Holding a green piece of paper decorated with patriotic symbols as a proxy for economic value is an act of faith.  To do so with the currency of your own country is a necessary act of faith, since daily life requires it in order to make economic transactions.  But to hold sizable amounts of the currency, or the currency-denominated assets, of a foreign country is carrying faith beyond any warrant provided by human experience.  History clearly reveals that the eventual debasement of currency is as predictable as night following day.  Why, then, are our foreign-trade partners so eager to hold huge hoards of U.S. greenbacks?

A survey of the current economic landscape abounds with evidence of the debasement of the dollar.  Gold, the hedge of last resort for financial liquidity, has returned to its former price of $450 per ounce.  Oil prices that hovered around $20 per barrel in the 1990’s have more than doubled, while housing prices are growing at double-digit rates.

The typical American homeowner is attempting to profit from this debasement by borrowing as much as mortgage lenders will lend to buy the largest home that he can(not) afford.  Household debt as a percentage of Gross National Product has continually set records for the past two decades.  When interest levels return to normal and join soaring energy costs, these households will have a painful financial hangover from their current libations.

The federal deficit (now approaching $400 billion per year) is the principal source of the dollars that fuel the inflation of the price of commodities and other real assets.  Financed primarily by foreigners and foreign central banks, with the balance bought by the Federal Reserve Banks, the deficit roughly correlates to the international current-account deficit generated by the negative balance of trade in goods.

The excessive growth of the money supply since the mid-90’s has driven after-tax and risk-adjusted interest rates to negative real returns on fixed-rate investments.  Stock-market returns, augmented by foreign earnings restated in depreciated dollars, and outsourcing of goods and services to cheaper foreign suppliers—plus the valuation of earnings at unrealistically low interest rates—barely support otherwise unjustifiable common-stock prices.  Both stocks and bonds provide unattractive real returns to U.S. investors, discouraging savings and encouraging excessive investment in cheap imports and an overpriced residential-housing market paid for with unsustainably cheap mortgage debt.

The Bush administration has been playing a game of chicken with our foreign competitors by devaluing the dollar as much as possible in an attempt to close the trade deficit.  The European Union and, to some extent, Japan have allowed the relative appreciation of their currencies, but the remainder of the Asian countries have kept their currencies pegged to the dollar.  The United States has been their most profitable market, providing the lowered costs that go along with access to the world’s largest homogenous market—the only principal market that offers them relief from border-adjusted value-added taxes.  U.S. manufacturers’ exports are likewise priced out of foreign markets by those countries’ value-added taxes, with no compensating relief offered by the U.S. Tax Code.

As the dollar depreciates, the rising prices of raw materials are soon followed by cost-of-living increases in wages and salaries, and that is on top of the cost-push of lower operating rates.  So the devaluation of the dollar has had the effect of a dog chasing its tail.  Compared with a basket of seven major currencies, the dollar has declined an average of 15 percent—and all to no avail; an equal decline is predicted during 2005.  As the Wall Street Journal recently observed:

[T]he Bush Treasury, and perhaps Mr. Bush himself, seem to have fallen for the notion that a country can devalue its way to prosperity. . . . Britain tried this in the 1970’s, and had to call in Margaret Thatcher to save the country from sinking to Third World status.  The Carter administration also tried talking down the dollar and ended up inspiring a global run on U.S. assets.

BusinessWeek asks, in the same vein:

Will trade imbalances topple the greenback? . . . [F]or more than a decade the global economy has become more dependent on foreign capital to finance its (U.S.) demand. . . . Foreign money now finances three-fourths of U.S. net investment.

Neither of these astute observers, however, diagnoses the real source of the problem and, thus, cannot offer a remedy.

The declining dollar is the product of three deficits: The federal deficit, the difference between excessive federal spending and ill-advised tax cuts; the personal-savings deficit, characterized by “consume today, and worry about tomorrow later”; and the manufacturing trade deficit, which clearly indicates the desperate need to level the taxation playing field for our disappearing manufacturing sector.  Ideological internationalists without concern for their nation, multinational corporations who profit from the hollowing out of the U.S. economy, and economists who do not understand the power of price mechanisms have used the media to mislead the public regarding the source of the problem and its obvious solution: border-adjusted (consumption-based) tax reform.

A country that manipulates her own currency to demean it as a store of value for the wealth of her citizens and as a respected medium of exchange; that borrows to encourage consumption at the expense of savings for investment (to be billed to future generations); and that provides foreign competitors with tax advantages that are insurmountable for her national industries’ survival is not being governed in the interests of her citizens.