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The U.S. Dollar has been falling since July 01, 2002 from it‘s high of 121.29 to it‘s all time low, which has been set in each of the last 7 days and continues to fall. Today that same index hit a low of 77.60. That‘s equivalent to a 36% loss in value. The dollar index measures the U.S. Dollar against a basket of currencies. The weaker dollar benefits us because exports are now less expensive, which should cause the Trade Deficit to disappear. That‘s the good news! Actually, that‘s the ONLY good news.

Now for the bad news. As the dollar declines in value, increased exports put pressure on the labor market which drives up wages, which is inflationary. Also, as the dollar weakens, imported products get more expensive, which is inflationary.

Now, follow the logic here, because this scenario could possibly trigger an economic collapse.

The Federal Reserve has the responsibility of maintaining the stability of the financial system. One of the options given to the Fed to accomplish this, is to control the money supply through interest rate adjustments.

When signs of inflation appear, the Fed increases interest rates to lower the money supply and thereby slowing the economy. The inverse of that would be that if the economy is slowing too much, the Fed lowers interest rates to increases the money supply, giving the economy a boost. Remember, lower interest rates weaken a currency because there is more of it.

The Fed in fact did lower interest rates on September 17, 2007, as a way to add liquidity to the market (increased the money supply), in order to ease the turmoil in the financial markets brought about by a collapse in the housing market and near collapse of many of the mortgage companies and banks that financed these high risk loans.

It began when the housing bubble burst, causing real estate values to fall precipitously and sales of new and used housing to plummet, followed by a huge increase in mortgage defaults and bankruptcies. Mortgage defaults were particularly noticeable in the sub-prime markets.

This is where the peril to the economy comes in. The Fed is now between a rock and a hard place. They are left with three choices:

They could (increase the money supply) lower interest rates even more, in order to prevent a further collapse of financial institutions such as banks and the real estate and stock markets. This leads to a weakening of the U.S. dollar, which is inflationary as described above.

They could (decrease the money supply) increase interest rates, in order to prevent the dollar from collapsing completely, which in this case could lead to hyper-inflation. Higher interest rates would also pressure the economy downward, causing a recession, stagflation or an outright depression. This is due to the fact that inflation rates have been either under estimated or under reported.

It doesn‘t take a genius, to see that prices have increased far beyond what we have been told. All you have to do is go to any super market, gas station, repair shop, automobile dealership, doctors office or prescription counter to see inflated prices. Not to mention utility costs.

Perhaps the basket of goods used to gauge inflation is antiquated. What should be used is a weighted basket of staple goods, such as food, gasoline, automobiles, essential services, utilities, healthcare, prescriptions, the cost of housing and taxes, and non-staple goods, such as electronics, clothing, home furnishings etc..

Anyway, I digress. Don‘t forget, that the dollar declined in value 36%, which means we are paying 36% more for goods and services. That‘s a far cry from the less than 2% inflation that‘s been reported year over year since 2002.

Just to buttress my statement that we are paying 36% more than in 2002, answer this question: Would you have traded a one dollar bill for a Canadian Loonie, which was worth about 75 cents back in 2002? Of course not. But today, it would take MORE than a dollar to buy that same Loonie.

Find the Value of todays U.S. Dollar compared to previous years

By Michael Scoglietti
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