Wednesday, January 30, 2008


Maybe it has to do with being part of “Old Europe” – where devalued money, inflation, and bubble economies have a long history. However you slice it, it appears Europe may understand the root of our economic woes better than the Federal Reserve’s Ben Bernanke, or the Bush administration. EU Economic and Monetary Affairs Commissioner Joaquin Almunia said falling equity markets in the U.S. – and fears of a U.S. recession – are a result of America’s trade deficits. We spend too much, yet fail to produce and sell enough goods to pay for our spending.

Left unsaid, but very much implied, is the U.S. can’t keep spending and pushing dollars out, and expect the world to hold on to our dollars without suffering some consequences. Simply put, if you put out too much of anything its price, or value, will go down. This is especially the case with the U.S. dollar as we continue to run massive budget deficits, which puts even more dollars into circulation.

Some may ask, So why does an oversupply of deficit dollars matter? Here’s why.

In the 1960s Charles de Gaulle became a vocal critic of U.S. policies that spread deficit dollars around the globe. Specifically, de Gaulle complained about America’s “exorbitant privilege” to create and use dollars without suffering the consequences of inflation at home. No other country enjoyed this privilege. We were able to do this because the world wanted and needed U.S. dollars immediately after WWII. This made the dollar the world’s currency. Problems emerged when we created and spent more dollars than we could back with gold. Charles de Gaulle saw this and cried foul.

So what happened after de Gaulle called attention to U.S. spending habits? We continued to spend. And when de Gualle’s criticisms failed, we spent even more.

The question for us then is, Why didn’t the U.S. suffer the inflationary consequences from creating more dollars? Very simple: The U.S. and its cold war allies came to an agreement. As Benjamin J. Cohen explained, the U.S. agreed to pay for the defense of the West and our Western allies agreed to hold dollars. This was both an economic and geo-strategic decision.

Our allies benefited because instead of spending on tanks and guns they could concentrate on producing better cars and stereos. In essence our allies said, “Go ahead and write those checks (i.e. create more dollars), we won’t cash them (i.e. we won’t send them back).” For our part, we maintained our perch as the undisputed leaders of the free world.

With the collapse of the Soviet Union the U.S. no longer needs to pay for the defense of the West. And market players know this. With other currencies to bank on – and with continued concern over U.S. spending and deficit policies – market players are telling us to get our financial house in order. Unfortunately, by cutting interest rates Fed Chief Ben Bernanke is telling these market voices “I can’t hear you.” Worse, George Bush doesn’t want to discuss how his deficit spending binge (he's added $3.5 trillion in debt) really impacts markets. Squaring this “Hear No Evil … See No Evil” triangle, most of the American public can’t see, let alone understand the issues.

All of this is allowing President Bush to kick this economic can of worms down to the next administration. The Fed’s recent rate cuts may help bail out some of America’s irresponsible financial institutions, and may even encourage market players to continue buying U.S. assets - for the moment. This moment, however, is borrowed time. Markets can’t ignore that we’re running record budget deficits, and have done little as our national debt rocketed from $950 Billion to roughly $9.2 Trillion in just 27 years. In the long run, deficits matter.

My friends, we have to accept one simple fact. We are living on borrowed time, and borrowed money.

- Mark

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