The value of a national currency is determined by many criteria in this international world of paper currencies backed by nothing more substantial than promises from heavily indebted sovereign governments. Those criteria include the budget surplus or deficit run by the national government, the amount of sovereign (national) and private debt, the strength of the economy, the surplus or deficit in the balance of trade, short-term interest rates, the degree of involvement in the economy by the Central Bank, and the international demand for the national currency.
These criteria are all interrelated, so they influence each other. But, in general, we can look at these criteria and their likely trend and estimate the future strength or weakness of the national currency. The following table examines the criteria that indicate the stability of the currency and the likely future inflation. The commentary relates the table of criteria to the US Dollar.
Budget – A government that continually spends more than its revenue creates annual budget deficits and ever-increasing national debt. The excess expenditures (simple version) are borrowed into existence, which creates a larger money supply. If the available goods and services do not increase proportionately, prices rise, occasionally rapidly, and occasionally slowly, but on average, higher and higher. The US government runs a large deficit each year, and consequently has an exponentially increasing national debt.
National and Private Debt – In the 1950s gasoline cost $0.18 per gallon, bread cost $0.20 per loaf, and gold was approximately $42 per ounce. Today, gasoline and bread are much more expensive and gold is about $1,600 per ounce. What about meat, electricity, medical care, college tuition, an automobile, or a house? Prices rise (on average) when the money supply is expanded more rapidly than production, and deficit spending is an important component of the expanding money supply. Massive borrowing by businesses (corporate debt markets) and individuals (mortgages, credit cards, student loans) also increases the money supply and weakens the purchasing power of the currency, whether denominated in dollars, pounds, or euros.
Economy and Trade – A healthy economy generates more than it consumes and thereby creates a trade surplus, which strengthens the local currency against other currencies. The US economy runs a very large trade deficit.
Short-Term Interest Rates – The demand for a national currency (strength) increases when short term interest rates are high and decreases when rates are low. Currently, short rates in the US are at multi-decade lows.
Central Bank – A strong Central Bank (The Federal Reserve is the Central Bank of the United States) is more inclined to enable the expansion of the money supply and to encourage excess borrowing and spending because it increases the profits of the financial industry and allows politicians to spend more than otherwise. A weak Central Bank is usually less involved in the economy and less inclined to increase the money supply. The Federal Reserve is a very strong Central Bank.
*Reserve Currency Status – The dollar has been the international reserve currency for many decades. This is a powerful influence that supports the dollar against other currencies because it forces most international transactions, such as buying and selling crude oil, to use the dollar in the international currency markets. Hence, the demand for the dollar and its relative value are maintained at a higher level than if the dollar were not a reserve currency. If the United States dollar is ever dethroned from its reserve currency status, the dollar will weaken and that will encourage higher prices for all imported goods and most domestic goods.
Based on the table above, the US dollar has one strengthening criteria, reserve currency status, and all other criteria are negative. Over the next few years, I believe the US dollar will weaken against most other currencies and especially against the cost of commodities. In other words, most of what you need to survive, such as food, electricity, gasoline, medical care, housing, transportation, and many other items, will be more expensive in the future. The purchasing power of a $100 bill will decline substantially.
What can you do to preserve the purchasing power of your dollars? Save more, spend less, and invest wisely. For specifics, please read the article, Maintain Your Purchasing Power – How and Where Should You Invest.
aka Deviant Investor
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