By Peter D. Schiff
Economists, who now see American troubles spreading around the world are predicting that foreign central banks will ignore the gathering inflation threat and follow the U.S. Federal Reserve down the rate-cutting path. Similarly, they argue that since the downturn began here, the recovery of the U.S. economy will likely be under way while the rest of world is still decelerating.
These assumptions have prompted a recent rally in the U.S. dollar, and an accompanying sell-off in gold, commodities and foreign stocks, and have cast doubts on the ability of foreign economies to economically "decouple" from the United States.
But investors should not take the bait.
America and the U.S. economy does, indeed, pose a global threat, but not for the reasons these economists suppose. Foreign economies are suffering not because American consumers have slowed their voracious spending, but because they are defaulting on hundreds of billions of dollars of existing loans underwritten by lenders around the world.
The conventional wisdom is that foreign economies depend on American consumers to buy their exports. This is false. The global expansion of the past decade has created new demand everywhere, and people and businesses in all corners of the world are spending. Indeed, in markets such as China, the government is actually taking steps to stoke domestic demand.
In America, however, spending has largely been achieved through a massive vendor-financing scheme. Foreign-supplied credit has allowed American consumers to continue buying, even while American income and savings have dropped. As this credit goes bad, the losses are landing on the bottom lines of foreign financial firms.
In other words, the global pain is not resulting from a contraction in the U.S. economy, but from having financed our preceding expansion. This is a critical distinction few have been able to make, and it is vital to appreciating the economic decoupling that already has occurred beneath the surface.
The current losses that banks in Europe and Asia are now suffering are real, but future losses can be avoided by suspending lending to Americans. Shutting off this credit will torpedo the dollar, but that is precisely what must occur. By allowing the U.S. dollar to drop to its natural, unsupported level, not only will the American caboose be decoupled from the global gravy train, but it also will allow the rest of the cars to move along the tracks much faster. Outside the United States, there still will be plenty of consumers to buy what is produced, and plenty of investment opportunities for those with savings. Rather than dragging the global economy down, such a development would actually un-tether it.
On the other hand, left to its own devices, the U.S. economy will implode. There will be fewer products for American consumers to buy and very little savings for anyone to borrow.
Some foolishly believe that many of the world's problems result from the U.S. dollar weakness, and that pushing the American greenback back up would be good for all. For example, the thinking goes, since the weak dollar contributed to the escalation in oil prices, the strengthening dollar should help bring prices down.
However, if foreign governments weaken their own currencies to push the dollar up, they will simply succeed in bringing oil prices down for Americans. Oil prices will go up for their own citizens. This can't be an attractive bargain for any European or Asian political leader.
The weak dollar is merely a manifestation of substantial structural problems underlying the American economy. Unfortunately for us, the solution to those problems, as well as the global economic imbalances, can only be found in a weaker dollar. Efforts to artificially prop up the U.S. dollar will only exacerbate those imbalances, and make its ultimate fall that much more severe.
[Editor's Note: Peter D. Schiff, Euro Pacific Capital Inc.'s president and chief global strategist, is a regular contributor to Money Morning, and most recently wrote about the gloomy "financial reality" that's facing U.S. consumers and feeding directly into the looming "Super Crash." Get our report on the once-in-a-lifetime profit plays that will emanate from this Super Crash – and get a free copy of Schiff's New York Times bestseller "Crash Proof: How to Profit from the Coming Economic Collapse" -please click here.]
News and Related Story Links:
- Money Morning Commentary:
Financial Reality Will Sound a Wake-Up Call for the Federal Reserve and the American Dream.
- Merrill Lynch Press Release:
Global Economic Decoupling Gathers Pace – but It's a Marathon, Not a Sprint, Says Merrill Lynch.
- Money Morning Exclusive Interview:
Exclusive Interview: Jim Rogers Predicts Bigger Financial Shocks Loom, Fueling a Malaise That May Last for Years.
- Money Morning Economic Analysis:
China Plans $58 Billion Stimulus Package and Rate Cuts as Policy Shifts from Inflation to Growth.