following up with dollar-strengthening action, the U.S. dollar will continue its downward slide.

For their comments to have a lasting effect, one of two things must occur:

  1. The Fed must raise interest rates to keep the dollar competitive with other currencies. This will not happen anytime soon (certainly not before November’s elections). The last time rates were raised, the U.S. banking system experienced a crisis, complete with failing brokerage firms and a liquidity crunch. The maleffects of the most recent rate increase have not yet run their course, so it is unlikely that the Fed will risk a reoccurrence by raising rates any time soon.
  2. U.S. government spending must be brought down so that more debt need not be monetized. Unfortunately, the new budget, at $3.1 trillion (the U.S. Budget has tripled since 1989!), calls for more spending and more printing in the coming year.

Perhaps, with a new Democratic President and Congress, the United States will pull out of Iraq and reduce military spending. This could go a long way toward cutting federal government spending, thereby slowing the rate of decline for the dollar. On the other hand, if non-U.S. dollar-holders lose faith in the long-term value of the dollar and reduce their purchases of U.S. T-Bonds, the U.S. government will have to print even more money to continue their rampant spending (much like Zimbabwe).

With their hands tied by the fragile economy, Paulson and Bernanke can talk all they want about a strengthening dollar, but market forces will prevail. Until and unless they raise interest rates and/or reduce government spending, the dollar will continue its gradual downward spiral. Lets see what they do–talk or act!

Chart of Cumulative Past Acts of the Fed
in its Inflation-Fighting Efforts
Chart Source:
Read Chart Commentary

Robert Jackson Smith

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