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Part III: The U.S. Dollar and the Thief in the Night
Welcome to the final part of this series, and thank you to everyone who sent his or her concerns and comments. The weakness in the U.S. Dollar is something that personally affects the quality of life for every U.S. citizen. If you missed Part One and Part Two, you can find them, along with all of my other articles, as well as great trading articles from other writers, in the Lessons From The Pros section of the Online Trading Academy website.
I wish that I could tell you that there is something new and positive to report about the greenback, but the only thing that is new are the new lows that have been reached by the U.S. Dollar Index, which reached yet another 15-year low this week (see figure 1).
Figure 1: The USD Index reaches yet another multi-decade low. Source: FX Street.com
The media has been abuzz this week about the Canadian Dollar reaching parity with the U.S. Dollar for the first time since the mid 1970's. Parity is the point at which one U.S. Dollar is equal in value to one Canadian Dollar. After achieving parity briefly on September 20th, the USD/CAD currency pair traded below that figure on September 21 and 24, before bouncing above 1.0000 on the evening of the 24th (see figure 2).
Figure 2: The U.S. Dollar falls to parity vs. the Canadian Dollar. Source: Saxo Bank.
The Evil Twins
Just as a high level of personal debt damages an individual's financial health, the high level of U.S. debt is damaging the country's fiscal well being. This debt exists in the form of two major deficits: the Trade Deficit, which could be described as the difference between the value of imports vs. the value of exports, and the Budget Deficit, which is the difference between the amount of money that the government spends vs. the amount of money that it actually has.
The U.S. deficits are huge and growing, and to finance this mountain of debt we're flooding the world with dollars. If this course continues, the dollar will decline until it is replaced as the world's dominant currency. The decline of the USD may accelerate soon, according to Jack Albin, senior vice president and CIO of Harris Private Bank, who writes, "growth in the S&P 500, up almost 8% in dollars year-to-date, dwindles to 1% when denominated in euros. If the dollar falls further, U.S. markets become much less compelling for overseas investors."
When the U.S. issues government bonds, it is essentially borrowing money to finance its deficits without raising taxes. This mollifies those who are opposed to higher taxes, and also appeases those who desire more government spending. Therein lies the problem; in reality, there is no such thing as a free lunch. In order to prevent the continuing explosion of the U.S. budget deficit, it will be necessary to either raise taxes or reduce spending – or both. Since either course of action will raise the ire of the voting public, few politicians can muster the will to blaze either trail. Instead, we take the path of least resistance – borrow more money to cover our spending, and hope for the best. Then, when these politicians retire or are voted out of office, these problems are inherited by their successors.
Yet even under a system that seemingly rewards our politicians for racking up big debts, a balanced budget was achieved in the U.S. less than ten years ago. How did this happen? About ten years ago, there were politicians in Congress who opposed and attempted to slow the growth of deficit spending in the U.S. They believed that taxes and spending should both be reduced, and that the government should spend no more than it collects. This philosophy, combined with a fortuitous series of events (most notably the rise of Silicon Valley tech companies and the so-called "peace dividend") helped to lead us to a balanced budget. That's right; the U.S. budget was actually in balance from 1998 through 2001. The balanced budget spoke well of political gridlock, because with a Democrat in the White House and the Republicans in control of Congress, both sides tended to check each other's worst impulses.
Because the budget was in balance, less debt financing was needed. The culmination of these events occurred on October 31, 2001, when the U.S. government announced it would no longer issue 30-year Treasury bonds. At that time, Peter Fisher, the Treasury Department's Under Secretary for Domestic Finance, remarked, "We do not need the 30-year bond to meet the government's current financing needs, nor those that we expect to face in coming years." Sadly, the era of the balanced budget was short-lived, and soon the U.S. budget would plunge into the red. After a four-year hiatus, the need for additional borrowing led to the issuance of new 30-year Treasury bonds.
In more recent years, this "pay as you go" philosophy has faded, and now both political parties spend as if there were no tomorrow. Perhaps this is what former Federal Reserve Chairman Alan Greenspan meant when he wrote, "The Republicans in Congress lost their way. They swapped principle for power. They ended up with neither.”
When a person's credit becomes over-extended, there is a price to pay. Just as an individual will eventually face serious consequences for piling on credit card debt, a country can't pile up debt and add to the money supply without weakening the underlying currency. We have gone far beyond the point where one political party can be labeled as imprudent on spending. Democrats and Republicans alike are at fault here. The question is, what to do about it?
Control Spending to Balance the Budget
Yes, it will require a great deal of political will, which seems to be in short supply these days, but we've done it before. We have to find a way to prevent our government from spending like a drunken sailor with a stolen credit card. While a balanced budget is not at the top of any candidate's political agenda, it would be if voters would make it clear that fiscal sanity matters. It's time to let our candidates know that we are not going to stand idly by while our currency is turned into a worthless piece of paper.
Control the Money Supply
The Federal Reserve publishes data on money supply. The narrowest measure, M1, is restricted to the most liquid forms of money; it consists of currency in the hands of the public; travelers checks; demand deposits, and other deposits against which checks can be written. M2 includes M1, plus savings accounts, time deposits of under $100,000, and balances in retail money market mutual funds. The Fed used to publish an even broader measure of the money supply called M3, but discontinued this practice in 2006, supposedly because it was too expensive to gather the information. This could be described as an amazing bout of selective fiscal sanity. Why would the Fed suddenly care about spending, when its solution to every problem is to print more money? Could it be that the Fed simply doesn't want us to know exactly how much money is being added to the overall supply?
Every time the government prints U.S. Dollars and adds to the money supply, the value of each individual dollar is lessened. For example, when the Fed injected liquidity into the markets in August, it essentially increased the supply of U.S. Dollars. While it is understandable to inject liquidity into the markets during a time of crisis, the overall supply of money as measured by M2 has increased by more than 10% over the past two years, and has more than doubled since the end of 1995. In a sense, one could say that by doubling the supply of dollars, we have cut the value of each dollar in half. Let's put a stop to this madness and regain control of our currency.
Have a question about Forex trading? Send an email to eponsi@tradingacademy.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.
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Ed Ponsi is a globally recognized name as a lecturer and teacher and is the former Chief Trading Instructor for Forex Capital Markets. An experienced professional trader and money manager, Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ed has appeared on CNBC, CNN International and TheStreet.com, and has recently written his first book for Wiley Finance, "Forex Patterns and Probabilities" (which you can purchase through