Popular opinion is that the United States will experience some violent inflation over the coming decade as punishment for the reckless borrowing, irresponsible budgeting and rabid consumption that has taken place in the US over the last twenty five years. However, in order for inflation to truly take place, one of these things usually happens: the money supply has to increase rapidly, demand must outpace supply, or the currency needs to depreciate. We’ll start with the money supply.
Most people would assume that the money supply truly has increased violently over the last couple years. This ignores a couple of key factors in the equation. One, is that the housing collapse has destroyed wealth in an equally violent way. It is only the very rare homeowner who feels more wealthy now than they did at the beginning of 2007. So, has the money supply actually increased? Loans have been written off, houses have been marked to market and people have gone bankrupt. In many ways, the stimulus has simply transferred the debt of American homeowners to the government, so that it can be repaid over time at a lower rate using the seemingly bullet proof credit score of the US Treasury.
As a transition to demand, if homeowners feel poorer now than before, what supports the claim that demand will increase in the United States any time soon? Consumer opinion is still negative and sentiment is well below where it needs to be to drive a substantial recovery. The destruction of wealth will most likely influence the savings patterns of US citizens for the rest of their lives. I anticipate higher personal savings for the coming generations than those that have preceded them. In this way, there will be less of the domestic demand necessary to fuel an inflationary move. So if the money supply and demand don’t seem to have the gumption to push inflation significantly higher, where does the dollar stand?
Educated minds have been very bearish on the dollar recently for a variety of reasons. First is the fact that the United States must rebalance their economy by relying more on exports. Secondly, the US government has racked up hundreds of billions of dollars in debt in an effort to stimulate the largest economy in the world. In terms of the trade argument, the United States will already consume less than they have on average over the last couple decades. The recent recession has been a sort of baptism by fire for many people, and it is an experience they won’t soon forget. The impact of the stimulus may be moot because of the points made above and the fact that the government still stands to make a profit from some of the bailouts (AIG and Citi).
With equities no longer being thought of as the end all be all for long term investing, people are now considering saving enough to have a cushion. This should continue into the future. The United States cannot continue to be the driver of consumption for the rest of the world. Trade is a zero sum game (in terms of accounts, not productivity) and the other major players in the world need to work to step up their consumption. Most pointedly, I am talking about China. Regardless, Americans must consume less and save more. If this happens, it will fail to provide a driving force for inflation.
Also, historically the dollar does not always behave as it is told. The crisis in Greece is a pointed example. As cracks seem to appear in the foundations of the European Union, the euro has suffered and there has been a flight to the relative safety of the dollar. There are arguably more pressing fiscal budgetary dangers in the United States, but again, the markets feel relatively more safe holding dollars.
The moral of the story is that the United States will not fail in the near term. It is in the best interests of the world to maintain the dollar’s status. Should the yuan ever be allowed to appreciate or the EU show signs of unity, there may be a challenger. For now, the dollar is the most stable dancer on the tight rope.
