What's Behind the U.S. Dollar's Decline?

by: Jim Kingsland

I'm old school. I think there should be reason for alarm when a nation's currency declines. I thought, that, I would quickly share what I mean when I say the dollar has declined since some people tend to get confused about the concept of 'decline,' at least in the blogosphere.

We can look at a long term dollar index chart and surmise that the dollar has not collapsed relative to trading levels over the last 20 years. The buck sank after the 1985 Plaza Accord (look it up in Wikipedia), and has been range bound. Actually, it still has a ways to go even before taking out the '92 lows on the chart below. The dollar index is a decent proxy for gauging currency sentiment as flawed as it may be with a heavy weighting toward European currencies.

At the very least, over the last couple of years, it's easy to see what happens when rate differentials are dollar friendly, versus the present situation of short term rates holding here in the U.S., as rates are lifted from Frankfurt, to Tokyo, to Auckland. So we're back to testing the dollar index lows of the last 20 years. As one measure of decline - the dollar has declined from the highs of the dollar index chart.

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USD End of the Day

Unfortunately, who really cares about the dollar index beyond the financial world? There are some folks walking around out there who don't even know who the Vice President of the country is (gosh, ignorance must be bliss!). Dollar index? That flies over most people's heads.

For a moment, forget about a financial index like the dollar index, and the technical support at the 80 level (which I think is vulnerable amid rising rates in other parts of the world), and consider the inflationary impact of declining buying power of the buck. Take the argument off the trading floor, and put it into the real world.

There are actually folks out there glib and silly enough to look at a dollar index chart and say, "what decline?" They must not go out shopping, or even dine at a low-end place like Applebees, or buy real estate at 450 Park Ave in NYC. Almost everything is more expensive. Sure, you can argue that electronics are cheaper, but how many computers, and plasma televisions can you own? Sure, you can argue that bottled water is more expensive than gasoline by more than a few dollars a gallon, but how much water do you consume in a week versus gasoline? Unless you live under a rock, you know that it takes more dollars to buy all kinds of 'stuff.'

The big takeaway for me is the insidious nature of the dollar's declining buying power, which can only get worse as dollars flood every corner of the globe thanks to that modern marvel of technology - the good old printing press that Ben Bernanke loves so much. Why risk political suicide by raising taxes when the far easier Washingtonian solution is to print dollars to kingdom come? The inside the beltway types know full well that most people are too busy trying to make ends meet. There's no inclination for the masses to correlate that rising shadow-M3 equates with declining dollar buying power which results in a tax that isn't called a tax, but just another term from the dismal science to ignore: inflation.

That's what I think of when I say the dollar is declining. You get less bang for the buck.

This diminished dollar buying power thing isn't reserved for just the dollar, of course. Any currency that's been around for a long time has had its glory days too (eg. pound, swiss franc, etc). My point in bringing up buying power versus a measure like the dollar index, is to remind us that on a relative and absolute basis, yes - the dollar is troubled and declining, just like the U.S. balance sheet is extremely troubled, and that we're all paying for it through higher prices.

I'll leave it at that. This could segue into a whole messy diatribe on the cost of maintaining an 'empire,' and how empire building and maintenance has always led to the demise of national treasuries, and currencies. But it's late.

A picture is worth a thousand words. Yes, the dollar has been declining, and for a long time, and on accelerated basis in recent years:

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Decline in US$ Purchasing Power

Decline in the U.S. dollar's purchasing power (1800-2005)
Source: Barron's