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The dollar’s death spiral

By Klaus Rohrich
Monday, February 14, 2011

The US dollar is the world’s reserve currency, meaning that most meaningful financial transactions are conducted in US dollars. If French or German companies want to purchase oil from Saudi Arabia, they can’t do so using Euros. They have to take those Euros and convert them to US dollars in order to pay the Saudis for their oil. This system worked really well for decades because the US dollar was a solid currency backed by a government whose monetary policies ensured the dollar’s strong economic performance on the world stage.

But over the past three years with the onset of the Recession that economic performance hasn’t been so strong, as the monetary policies of the US government are leading the currency into serious decline. The massive deficits that both the Bush and the Obama administrations have racked up have caused the world’s lenders, China tantamount among them, to reconsider the dollar’s soundness.

What the US government is doing to the dollar is very similar to what was done to the real estate market over the past two decades. People would purchase houses with mortgages that were often in excess of 100% of the property’s value. As such, when the financial crisis and subsequent Recession caused more and more individuals to default on their mortgages, the value of real estate declined precipitously, leaving ever more people with mortgages substantially larger than the value of the real estate.

This is not to say that George Bush or Barack Obama is solely responsible for the dollar’s decline. That’s due to decades of politicians at all levels of government who engaged in financial pandering in order to buy votes. Believing that governments are too big to fail, local, state and federal politicians enacted legislative sleight of hand that resulted in uncontrolled spending, much of it in unfunded liabilities, like unionized government employees’ pensions, Medicare, Medicaid and Social Security, to name a few. While many elected officials didn’t worry about how to pay for these unfunded liabilities, as they would be someone else’s problem in the future, the decline in tax revenue that came about as a result of the Recession caused a squeeze in available cash.

Counter intuitively, both the Bush and the Obama administrations believed the problem would go away with massive infusions of government cash that would “stimulateâ€