The Dollar in Danger

Since March, the dollar has lost about 15% of its value against the world's other major currencies. That's a dull way to put it, though, so you're more likely to read or hear that the greenback is "wobbling," "slumping," "plunging" or even "collapsing." Marc Faber, a Hong Kong--based investment guru with a flair for the dramatic, went so far as to declare in a TV interview a few weeks ago that the U.S. currency was on its way "to a value of exactly zero."

Those are strong words for what, going strictly by the numbers, has been nothing more than a retracing of the dollar rally that followed last fall's financial panic. When investors around the world got scared late last year, they poured money into U.S. Treasury securities that they perceived to be safe. That drove up the dollar. Then, after a few months, investors began taking risks again, putting money back into the U.S. stock market and into all sorts of investments in the rest of the world. So the dollar fell.

But it still hasn't fallen even with the levels of summer 2008. So why all the hullabaloo? Why the sky-is-falling talk? Part of it is political. When you hear Republicans trying to pin the dollar's troubles on the Obama Administration, for example, it's worth remembering that the dollar has been on a downward trend since 2002. There's also a noisy colony of goldbugs and other Cassandras who are always predicting the dollar's demise.

Still, it's not just partisan hacks and Chicken Littles who are worried about the dollar. There are (at least) three good reasons to fret. First, the events of the past 14 months have made predictions of impending economic doom seem a lot more credible than they used to. When Faber forecasts not only a worthless dollar but also a "collapse of our capitalistic system as we know it today," it's impossible to dismiss him out of hand. Second, the data point that has dollar worriers most alarmed--burgeoning U.S.-government debt--is for real. Finally, the global monetary setup we've had since the early 1970s (one with the dollar at its center) is looking rickety. Something has to give.

There's not much to add to the first point--that really bad stuff can happen--other than to note that capitalism has just experienced the equivalent of a meteor near miss. But the second and third points demand more explanation. The reason a big federal debt undermines the dollar is that a government with really big debts will be tempted to inflate its way out by printing money to pay creditors. Printing more dollars (the process actually involves the Federal Reserve's purchasing government securities with dollars it conjures out of thin air) reduces the value of existing dollars. And a government in truly dire fiscal straits--Germany in the 1920s is the most famous example--may print so much currency that it makes the stuff effectively worthless. Our fiscal straits aren't that dire just yet. But chronic deficits during George W. Bush's Administration, even bigger deficits brought on by the financial crisis and President Obama's efforts to stimulate the economy, plus looming shortfalls related to Social Security and Medicare will add up to economy-straining debts a few years from now--barring major changes in fiscal policy or a huge economic boom.