The Beginning of the End for the Greenback

It isn't often that currency traders worry what supermodels think about the dollar-euro exchange rate. Maybe in this case, however, they should.

The pop culture world was abuzz in early November when some news outlets reported Gisele Bundchen, one of the world's richest supermodels, opted to be paid in euros because of the dollar's weak outlook. Her spokeswoman denied that the model was spurning the dollar, saying Bundchen is simply paid in the currency of a job's location. Nonetheless, it seems a tipping point may have been reached. Quite simply, the American greenback just isn't worth what it used to be.

In fact, the U.S. dollar has been falling against every major currency and gold and silver for several years. This past summer, the Canadian dollar surpassed the U.S. dollar in value for the first time since the Carter Administration, way back in the 1970s. Gold is trading around $800/oz. at this writing in mid November, compared to around $600/oz at the same time last year. Silver was trading at $12/oz at this time last year and is now in the $14/oz. range. For both metals, the 5-year trends are even more noticeable: Silver was just over $4/oz in Oct. 2002, Gold was about $320/oz.

Going global in terms of one's currency makes sense these days, Steven Tepper, associate director of Vanderbilt University's Curb Center for Art, Enterprise and Public Policy, told The Associated Press in early November.

"Any international business person that is moving assets around the world will want to do as many deals in the strongest currency available, which is certainly not the dollar these days," Tepper added.

A weaker dollar is doing more than just getting the attention of select world super models, however. It is impacting middle America right where it hurts, bringing higher inflation. These higher costs are making our basic commodities cost more. The value of the American dollar is dropping at a particularly bad time compared to the price of oil. Total vehicle sales rose 24 percent, year over year, for the first 10 months of 2007 in China, to 7.15 million units. Vehicle sales in China have skyrocketed in recent years, from 2.73 million in 2001 to 7.2 million in 2006. China is now the world's second largest auto market, only behind the United States, and the demand continues to grow.

"(The Chinese) auto market has experienced significant growth in recent years, but that growth rate will drop to somewhere between 15% and 20% within the next five years as China's total sales are approaching 10 million units," Zhao Shengli, an auto analyst with China Galaxy Securities Co Ltd., told the Auto Channel on Nov. 14.

All these new cars and trucks need gasoline, creating a huge increase in demand for oil. With the dollar weaker against the euro, when a barrel of oil costs $100 US dollars, that same barrel will only cost 60 or 70 euros, depending on the exchange rate at the moment. Growing world oil demand and the falling US dollar are giving American consumers a double whammy.

Unfortunately, the pain isn't just at the pump, its all around us. Take, for example your morning glass of milk. The price of milk has been climbing steadily, up 34 cents per gallon of regular while milk on average in the second quarter of 2007 and another 48 cents per gallon in the third quarter, to a national average of $3.94 per gallon, according to the American Farm Bureau.

"Dairy products continue to increase in price," said AFB Economist Jim Sartwelle in his quarterly report. "Strong competition from overseas consumers for U.S. milk products has helped drive prices to current levels."

With the relative value of the euro and other foreign currencies climbing, dollar-carrying American will find it harder to compete, be it to buy a gallon of gasoline or a gallon of milk.

Part of the problem is that the dollar is a fiat currency, and has been since before World War II. A fiat currency is a currency that isn't backed by a security, such as gold or silver. Our dollars are printed on an as needed basis and infused into the economy by the Federal Reserve. When they need money, the make it the old fashioned way: they print it. That means that while there might be plenty of gold in Fort Knox, it isn't there to back up your dollar. The value of the dollar is essentially based on what the world thinks it is worth today and what it will be worth tomorrow. It is simple supply and demand. The supply of our dollars is high, causing the demand to slacken. Right now, the world is more enamored with the euro, gold, the Canadian dollar, oil and probably a few other things more than the dollar.

There are things that the Fed can do to strengthen the dollar. Chief among them is to tighten monetary police and raise the U.S. interest rates. In Australia, the Reserve Bank of Australia has raised interest rates 10 times in recent years, moving to 6.25 percent in October, its highest level in 11 years. The moves have caused the Australian dollar to rise in value against the American dollar from 78 cents in January 2007 to 92 cents in November.

Many believe that a major move in U.S. interest rates must be coming soon to stem the falling value of the dollar. Tightening of monetary police and an increase in interest rates would make dollars more scarce in the economy and when there is less of something, Economics 101 tells that demand will drive up the value of the dollar. Having fewer dollars available will have a slow down effect on the economy.

Writing in the Sept. 10 edition of Newsweek International, Jeffrey Garten, professor of international trade and finance at the Yale School of management, commented that during the presidency of George W. Bush, the dollar has depreciated in value about 25 percent - "without a peep from Washington." Garten also points out that it appears unlikely the Bush Administration will change its policy on the dollar in the year or so it has left in office.

Garten sounds the alarm for a potential currency crisis: "We could have the worst of all worlds - inflation, high interest rates and recession. Finally, a weakening dollar could lead to more acquisitions by the cash-rich countries - China and the Gulf states - that arouse a political backlash in America. That could ignite more protectionist pressures, and send Wall Street reeling."

But when a change comes, be it during the current presidency or the next one, the cost could be steep. A rise in interest rates doesn't happen in a vacuum. There will be other consequences as well. A rise in interest rates means that it costs more for businesses to take out a loan to invest in new widgets and consumers have to pay a higher rate on their home improvement loans. The extra cost could just be enough to cause some to put off those investments, thereby slowing down the economy.

An increase now in the value of the dollar would likely hurt many American companies, which are doing a brisk export business these days as overseas consumers take advantage of the relative strength of their currency. A slowdown in the export business - just when General Motors and Ford are trying to sell more cars in China -- coming at the same time that the money supply tightens up at home could plunge the nation straight into recession, no matter how delicately the nation's monetary leaders walk their tightrope.

It is likely that, sooner or later, larger or smaller, a day of reckoning is in the offing for the U.S. dollar. It's enough to make a super model want to keep a tight grip on her pocketbook.

Sources:

Bivens, Josh; economist at American Policy Institute: interview with CNBC, Oct. 10, 2007

Canadian Press: Strong Loonie Helps Maine Lumber, Oct. 8, 2007.

Eichengreen, Barry; finance professor, University of California-Berkeley: speech to the Economic History Society, April, 2007.

LaCapra, Lauren Tara, Associated Press Writer: "Pop Culture picks up on dollar decline." Nov. 14, 2007

Mance, Saadiq; editor, Emerging Minds magazine: Sharp Moves in Price of Gold and Silver Should be Top Concern of Middle Class America, August 2007.

MetalMarkets.org.uk: Canadian Firm Increases Gold Forecasts, Oct. 8, 2007.

Reuters: Citigroup Ups Gold, Silver Forecast, Oct. 8, 2007.

Shengli, Zhao, China Galaxy Securities Co Ltd., quoted by Auto Channel (theautochannel.com) Nov. 14, 2007

Silver Institute, The. 2006 Report on Silver Production, Demand, Usage.

White, Aoife; Associated Press business writer: "EU Worries About Weak US Dollar, Oct. 8, 2007