Reply #19: If the dollar keeps dropping...

[davekriss]

...we'll have a repeat of the effects of the post-James Baker Plaza Accord from around 1986-1988.

Back then, the Reagan administration was battling the awful effect of a too strong dollar. Reagan followed a rich-man's Keynesian strategy of cutting taxes even while building up national defenses. At the same time, Paul Volkner was battling high inflation at the fed. Federal debt was consuming most of our private savings so, for the US to technically remain solvent, we had to look overseas for the cash to fund the (then) huge Reagan deficits. What happened? Real interest rates reached records not seen since (ok freeper bozos, Carter holds the record for nominal rates, inflation + real rate; Reagan holds the record for real rates).

Our interest rates in the early Reagan administration grew attractive, after discounting for risk, compared to the rest of the world, so foriegn funds flowed into the treasury and the massive debts were funded.

The problem was, you could only buy a US Treasury Bond with US dollars, so the rest of the world raced to trade their Yen and Franc and Marcs for dollars, bidding up the relative value of the dollar compared to the rest of the world's currencies. I recall the Yen falling to around 268 per dollar -- that was cheap!

The unfortunate effect of a too strong dollar was people rushed to buy cheaper Toyotas and Sony TV's. American firms lost market share and sometimes whole industries, resulting in the rusting of the bedrock of blue-collar middle classism, the midwest manufacturing base. Reagan was fast plummeting in popularity so something had to be done. In rushed the black knight, James Baker the III, who hastily formed the Plaza Accord where the central bankers of the leading economies agreed to trade reserves to maintain the dollar in a narrow target range. However, they didn't have it quite right and over-adjusted and the dollar plummeted. Now a dollar could only fetch 89 Yen.

There were some good effects from this. Now Toyotas and Sony TVs were looking expensive so there was some recovery of market share and, thus, some recovery of bedrock blue-collar jobs (of course, offshoring put an end to any "recovery"), but there was a huge downside too. As a result of the weak dollar, we held a massive "fire sale". Whereas before the Reagan administration the US owned 3.7x more of the rest of the world than the world owned of us, by the end of the GHWB administration the rest of the world now owned 0.4x more of us than we of them. How many of us today work for a firm owned by some transnational headquartered in Bonn or London or Hong Kong?

These are huge structural changes that have made us a less prosperous, less eqalitarian nation. A shame, really (it didn't have to be, but as now, we like lemmings followed Republithug idealogues over the cliff).

We've been able to maintain a modicum of US prosperity because of dollar hegemony. A lynchpin to this hegemony is agreements with nations like Saudi Arabia, who agree to trade oil only in dollars in exchange for military aid and non-interference in internal affairs. This agreements, however, are unravelling (note that 15 of the 19 hijackers on 9-11 were Saudis). Thus the invasion of Iraq, which I believe was first and foremost meant to establish impregnable military garrisons from which the US can radiate imperial power throughout the region, thereby preserving hegemony but now with bombs and bullets.

This strategy, of course, is failing miserably. All Bush has accomplished is gain of the ill-will of the world. So the rug will be pulled out from under the dollar (I expect 1.4+ per Euro by March), increasing prices and slowing US consumption (as so much of what we consume now comes from overseas); interest rates will rise as the dollar devalues in order to attract the foriegn cash needed to fund the Bush deficits, further eroding aggregate demand -- and so we will fall into a very steep recession (if not an actual depression).

The near/mid-term, I believe, is pretty bleak.