MARKETS

The balancing act the Federal Reserve and the politicians are playing with the US economy will mean a cheaper dollar and an ascendant Asia in coming years, observes Axel Merk of Insights.

One of the US economy's greatest attributes has been its flexibility, in large part a result of the allowance of free market forces. While massive monetary and fiscal efforts in the US and globally may have compromised these free market forces, we believe they will play out over the long term.

In our opinion, the US dollar is a natural valve to allow the US economy to adapt to global market dynamics; we consider both free market forces and the unintended consequences of monetary and fiscal policies may push the US dollar lower over the long term.

The recent financial crisis has in many ways exacerbated the global imbalances that concerned us leading into the crisis. Of grave concern is the unsustainable federal budget deficit, which may have morphed out of control. More worrying still, is that despite a lot of political grandstanding and rhetoric, we are yet to see any tangible evidence of fiscal restraint from either political party.

Contrast this with the stance taken by many other governments around the world, which have enacted stringent austerity measures. With a sluggish economy likely to hamper tax revenues, we are unlikely to see any marked improvement in public finances over the near-term. The notion of a balanced budget seems a very distant thought when overlaying the near-term outlook with the budget implications of long-term obligations, such as Medicaid, Social Security and Medicare.

Put simply, the fiscal position of the US has deteriorated significantly, and we consider the outlook remains challenging. We believe this situation is likely to wear away at the safe haven status the US has held for so long. As alluded to above, many other countries have been more fiscally prudent and now find themselves in much healthier fiscal positions relative to the US.

The US current account (trade) deficit remains at unsustainable levels, despite recent improvements. The current account balance is what the US earns from other countries (exports, services, investments abroad) less what the US pays to other countries (imports, services, loans).

The balance on trade (the difference between exports and imports of goods and services) is the largest driver of the US current account deficit. In our assessment, the narrowing of the deficit in 2009 was attributed to a weak US economy and consumer, rather than the strength of the US export sector-in fact, the economic downturn caused both exports and imports to fall, it's just that the rate of decline was more pronounced for imports given the weakness of the US consumer. To put the present current account deficit into perspective, the net shortfall between what the US earned and what the US paid in 2010 was $470.9 billion.

Another way to look at this number is that foreigners had to purchase nearly $2 billion worth of US denominated assets (such as U.S. Treasuries) every single business day just to keep the US dollar from falling.

Additionally, we believe the Federal Reserve's (Fed) actions will likely result in continued devaluation of the US dollar. When a central bank substantially increases the money supply, all else held equal, the central bank causes inflation, a devaluation of the currency's purchasing power. The Fed has been one of the more prolific money printing central banks around the world, increasing its balance sheet more than threefold since the beginning of the global credit crisis (in simple terms, a central bank's balance sheet can be thought of as money that has been printed).