|
But in any economy you need a medium of exchange (Even in Barter Economies some "standard" is used in Colonial Virginia it was Tobacco, in Western Pennsylvania during the Whiskey Rebellion it was Whiskey). The best medium of Exchange is known as "Money". Other items are prices in term of "Money" for purposes of exchange.
Since WWII (and in many ways since WWI) the currency used in international Transactions has been the US Dollar. If Britain wants to sell something to someone in South Africa, the exchange is from each countries currency (Pounds for Britain, the Rand for South Africa) to Dollars. Than back to their home currencies.
Now in the simple two country transaction in my example you really do not need to convert to Dollars, you could do a direct Exchange, but most international Deals are multinational in scope and thus easier if everyone involves uses Dollars.
For example I want to sell Tractors made in Britain with French Engines, Mexican tires and Japanese electronics. Instead of dealing with pounds, Euros, Pesos and Yens, All I deal with is Dollars (Converting all of the other currencies to Dollars first). When I sell the Tractors I do the same, selling them in Dollars and leaving whoever buys the tractor to convert the Dollars to their own currency.
This use of Dollars as the international Standard has been the rule since 1944(When in a Meeting between Britain and the US it was agreed that the Dollar would be used as the standard for all international transaction after WWII). This was the formal policy of the US till Nixon (do to economic stresses of the Vietnam War) left the Dollar float destroying the consensus of the West regarding the Dollar versus other currencies but by then most countries had become use to dealing in Dollars for international transaction that the practice continued afterward.
Now the Reason Nixon left the Dollar float (i.e. Would NOT buy foreign currencies to maintain the fixed ratios set in 1944) was that to maintain the fixed ratios set in 1944 Nixon had to either raise taxes (Which he did not want to do) OR cut military expenditures (i.e. Quit the war in Vietnam). Nixon did NOT want to do either so rather than protect the Dollar he left it float. Historically the Dollar had been worth 1/4 of A British Pound, 5 German Marks (I forget the Yen and French Francs Ratios). The US Dollar than dropped in relations to the German Mark and Japanese Yen (and the English Pound dropped even more for similar reasons).
Now that Currencies float, the question remains how does one value the Dollar? The simple answer is what does the dollar buy. Remember the Dollar is the international exchange medium and as such has value from being an international trade medium. On the other hand no one wants to hold onto anything that will lose value, thus a lot of people do NOT want dollars given its value has been falling. These two actions have neutralize each other but the question has been for how long.
To better understand how the Dollar is prices it is best to ignoring the Dollars use as the international medium of exchange. Such exchanges complicates the situation and is the main reason the Dollar has not collapsed. Given that background lets look at how any currency is valued:
1. What return on investment can I get investing in that Currency (i.e. Investing in that country)? If a country has a high interest rates putting the money into that country will bring in a huge increase in money, but if the interest rate is below the inflation rate you are actually losing money. High Inflation tends to chase away investors unless that countries interest rates are even higher. The problem with high interest rates is that sooner or later people stop borrowing and the rates drops, in inflation continues the investors will lose money. Thus when you have high inflation (or the possibility of uncontrolled inflation) people tend to sell that currency so it value drops in relations to other currencies.
2. Will I lose money? Sometime you have to buy a country's currency to do transaction in that country. Again if you have high inflation the person dealing in that currency will want sell the currency as soon as possible, even at a huge discount. If more and more people start to believe a country' currency will fall, they tend to sell dropping the value of that currency.
Now how does the the US budget Deficient, Saving Deficient and Trade Deficient affect the above? The Saving Deficients would be less worrisome if we had a Balance Budget, but the Budget Deficient has to paid for by borrowing money from someone. Since the US Government can NOT borrow money from American (No Savings) the US Government has to borrow money overseas. Overseas investors keep looking at return on investments and have been saying NO (Except for Central Banks). Thus less and less money (other than from Central banks) have been coming into America.
Now other countries central banks have been buying American Dollars but in an effort to prevent their own currencies from raising against the dollar. Private investors prefer the Euro, Yen or even the Chinese Yuan over the US Dollar, but Japan and China do not believe their economy could withstand a drop in exports to America (which will occur when these Central Banks stop buying US Dollars).
This is the reason why the US Dollar has not yet Collapsed under Bush. Japan and China do NOT want their currencies to raise against the US Dollar. Every time the US Dollar starts to go up, these countries buy up US Dollars with their Yens and Yuans (Europe has stayed out of this mess, but has seen the Euro go from 80 Cents per US Dollar to $1.30 per US Dollar since Bush became President).
No one today wants US Dollars. If the Dollar was NOT the international Medium of Exchange AND the US was not the main export market for Japan and China the Dollar would have Collapsed two years ago. Japan and China can NOT continue to buy US Dollars. The Dollars Japan and China have purchased over the last four years can never be cashed in for what the two countries are paying for the Dollars.
I compare today's international trade as three drunks trying to avoid a hangover by staying drunk. Japan and China are buying drinks for the US on promises that the US will pay them back tomorrow. Japan and China know the US does not have the money to pay them back, but if they cut off the flow of drinks to the US the US will go home AND ALL THREE WILL HAVE TO SOBER UP AND SUFFER A SEVERE HANGOVER. So far Japan and China fear the Hangover more than losing all of their money, but sooner or later they will either run out of money, or the US will fall into a stupor so deep that he can no longer take their drinks.
I know I went a little off the Subject of valuation of the Dollar, but you have to understand the above to understand why the US dollar has NOT collapsed already. The US Dollar and the economy behind the Dollar (The US Economy) does not have the economic strength to support today' dollar valuation in terms of Euros, Yens and Yuans and as such the Dollar should and will drop, the question is when.
|