How the dollar and the deficit threaten savings accounts
October 13, 2010
Recently, MoneyRates.com looked at some of the pluses and minuses of the decline in the U.S. dollar relative to other currencies. Now, it's time to look at what may be the deciding factor -- the reason you should be concerned if the slide in the dollar is pushed too far.
As previously discussed, the positive aspect of the slide in the dollar is that it is good for trade, while a significant negative is that it could also prove to be inflationary. What tips the scales on this issue is that driving the dollar too far down could precipitate a crisis with regard to the U.S. budget deficit.
The deficit and the dollar
To some degree, the slide in the dollar may reflect global concerns with the growing U.S. deficit. The U.S. dollar has been the world's reserve currency of choice for a long time now, but foreign reserve banks might understandably grow impatient with buying a currency that is steadily losing value.
This could have a spiraling effect. The more reluctant foreign countries are to buy U.S. securities, the more expensive it will become to fund the deficit -- pushing the deficit higher still.
A road paved with good intentions
In the House of Representatives, a protectionist bill targeted at Chinese imports got a broad amount of bi-partisan support. Basically, the purpose of the bill is to punish the Chinese for not allowing their currency to appreciate more rapidly against the dollar. To look at it from a slightly different angle, the intent of this bill is to punish the Chinese because the dollar isn't being devalued quickly enough.
It shouldn't be surprising that protectionism and China-bashing should be popular with politicians during an election season, but there are important, unintended consequences to focusing solely on the trade impact of a lower dollar. If China stops buying U.S. bonds, the dollar would sink, but interest rates would soar and the deficit would mushroom.