PRESTOPUNDIT -- "It's a team sport, baby!"

A brilliant piece of economic analysis from Paul Kasriel:

The dollar is bound to depreciate. The rest of the world advances us approximately $1.5 billion a day. Private global investors are beginning to question how we will be able to pay them the interest and dividends on these advances. To see why they might now be concerned about this, consider two corporations. Corporation 1 uses the proceeds from its stock and bond sales to invest in plant and equipment and research and development. These investments increase the odds of it earning higher profits in the future. Corporation B uses the proceeds from its stock and bond sales to throw a party for its employees every Friday afternoon. Although Corporation B may have temporarily happier employees than Corporation 1, in the longer run, both Corporation B's stock and bond holders and employees will be unhappy because it will not see higher earnings growth. Investors will stop advancing funds to Corporation B if it continues to use those funds for employee parties. In effect, we are throwing parties with the $1.5 billion the rest of the world advances us each day in that we are using these funds to buy bigger cars, bigger houses, and cruise missiles. These purchases are not the stuff that will allow us to grow faster in the future. Moreover, Fed Chairman Greenspan has effectively said to investors in U.S. Treasury securities that he will do all in his power to insure that the coupon payments they receive will be worth less. That is, Greenspan has indicated that he will conduct U.S. monetary policy so as to increase the U.S. inflation rate. This is not exactly what the creditors to the world's largest net debtor want to hear. So, these creditors, at least the private ones, would be expected to cut back on their demand for U.S. dollar-denominated assets. This is the "necessary" part of the dollar's depreciation.

The "evil" part is that a depreciating dollar impoverishes Americans. A depreciating dollar means that we have to give up a greater quantity of goods and services to the rest of the world in order to get the same quantity of goods and services from them as before. A depreciating dollar means a decline in (or slower growth in) Americans' standard of living. In effect, we will be working harder but enjoying it less. So it goes.

Posted by Greg Ransom