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The Mighty Yankee Dollar


A lot of people think the Yankee dollar is headed into the toilet but so far it has remained relatively stable. (This means the worldwide demand for the US dollar is about equal to the supply). So where does the demand for the dollar come from. Its only a piece of paper with some numbers, it pays no interest but it is the legal tender of the USA. Although gold is a solid very valuable metal, its value does vary. Back in 1980 its value fell from around $8oo dollars to about $200 in a steep decline.

Dollars are simply IOUs. When the Fed prints dollars they are actually printing IOUs. That means they are pledging all American products, businesses, workers' labor, etc. for sale in exchange for the dollar IOUs. Americans stand ready to exchange their products, services, labor, food, businesses, stocks and bonds, real estate etc. in exchange for their dollar IOUs. America is for sale (at the right price)!! If the Fed prints more dollars then demand warrants its value will fall. Apparently they have not printed too many because the dollar's value is not falling. Hyper inflation would destroy the value of the dollar for both the foreign and domestic holders but we are far from this condition.

Since the Japanese and Chinese and oil producing countries together own trillions of US dollar IOUs they want to keep the value of these dollar IOU investments as high as possible. It is in their interest to keep the value of the dollar high and stable. If the IOU dollar holders start dumping their dollar IOUs too fast their whole dollar investment would tumble, so why would they do that? If anything - they would be delighted if the dollar's value increased. Besides who would they dump them too?? As long as the US maintains its high credibility this will never happen. Most foreigners are happy to accept these dollar IOUs because of their credibility value - right now these dollar IOUs are the world wide currency. America is for sale - you can buy most everything with the dollar IOUs. The exchange rate with foreign currencies remains strong.

The dollar holders get nervous when they think the Fed is printing too many IOUs. This goes on all over the world, the holders of large amounts of US dollars want to keep them as valuable and stable as possible. The trouble with the dollar IOUs like gold is that they pay no interest. That is why when the treasury bonds are put up for auction the dollar IOUs holders gobble them up even though they are paying ridiculously low interest (the demand for these bonds is very high).

The US treasury bonds are as safe as the dollar BUT they also pay interest. US treasury bonds are simply another form of government IOUs. They are probably the safest investment in the world - the US has never defaulted on a "treasury bond IOU" as far as I know. In time of world financial chaos  investors flock to the US treasury bonds for safety although they may as well just keep their dollar IOUs.

The treasury sells bonds through auctions (exchanges bond IOUs for dollars IOUs). This exchanging IOU bonds for IOU dollars takes the dollars out of circulation reducing the supply of dollars outstanding theoretically making the dollar stronger. If the treasury puts too many bonds up for auction, beyond the current demand, the bonds' interest rates will rise while the value of the bonds will fall so why would they do that?? It pays to keep the supply of bonds limited so demand is strong and US treasury doesn't have to pay so much interest. This is the way the treasury can also control the interest rates and dollar supply.

Actually they really don't have to auction any treasury bonds at all, the dollar holders would just have to invest their dollar IOUs in other ways. When you buy treasury bonds you are actually just exchanging bond IOUs for dollar IOUs. The treasury could just "print" dollars electronically putting them in circulation through the banks and paying their obligations (infrastructure, military, social programs, employees, etc.) with them. The treasury should never pay more than 1% on their bonds. Why pay all that extra expense when the dollar IOU holders are already holding our debt at 0% interest. As long as there is enough demand for the dollar it will remain strong. One way to keep the dollar strong is to keep buying foreign goods in exchange for our IOUs. This keeps the demand for dollars from foreign manufacturers high and increases the potential demand for American products.

Actually the demand for the dollar is getting stronger in some instances! That means the Fed is not printing enough dollar IOUs - the demand is greater then the supply so its value is increasing. A dollar can buy more goods then the same dollar could last year. Index of food sold to be eaten at home fell last year. Homes are cheaper, bread, milk, meat and eggs are all cheaper. Natural gas is cheaper, the cost of heating your home and hot water is less. Oil is cheaper then the highs of last year. The cost of labor remains relatively stable. The conditions supporting the inflationary growth of the last decade has abated (at least temporarily). The value of the dollar seems to be stable or appreciating. This means the demand exceeds the supply so the treasury will have to print more dollar IOUs to satisfy the demand.

With the trillions of American dollar IOUs circulating around the world - there is a tremendous amount of potential demand for American products, etc. out there. Now if only the dollar holders would start spending them. Unemployment would fall and American factories would hum again! The only trouble with this is that many foreign governments around the world set up trade barriers to prevent or hamper their people from buying our products, they would rather just take more of our dollar IOUs then buy our products.

Don Hamilton - author of The Mind of Mankind

Disclosure: No Positions

Disclosure: no positions