By: Wayne Brown
The U.S. Dollar and its buying power along with the supply of money in our monetary system is a rather complicated subject and varies in nature based on the direction the particular discussion may follow. On that basis, most folks just give up attempting to understand it and go on with living. I am certainly not going to attempt that task in an article of this length, but I do want to shed some light on the subject as it does affect how we view the actions of our government and the reactions of our economy. As in any function, the explanation is riddled with minute details. One thing I have found about the minute details of a particular model is that if you ignore them you still get the overall effect in the end…the measurement of the result is just a bit less accurate.
We all know that the U.S. Treasury is in charge of manufacturing all the money which is used in the United States. This is done through a series of manufacturing mints or plants located in various spots throughout the country. All paper money has a predicted service life therefore the treasury prints replacement bills which are place into circulation as older worn bills are removed. This function happens at the local bank level in most cases. Note that your ATM machine distributes new $20 dollar bills most of the time. The $20 bill is the backbone currency on which most retail business is transacted. On that basis, the $20 bill is also quite susceptible to counterfeiters who attempt to rob the money supply by distributing bogus $20 bills in the retail sector and collecting legitimate money in change for the effort.
The actual supply money or the amount of money in circulation in our country is monitored and regulated by the Federal Reserve System, also referred to as “The Federal Reserve” or “The Fed”. In its simplest form, this organization is basically a banking institution created by the government in the early 1900’s to manage the money supply independent of government influence. The directors and members of the commission running this organization are appointed by the President and confirmed by Congress. In addition Congress holds oversight on the Federal Reserve if its activities appear to be getting out of hand. The Fed has a number of duties in addition to managing the money supply. They are the core regulators of all U.S. banks and provide directions and regulation to the banking industry along with a number of other functions.
The Federal Reserve monitors the supply of U.S. currency in circulation and keeps track of the buying power of that money relative to other currencies in the world. The strength of the dollar on both local and international markets plays directly into the computation of U.S. trade deficits. When the dollar is strong, it buys a lot in other economies thus our export values as a country may lag the value of our imports in terms of how much product goes out versus what comes into the local market place. Basically, when the dollar is strong, companies like Wal-Mart can put a lot of foreign produced products on their shelves at either high profit margins or at good value to the customer.
Conversely, when the dollar becomes weak in international markets, just the opposite begins to occur. Our money then buys less abroad and the currency of other countries may buy more of the goods and services we produce. If they get more for their money, then we get less for ours and less of our own money returns to circulation within the local economies. This creates cash flow issues for both individuals and businesses as consumers have fewer dollars with less buying power to spend.
To take a simple example of this particular situation, let’s look at a present day product which might be produced abroad yet used as components in products assembled and sold in the U.SA. Let’s take a look at the microchip which is used as a memory and processing device in our computers. In many ways, it becomes the heart of the computer and thus drives a significant portion of the costs associated with the electronics. If the dollar is strong in the international market, it buys a lot of computer chips. For the purposes of this example, let’s just say that the buyer gets 1000 microchips for each $1000 dollar spent. If each computer produced uses 50 microchips, then the manufacturer of the computer can produce 200 computers for sale into the USA market at a given profit margin.
Conversely, if the dollar is weak, and those same 1000 microchips now cost the buyer $3000 dollars, then it is easy to see that the price of producing the computer for sale in the market place has significantly been increased. Now that same producer can only market 60 computers into the market for the same number of chips purchases. The cost of manufacturing has gone up and if the margin of profit is to be maintained, the retail price of the computer will also have to go up. Otherwise, the manufacturer has to absorb the increased costs or find other avenues within his manufacturing in which to implement cost cuts which will offset the increase. Normally the manufacturer will take the hit on the short-term, but if the situation goes on, it eventually gets passed to the consumer in the form of higher prices.
Keep in mind there are many other complexities which could affect the above example and determine the price of a microchip in the market place. The example simply assumes there are conditions present in the market which drive the price of the microchip up and lower the purchasing power of the dollar.
Now that we understand that concept, let’s get back to the Federal Reserve managing the money supply. As you may be aware, we entered into some tough economic times in the USA in late 2008 which almost threw the country into another depression. For the past two years now, we have heard various and sundry political pundits expound on how to get our economy out of the doldrums, reduce unemployment, and began to see economic growth again in the country. Along with that, we have seen various pieces of legislation beginning with the TARP bailouts during the Bush Administration and continuing with the $800+ billion dollar stimulus spending package of the Obama Administration. On the one hand, TARP supposedly stabilized the financial sector from collapse and domino effect through the banking system of the country. In terms of the stimulus, the economy did not respond and unemployment figures continued to climb after two years of awaiting significant results. Ultimately, as a country, we have ended up submerged in debt and at the brink of having our debt load equal to the value of our gross domestic product….not a good circumstance.
Given all that turmoil within the past few years, the Federal Reserve is still focusing on the money supply and the value of the dollar which is in effect their job as defined but given the wrong indicators to measure value and some decisions may not go in the proper direction.
Although our own economy is experiencing a deep low, the value of the dollar on international markets is still seen as high. This is due in large part to the fact that other nations currencies are greatly undermined by the troubles they have within their own local economies. Thus, we still get a lot of bang for the buck in the international trade arena. This causes other countries to complain and it creates deficits in trade on paper which makes it appear that the USA is not trading as freely as it could with other countries. Suffice to say that when the President attends meeting such as the G-8, he gets pressure and receives complaints to do something about the strength of the dollar and bring it more into balance in the world arena of trade.
This situation with the dollar on international markets does register greatly with the Federal Reserve as does the comments of the President and Congress relative to the buying power of the dollar. Recently, the Federal Reserve dumped an additional $600 billion dollars into the USA economy. This money was ordered by the Reserve and printed by the Treasury. It did not go to replace existing money. It is “new money” basically created at the whim of the Federal Reserve on the rationale that we have to increase the money supply in order to reduce the strength of the dollar on international markets. At the same time, the Reserve also points out that we, as citizens, should not worry because even though the dollar is devalued, there is no inflation in the local economy therefore no danger of further reducing the dollar value in terms of consumer buying power.
This is where the indicators start to come into play. The Federal Reserve has determined indicators for inflation within the USA economy which we constantly hear referred to as “The Cost of Living” indicators. These items have been determined to be indicators as to the rise or fall of costs and thus inflation in our domestic economy. Unfortunately those indicators do not always do the job because they miss some of the international relationships with certain product which affect our daily lives significantly.
As we are all aware, with the emergence of China from third world status, this giant population base has suddenly become a siphon in terms of demand for given products in order to drive the ever-increasing manufacturing base within the country and to satisfy the demands of a growing economy as more Chinese people gain affluence and purchasing power. One good example is the competition for crude oil on the world markets. Crude is basically purchased in bulk futures in an open bidding market. The simple explanation of that is whoever is willing to pay the most will get the most…it’s greed, sheer greed although the oil companies call it making a decent profit.
Given China’s need for crude the price on world markets for a barrel of crude oil continues to climb. This shows up in the USA as an incremental increase in the price of gasoline at the pump for the consumer. It is inflationary and it is an indicator that the dollar which they hold in their hand is purchasing less. Thus more and more of their household income goes into the fuel tank of the car in order to get to work and earn a pay check.
As Harry Truman might say, the buck does not stop there. Americans are sometimes desensitized to how our economy really functions and thus do not see the interconnects involved when the price of a particular item goes up. More than 70% of all products sold at the retail level in this country are moved from point of manufacture to point of sell by truck. Trucks run on diesel fuel for the most part. When crude oil goes up, so goes diesel fuel. Also, you want to keep in mind the fact that diesel fuel is already more expensive than the most expensive gasoline. Even though it is almost a waste product of the distillation process of petroleum, it is the most expensive fuel coming from it. At one time in this country the opposite was true…something must have happened. At any rate, this relationship between the movement of products to retail market with trucks that burn high priced diesel shows up in the retail pricing.
We see the effect in goods on the shelf, in food prices, in the shipping costs with UPS. There is not an avenue within the transportation sector that the rising price of fuel does not eventually impact. It becomes inflationary in that it drives the price of more than one consumable in the market and in the end the consumer has less money by virtue of higher prices. We call this inflation and we are already seeing it at the pump. It will continue even after the Christmas travel season as the projected average price for a gallon of gasoline will exceed the $3.00 point in January 2011.
This is all occurring at a time in our domestic economy when large manufacturers and small business alike are being accused of hoarding their money rather than reinvesting it into the economy and the production process. Of course a portion of this is true but most of it comes from the erroneous thinking of those in Washington who just assume that American business is continuing to run along at the same level of production and sales and the same amount of money is coming into the coffers. That is a huge assumption which is very wrong in most cases. Most American business are holding on to their cash because they are “cash flow” strapped. They need their liquidity to meet their payrolls and pay their taxes. Given the current state of unknown in terms of both taxes and the coming healthcare initiative and one can easily see why American business is huddled in the corner shaking in its boots.
There are some economic principles which have stood the test of time although most economists are even worse than the weatherman when it comes to making even short term predictions. One of the principles which we must always acknowledge in our country is the principle of “guns and butter”. It is a simple one. It basically says that as a government, we have a limited source of revenue in the treasury and a limited amount of buying power. With that buying power we can either buy butter as an example of our consumerism in this country or, should we have to engage in war, we can buy “guns”. In truth, we can buy somewhere in a balance of the two without totally doing without either completely. But there has to be a balance because those who run our country must respect the fact that there is only so much money to spend on either one or both.
This is the principle which our elected officials have totally lost sight of in this country today. Currently ,we are conducting a war on terrorism at various spots throughout the world. It is an expensive and necessary war if we are to survive as a nation and be free of those who would attack us on our own shores and continually recreate another 9/11 until we decide to capitulate and come around to their way of thinking. Given that we have no intention of doing so, we have to respond in kind and conduct a war to eradicate these monsters from the earth. Thus, we need “guns” and sooner or later that need will overshadow our ability to buy “butter”. Suffice to say that somewhere in the past couple of years we may have reached that critical point.
This becomes the reasoning behind why it is so necessary to change the thinking in Washington today. As far as I can see, the intention on both sides of the aisle is to continue spending at levels which will match recent history. In doing so, we are not increasing the income of the government, at least not until the economy recovers to generate growth and expands in the income sector for all Americans. Thus, on the short-term we need to see some strong, serious talk coming out of Washington as to how they intend to reduce spending and spending rates as well as how they intend to reduce the size of the Federal Government and its intrusion into every aspect of our lives to now include church bake sales.
The Federal Reserve will continue to dump new money into circulation further devaluing the dollar and claiming that inflation is in check. Consumers will in turn see higher prices in almost every sector of the economy even though the economy is depressed and not operating at full bore. The deficit will continue to increase and our politicians will continue to ignore economic principles and claim that we can have as much butter or guns as we want because we are after all the great nation of The United States of America.
Folks, it time to get back to sane operations in this country and it starts with us, the voters and the taxpayers. Your political orientation matters little here as the outcome of the current situation will be the same for everyone if it continues in the current direction. We have to instill some fiscal sanity into the Federal Government and we have to do it by stopping the waste of taxpayer dollars currently going on in Washington D.C.
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