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The Falling Value of the Dollar

Deficit is source for concern


In recent months the value of the U.S. dollar has fallen dramatically against other currencies, most notably the euro, reaching record lows around $1.35 to one euro. Economists have identified the U.S. deficit as a source for concern, along with our dependence on China and other East Asian countries to buy our government bonds and fund our international debt. However, recent speculation suggests that perhaps our economy is no longer appealing to China, and a withdrawal of their investments could have serious domestic and international ramifications. Add to the mix the political unrest occurring due to the war in Iraq and terrorist concerns. Investors are increasingly looking toward putting money in commodities such as gold, which provides a safe haven in times of economic uncertainty.

Since September of 2004, gold has broken through the $400 level and risen to more than $450. In the early 1980s, gold reached a historical high of more than $600, enticing today's investors with the notion that current gold prices could continue to rise. Hendrik Spruyt, a political science professor who teaches classes in globalization at Northwestern University, offers his thoughts on the U.S. economy, gold prospects and possible solutions to the budget and trade deficits:

Chicago Life: How serious is the current deficit and depreciation of the dollar?

Hendrik Spruyt: The two deficits to worry about are the budget deficit, which is at quite high levels, and the trade deficit, which is also at record levels. The combination of those two raise concerns, not only in political circles but also for the private bond markets. Across the aisle, both Democrats and Republicans have worried about it. And that could have ramifications not just for the United States, but also for the worldwide economy. And that's one of the issues with a global economy &ndash if one of the premier economies catches a cold, then everyone else catches the same cold, as well. So it's a real source of concern, worldwide actually.

Chicago Life: Do you think gold is a viable safe haven?

Hendrik Spruyt: Gold is the typical refuge in times of trouble, either political or economic. Gold has gone up dramatically, not only because of the economic uncertainty but uncertainty about the world at large, including the situation in Iraq. Certainly the dollar has dropped quite a bit against the euro and has been held artificially high against Asian currencies. But the real problem is the trade balance with China and Japan, a negative one, which is where the big trade deficits come from.

Chicago Life: Is there an immediate danger of China pulling money out of treasuries? What would the consequences be?

Hendrik Spruyt: There is a real danger that when they stop buying these bonds we will have a real problem with the government debt. The way to think about money is to think about it as any commodity. If it is in demand, the price of that currency is high, and if it is not in demand, the price goes lower. So if they stop buying bonds, we will have a real problem with interest rates. Someone will have to save money to make up for the debt. Americans aren't saving &ndash we are notorious spenders. We're always spending more than Europeans and Asians. If we're not saving, and making dollars available by saving, then we have to find some other way. The way so far has been to get the Asians to buy our debt. If they stop doing that, the only way to take care of the debt is to encourage saving, which would entail raising interest rates.

Chicago Life: Does the current deficit parallel any historical deficits, either in the United States or any other developed countries?

Hendrik Spruyt: It is difficult to compare, in the sense that our economy today and the global economy, are so different. If you look at the figures between the late 1950s to the late 1980s, the Euro currency market, which is the amount of money invested elsewhere, multiplied a hundredfold in about 30 years. That has led to a completely different financial market than there was 30 years ago. Also, the global economy means that it has to be managed jointly, with the Chinese, Japanese and increasingly, the Europeans. You now need co-leadership.

Chicago Life: Do you have any predictions as to what will happen with the current deficit and the U.S. economy?

Hendrik Spruyt: Well, there is a question as to whether or not we can tackle the deficit without raising the taxes. On the one hand, you have John McCain, a Republican, saying, well, the figures don't add up. You can't go to war and lower taxes at the same time. That doesn't mean the Democrats had a plan either. John Kerry's figures were probably too optimistic. To be fair here, the general sense is that it is very difficult to get around deficits partially precipitated by the war in Iraq and the defense expenditures, which is part of the story. But no politician wants to say, "We need to raise taxes." Ultimately, we have to start looking at expenditures.

Published: February 01, 2005
Issue: Winter 2005