Doom For The Dollar--And Everything Else

Doom For The Dollar--And Everything Else
Dan Ackman, 01.10.05

NEW YORK - The stock market is up and economic growth has been steady, if
unspectacular. But, an increasing number of economists are seeing serious
storms build on the horizon. They point to ever-growing federal budget
deficits, a record current-account deficit, increased consumer debt, a real
estate market that looks like a bubble ready to burst, a surge in personal
bankruptcies and the prospect of inflation.

Meanwhile, interest rates are on the rise, and if they increase much more,
many of these problems could get dramatically worse.

Doomsayers tend to be ignored--until it's too late. This week, we give
voice to five prophets of doom, starting with Peter Schiff, CEO and chief
global strategist of Euro Pacific Capital.

Could the falling dollar mean we're in for a major financial disaster? He
thinks so.

He has been warning about the currency's fall for a while now. Even though
it lost a third of its value in the last two years against the euro, he
believes it will decline even further. But, the dollar's fall is more a
symptom than a cause. The real problem is that the U.S. is producing too
little--and spending too much--and the result is likely to be far worse
than the happy-talkers on Wall Street will ever let on.

"We are going to go through one of the most trying financial times in U.S.
history, including the Great Depression," Schiff says.

Why Should We Care About The Falling Dollar?

"The basic problem," Schiff states, "is that Americans don't produce
enough, and don't save enough." Indeed, over the past 15 years, the savings
rate has fallen from over 6% to less than 1% in recent quarters. As a
result, the goods that we are consuming are being supplied to us by
foreigners. Not only are they producing the goods, but they are lending us
the money to buy them, and, in doing so, are driving the U.S. deeper and
deeper into debt to the rest of the world, Schiff says.

As American industry has lost productive capacity, it has become
increasingly difficult for the U.S. to produce enough--and sell enough--to
reduce that debt. The massive U.S. trade and current-account deficits, now
at around 6% of the gross domestic product, mean that non-Americans are
exchanging consumer goods today for consumer goods they will obtain in the

The U.S. doesn't have the ability to supply those goods, Schiff says. "We
are using dollars that we print to exchange for goods that we don't
produce. We have to borrow from abroad as there are no domestic sources of
savings, so the value of those dollars will continue to fall."

How Bad Will It Get?

"Very bad," Schiff says. The dollar will fall a lot lower than it already
has--dropping by perhaps 50% against the Japanese and Chinese currencies.
How will the government respond? Could efforts to forestall the currency
decline have a perverse--and ultimately negative--effect? No matter what
the outcome, Americans will have to consume a lot less and save a lot more.
Spending on cars, clothing and electronics will all drop
dramatically--perhaps right out of the economy.

What Caused It?

"We are a society that has lived beyond its means for a long time," Schiff
says, adding that while the trend has been evident for two or three
decades, "in the last five years, it has gone off the deep end." Americans
are relying on foreigners more and more to produce goods, rather than
producing them themselves.

What Will The Results Be?

Americans will have to restrict future consumption or default on debt,
whether directly or indirectly.

"I think something in the near future--maybe early this year--will make us
realize the error of our ways," Schiff says. "Our creditors are going to
stop. They are going to bite the bullet," which means realizing we can't
repay them in the way they want and expect.

They will take a huge loss, but it will be necessary to check an
unsustainable process. At that point, the people of Japan and other Asian
nations will be able to consume a lot more, because they will send less of
what they produce to the U.S.

"They will not be producing for us; they will be producing for themselves."

Meanwhile, to attract savings from abroad, the U.S will have to increase
interest rates into the double digits. This will cause a serious wave of
defaults in the real estate market and elsewhere.

"The further into the future this starts, the worse it will be for
Americans," Schiff says.

When And Why Will It Bottom Out?

"I don't know. A lot will depend on the government," Schiff says. The debt
to Japan, China and others has been building for a long time. The process
will also take some time to reverse. But, the analysts on Wall Street don't
want to say this.

"They pull their punches, because they don't want to be marginalized. But,
the fact is we owe Japan a fortune; it's not the other way around." And
that, Schiff says, means the dollar will be heading south for a while.

Video: The Dollar's Dip Spells Disaster

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