Tuesday, October 06, 2009

The Economic World War

With the growing din of rumors of many countries planning to end the use of the dollar as the world's trade currency, what are the implications?

If this were to happen, expect trillions of dollars to return to America. While U.S. exporters will benefit from the weakened dollar, inflation will increase by a huge amount.

But the curious aspect in this is China's involvement. According to the US-China Business Council, China exported $252 billion in goods to the U.S. in 2008. Overall, China exported $1.4 trillion to all countries. By letting the U.S. dollar fail, China would be risking up to 18% of it's export economy. While it would be unrealistic to expect U.S. imports from China to drop to zero, it would undoubtedly cause a drop in China's export business here.

Here is where it gets interesting. If China maintains their currency peg to the dollar, they could make their goods even cheaper on the world market, and still maintain their export trade with the U.S. But then China would be in the driver's seat economically, allowing them to de-peg their currency from the dollar slowly, allowing them to grow their economy away from a reliance on the U.S. export business. Chinese goods will grow in cost at a rate close to our own inflation rate.

In case you have not already guessed it, the U.S. economy will be a huge mess. While our export businesses will thrive, import businesses will dry up. The price of gas will shoot up, hurting our economy in multiple ways, with the most obvious being the increased cost of goods and services.

Let us not forget, the Federal Reserve will have it's hands tied by our heavy government debt burden. If they increase rates, they will also increase the government's cost of financing our debt, thereby digging our debt hole deeper. If they don't increase rates, inflation will soar.

Technically speaking, the U.S. will be in the middle of a perfect economic storm: heavy government debt with reduced tax revenue, soaring inflation, and weakened domestic businesses leaving unemployment high (and possibly growing). If the Democrats manage to pass universal health care, they will be forced into heavy rationing of it long before they had hoped. With Social Security and Medicare debts coming due as more Baby Boomers retire (or are forced into retirement by unemployment), our government debt burden will increase even more.

In summary, we are screwed if the dollar is removed as the world's trade currency.


Justine Nicholas Valinotti said...

One thing my life has taught me is that one doesn't realize that one has privilege until one loses it. And that is exactly what will happen to this country when the dollar loses its hegemony over the world's economy.

Most Americans don't realize that, even in tough times like these, most things, from gasoline to groceries, are cheaper here than they are in most places in the world. Much of that has to do with the dollar's dominion, which, to a very large degree, was a consequence of the US being one of the chief de facto empire of the 20th Century.

EdMcGon said...

Good point Justine. We are like a championship sports team, which keeps playing like everyone should lose to us, completely forgetting what brought us our championship in the first place.