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US Dollar Overview: Declining Internally and Internationally

If there is anything good to say about the U.S. Dollar, it is that it is linked to an economy which has one of the highest GDP (Purchasing Power Parity) at $14.1 trillion, very close to the European Union's $14.4 trillion (2009). These are the highest GDP numbers in the world. In third place is China with $8.8 trillion. All the others are significantly behind in GDP: United States has three times the size of Japan’s output, five times the size of Germany’s, and seven times the size of United Kingdom’s. The U.S. economy also maintains a very high level of output per capita GDP (PPP) of  $46,381, the 6th highest in the world.

Another saving grace for the US Dollar is that it is linked with oil. Prior to 1971, the US Dollar was linked to gold in one form or another, either as a gold standard up 'til 1931, or as a fixed exchange with gold  (1 U.S. Dollar = 35 ounces of gold) under the Bretton Woods Agreement of 1944. But when the US dollar began to lose value in the 1950s and 1960s, due to surging capital outflows aimed at Europe’s postwar recovery as well as  plenty of fed money printing, it became increasingly difficult for the United States to convert dollars into gold on demand at the fixed exchange rate, and thus in 1971 Nixon shut down the gold window, paving the way for a long decline in the dollar (58% since 1971).

As powerfully as the dollar has fallen since 1971, it has not fallen as hard as it could because the Government negotiated with OPEC in the early 1970s to denominate oil prices throughout the world in United States dollars (USD). US dollar-denominated oil prices has thus become the “black gold” to help back the US dollar in the absence of real gold backing. Since most oil sales throughout the world are denominated in United States dollars (USD), and because most countries rely on oil imports, these countries are forced to maintain large stockpiles of dollars in order to continue imports. This creates a consistent demand for USDs and upward pressure on USD’s value, regardless of economic conditions in the United States. This in term allows the US government to gain revenues through issuing bonds at lower interest rates, and allows the US government to run higher budget deficits than other countries.

Because the US dollar is linked to a country with a top GDP, and because it is also linked to oil, with its petrodollar (or “black gold”) backing established since early 1970s, the US dollar holds about 60% of world reserves, as compared to its top competitor, the euro, which controls about 24%.

However, the truth of the matter is that in the last 50 years, despite its top GDP position and its petrodollar backing, the dollar has seen a dramatic devaluation in both its internal purchasing power and its external purchasing power.

U.S. Dollar devaluation of internal purchasing power:

Decline in Purchasing Power of the Dollar That is a 45% downward slope on the devaluation of the dollar since 1950. Imagine having $100,000 in savings since 1950, and having that erode 88% in value. We are like frogs in the frying pan unable to see the pain of the devaluation because it happens over time, but when we are shown it in such big picture, it can be painful and disheartening. There is very little incentive to have savings in US dollars anymore with such fast erosion.

Let’s look at another chart showing how the devaluation of the dollar since the passage of the Mint Act of 1772.

As you can seen from the chart, the dollar has been in a 50% fluctuation range from 1800 to 1950, when the dollar was more or less pegged to gold, but after 1950, with increased government spending and limited convertibility to gold, the dollar began its long descent.

Here is another picture that charts the cumulative Consumer Price Index (CPI) since 1800:

Consumer Price Index (CPI) Here one can see that the CPI had remained relatively steady up till 1913, with the Birth of the Federal Reserve (with its manipulations of interest rate and power to print money), and that the CPI dramatically curves upwards when gold is removed from the monetary system in 1971.

The history of fiat money has been one of failure. Every fiat currency since the Romans has ended in devaluation and eventual collapse.

A 88% deterioration of the purchasing power of the US Dollar since 1950, or 92% since 1913, suggests that the US dollar is seriously ailing and doomed to fail.

But how does it stack up to other fiat currencies also doomed to fail?

U.S. Dollar devaluation of international purchasing power

As of 2007, the US dollar had lost 73% versus the Swiss Franc and Japanese Yen since 1969 (39 years).  The chart above also shows that it lost 59% against the Euro as of 2007. However, because of European debt worries, the dollar has risen against the Euro in the last couple years, though overall it still down 30% against the Euro as of 2011. The Swiss Franc and Japanese Yen have continued to strengthen against the US dollar from 2007 till 2011.

All this depreciation against other currencies is not to say that the other currencies themselves are not depreciating in terms of their own purchasing power. Because they all are fiat currencies susceptible to credit expansion and monetary adjustment, they have all been depreciating in significant ways, and they will all eventually depreciate to nothing. It is just that the US dollar is depreciating so much faster for so many reasons.

Top Reasons for why the Dollar depreciates faster than other currencies in the long term

There are perhaps numerous reasons why the dollar has been depreciating faster than other currencies, but we will look at the top four:
  1. The Fed has had an aggressive 29 year policy of maintaining low interest rates to encourage spending and borrowing. Ultimately, this policy has pushed people out of low yields of safe investments and encouraged borrowing into the seemingly higher-yielding, but riskier, investments like the stock and housing market, fueling these asset  bubbles and creating new ones in the wake of their collapse. The dollar depreciates under this long term low interest rate policy.
  2. The Fed has had an aggressive long term policy of expanding the money supply through its fiat banking system and shadowy printing presses, financing the Government's fiscal irresponsibilities and insuring the gambling houses on Wall Street against the collapse of their rigged bubble schemes. This monetary expansion increases inflation and erodes the dollar.
  3. Inflation has grown steadily in official CPI numbers, and astronomically in unofficial CPI numbers (shodowstats.com), because of aggressively low interest rates and money pumping to finance and bailout “bubble” economies and an astronomically growing (insanely irresponsible) public debt.
  4. Government and people are in massive $55 trillion US Total Debt due to crazy fiscal and monetary policies, the debt of which cripples the economy and erodes the US dollar. 
Since all of these reasons are quite involved in and of themselves, I will address them in separate articles.

Long term, the US dollar is always going to depreciate faster than other currencies for the above mentioned reasons. Short term, it can have its moments of strength, so be cautious.

We as traders can have an edge in trading dollar based pairs in knowing the reasons for why the long term trajectory of the US Dollar is DOWN, and that it is going down faster than the downward trajectory of all other pairs on the opposite side.

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