Who’s afraid for the dollar? Part I

We hear many prognosticators talk negatively about the dollar (I call them “dollar bears”). Some predict the dollar will get so weak it will crush the economy, cease to be the world’s reserve currency, and drive interest rates to double-digits. Some even talk about Zimbabwe or Weimar Republic style hyperinflation due to the all the money the Federal Reserve is “printing”.  These fears are overblown and unrealistic in my opinion and I’d like to take a moment to explain why this is not something we should fear. Since this is an extensive topic, I will break it into several parts.
The “falling” or “weak” dollar hypothesis is based on several items in particular. Reasons include that the Chinese will stop buying our debt; that the Fed is “printing” money which will result in hyperinflation; and how massive government deficits will scare lenders and cause higher interest rates. Let’s examine these in more detail.

The government is just “printing” money
This was discussed in a recent post. Aside from the Fed creating large reserves which aren’t being translated into the money supply, they are also engaging in “quantitative easing”. One way to increase the number of currency units (dollars) in circulation or “get more dollars out there” is to actually “print” bills like $20s or $100s. In eras gone by, governments actually used to run the printing presses and create money. You may remember pictures of Germans in the 1920s carrying wheelbarrows full of money just to buy bread.

Today, money is “printed” by the Fed simply by buying bonds and other assets from banks. When they buy a treasury note, they credit cash to the bank. The bank then has excess reserves which it can lend out and increase the amount of dollars in the world. This process is sometimes referred to as “quantitative easing”. Currently, quantitative easing is NOT increasing the money supply.

What about other countries also printing money?
The UK, China, Japan and even Switzerland are also printing money (with others like Canada, Sweden seriously considering it soon). If everyone grows their money supply at the same time, we might get some inflation, but the relative value between currencies ought to remain about the same. If there are 1,000 dollars and 500 pounds in a hypothetical world, we have an exchange rate of $2 per £1. If both countries print 50% more currency, we have $1,500 and £750 which is still $2 per £1. A dollar might be worth less, but it will still buy the same amount of foreign stuff. As someone said recently (and my apologies to the witty originator of this) “the dollar is the worst currency, except for all the rest”.

What about all the printing plus all the debt our country is borrowing?
The Fed has expanded its balance sheet about $1.3 trillion and the Treasury is borrowing another $1.8 trillion this year. So the country is trying to expand its spending by about $3 trillion. In 2008, the stock market lost some $6 trillion and housing has another $6 trillion since 2007. That is $12 trillion in wealth destroyed compared to a hoped for creation of just $3 trillion. We’re still left with much less money than before. Yes, budget deficits can be problematic for the dollar but aren’t sufficient to cause its decline on their own.

Next up: Part II, the Chinese and the Dollar