Foreign Currency Inflation Causes U.S. Dollar Deflation

Dangerous Deflation is Death to Debtors
[courtesy Google Images]

Forbes magazine recently published “Egypt Is About To Slash The Value Of Its Currency To Revive Its Flagging Economy”. According to Forbes,

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“Egypt’s Finance Minister Amr El Garhy has said his country needs to move faster in dealing with its currency woes, opening up the possibility of a large and rapid devaluation of the Egyptian pound.”

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Big deal. Egypt is devaluing (inflating) the Egyptian pound. Who cares, right?

Q:  What’s the value of the Egyptian pound have to do with the U.S. dollar and U.S. economy?

A:  Actually, more than you might suspect.

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● In order to understand how foreign currency changes can affect the U.S. dollar, you need to recognize that, because fiat currencies have no intrinsic value, they must be devalued in relation to something else

Q: OK—if the Egyptian pound is going to be devalued/inflated, in relation to what will it be devalued?

A: In general, the fiat Egyptian pound will be devalued in relation to other fiat currencies. But, in particular, the Egyptian pound will be devalued in relation to the World Reserve Currency which is, primarily, the U.S. fiat dollar.

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● Remember, there’s a “teeter-totter” relationship between the U.S. fiat dollar and the world’s fiat currencies. This one-to-many relationship is most apparent in the U.S. Dollar Index which measure the value of the U.S. dollar in relation to six other fiat currencies (Euro, Japanese yen, English pound, Canadian dollar, Swedish krona, and Swiss franc). The fiat dollar (World Reserve Currency) sits alone on one end of the teeter-totter; virtually all of the world’s fiat currencies sit on the other end.

Q: Which means what?

A: First, it means that when the value of the U.S. fiat dollar goes down (inflation), the average value of the world’s other fiat currencies must go up (deflation).

Second, it means that whenever a single, foreign fiat currency (like the Egyptian Pound) is devalued/inflated and goes down, it will tend to cause the US fiat dollar to go up in value and therefore experience some deflation.

Deflation (an increase in the value/purchasing-power of the dollar) is dangerous and potentially lethal for individual, corporate and government debtors since it forces debtors to repay their debts with more valuable dollars—which are harder to earn and acquire than cheaper, devalued/inflated dollars.

The U.S. government is the world’s biggest debtor. Therefore, the U.S. government hates deflation. That’s why the Federal Reserve has worked diligently to cause inflation for the past 50 years.

Third, and surprisingly, when the values of most foreign fiat currencies go down (inflation), the fiat dollar’s value should go up (deflation).

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• Currency wars are being waged among foreign, fiat currencies. Each nation’s objective in these currency wars is, strangely, to prove that its national currency is worth less as compared to some other nation’s currency. As currency wars rage on, the adversaries’ currencies become worth less and less.

Q: Why do these self-destructive currency wars persist?

A: Because the global economy is in recession and/or depression.

In order to make each nation’s exports more competitive in the context of a global depression, foreign nations try to devalue (inflate) their currencies to make their exports cheaper and more attractive on the world markets.

The whole thing is insane even suicidal, but it’s the kind of insanity that becomes inevitable when nations abandon gold and silver as their money and instead adopt a debt-based, fiat currency.

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● Historically, when a currency was devalued, it was devalued in relation to gold or silver. For example, if the going rate for French francs was 50 francs per ounce of gold and France wanted to devalue its currency, it could simply pass a law that said “from now on, you’ll need 100 francs to buy an ounce of gold.” Voila! 50% devaluation. The devalued currency becomes worth half of what it used to be—and the French government’s debt would also be effectively cut by half.

Note that while the value of the French franc might be reduced by half in relation to gold, that reduction would not directly affect the value/purchasing-power of the British pound or U.S. dollar. Yes, there’d be a relatively small, indirect effect on the value of other currencies, but the devaluation/inflation of the French franc would not translate into significant deflation for other currencies like the U.S. dollar. If the price of gold as measured by dollars had been $20/ounce, that price would remain $20/ounce even after the price in francs had fallen from 50/ounce to 100/ounce.

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● In today’s brave, new world of fiat currencies, when the fiat dollar became the World Reserve Currency, it assumed the place of gold. Thus, the values of virtually all of the world’s remaining fiat currencies are ultimately expressed in relation to the dollar, rather than in relation to gold.

Under the world’s dollar-based monetary system, there is a teeter-totter relationship between the U.S. fiat dollar (the primary World Reserve Currency) on one end of the teeter-totter and the balance of fiat currencies on the other end. Today—if there were still French francs and if the franc was officially devalued/inflated by 50% in relation to the fiat dollar—the fiat dollar’s value would be significantly increased/deflated.

I’m not suggesting that a 50% devaluation of the fiat franc would cause the fiat dollar’s value to rise/deflate by 50%. In this teeter-totter relationship, the dollar sits on one end of the “teeter-totter” and the majority of the world’s remaining fiat currencies sit on the other end. The effect on the fiat dollar caused by a devaluation of a single currency (like a French franc or Egyptian pound) would be blunted by the presence of all the other fiat currencies that were not devalued and might even have been deflated (increased in value) at the same time.

For example, suppose the fiat franc was devalued/inflated by 50% at the same time the value of the English pound was increased/deflated by 30% and the value of the Japanese yen was also increased/deflated by 10%—the total effect on the fiat dollar might be negligible. So long as foreign fiat currencies were changing their values in a random manner, the fiat dollar would remain in control. If it went up or down, the other currencies would react.

However, if a significant number of foreign fiat currencies were simultaneously or persistently devalued/inflated, their net effect would result in forces favoring fiat dollar deflation. If, as in currency wars, the values of a bunch of fiat currencies fell (inflated), the value of the U.S. dollar sitting on the other end of the “teeter-totter” would have to rise (deflate).

Fiat dollar deflation could be bad for the overly-indebted U.S. government (it would have to repay the National Debt with more valuable dollars) and also for the U.S. economy (which would be slowed by deflationary forces or even pushed towards an economic depression).

That’s pretty much what seems to have happened since the Great Recession of A.D. 2008-2009. Global trade has collapsed. Foreign exporters have competing for the diminishing global trade by devaluing/inflating their fiat currencies to make the price of their exports cheaper and therefore more attractive to foreign buyers. Result? We’ve had an ongoing series of currency wars wherein many foreign fiat currencies are intentionally and persistently devaluing.

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● While it might appear that a currency war has broken out between between, say, the Japanese yen and the Chinese yuan or between the EU’s euro and the English pound, etc., the real “war” is between the various exporters’ fiat currencies and the World Reserve Currency (the U.S. fiat dollar).

Why? Because the value of each of those foreign fiat currencies is ultimately set in relation to the World Reserve Currency (fiat dollar).

Result? If most of the foreign currencies on one end of the monetary “teeter-totter” go down in value at more or less the same time, the fiat dollar’s value will be pushed upward towards deflation.

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● I’m not claiming that the forces of inflation in foreign fiat currencies have necessarily caused a net deflation in the fiat dollar. I’m saying that those forces of foreign inflation could blunt the Federal Reserve’s effort to cause dollar inflation.

In other words, if there were no currency wars being waged among foreign fiat currencies, the Fed’s efforts might’ve caused 4% dollar inflation—enough to stimulate the U.S. economy. However, so long as currency wars rage among several foreign fiat currencies, the Fed’s efforts might only cause 1.5% inflation—that’s still a net inflation, but not enough to stimulate the economy.

Thus, it’s at least arguable that much of the Fed’s failure to increase U.S. inflation to the level needed to stimulate the U.S. economy might be traced to the global trade depression and the resulting currency wars. If so, we can speculate that the effort to cause significant dollar inflation won’t succeed until the global trade depression ends and/or the fiat dollar abandons its role as (primary) World Reserve Currency.

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● So long as post-WWII global trade was growing and the dollar (World Reserve Currency) was inflating, the Fed was creating deflationary pressures on foreign fiat currencies and foreign economies. The dollar’s inflation artificially stimulated the U.S. economy but slowed foreign economies sitting on the other end of the monetary “teeter-totter”. The dollar’s post-WWII inflation was a “currency war” waged by the U.S. government against all the major exporting countries in the world.

However, now that global trade is depressed and foreign fiat currencies are being simultaneously devalued/inflated, the tables have turned. Now, the same teeter-totter relationship that allowed U.S. inflation to stimulate the U.S. economy (and slow foreign economies) is causing the U.S. dollar is suffer deflationary forces that tend to slow the U.S. economy. The dollar is reacting to currency wars. When several foreign currencies go down, the dollar must go up. The dollar is no longer in control.

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● Why’s this happening? Ultimately, because we abandoned gold and silver money and adopted fiat currency. Also, because the U.S. dollar has been the World Reserve Currency. So long as the fiat dollar was the only (or primary) World Reserve Currency, it sat alone on one end of the world’s monetary “teeter-totter”. The other fiat currencies sat together on the other end. When the dollar went down in value (inflated), the foreign currencies tended to rise (deflate). But now, when several foreign currencies are being simultaneously and intentionally inflated/devalued and are therefore falling in value, the U.S. dollar will be forced to rise in value (deflate) and thereby slow the U.S. economy.

What goes around, hmm?

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• So long as:

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1) The U.S. dollar retains its title as “World Reserve Currency”;

2) The global economy remains depressed; and,

3) Several “currency wars” exists between other fiat currencies—then,

4) Whenever several foreign fiat currencies are devalued/inflated, the U.S. dollar will experience deflationary pressure.

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These deflationary pressures could explain at least part of the reason why the Federal Reserve, after seven years of trying to cause significant inflation in the U.S. economy, has generally failed to do so. The Fed has been unable to extinguish or even overcome the deflationary forces imposed upon the U.S. dollar by the currency wars among the foreign fiat currencies.

So long as the post-WWII global economy ran hot, the one-to-many relationship between the World Reserve Currency (fiat dollar) and foreign fiat currencies helped stimulate the U.S. economy. Today, however, when the global economy has cooled, that one-to-many relationship still exists, but tends to work against U.S. best interests.

There’s no free lunch. If foreign fiat currencies are being persistently devalued by currency wars, their end of the teeter-totter is going down (inflation) and the U.S. end of the teeter-totter should rise (deflation). Because the dollar is the (primary) World Reserve Currency, the American economy is especially vulnerable to the foreign fiat currency wars spawned by a global economic depression.

Ask not for whom the foreign currency wars toll. The currency wars toll for thee.