A Word on the US Budget Debacle

04/11/2011 10:56 am EST

Focus: MARKETS

Terry Savage

Author, The Savage Truth on Money

Embarrassing. That’s the only word to apply to the fiasco in Washington, DC last week.

I watched most of the debate from Europe, arriving home in time to see Friday’s late-night showdown and mutual surrender.

Financial respect for America went sliding down the drain, along with the dollar. That was glaringly apparent—dollars bought less every day when changed into euros. In the past ten months, the dollar has fallen 14% against the euro, much of it coming in recent days.

Even as the European Union faced headlines about weakness in their banking system, and about Portugal’s need for a bailout, their currency increased in value against the dollar. Showing their determination to fiscal sanity, the European Central Bank raised interest rates 0.25 percentage points.

But despite relatively good economic news about growth and jobs in the United States, the dollar fell in value, amidst the budget squabble.

You can blame this past week’s dollar decline on the global news broadcasts, showing the inability of America’s elected leaders to pass a budget for our nation. We looked ridiculous in the eyes of the world.

Even the Italian sex scandal over Premier Silvio Berlusconi’s escapades with a minor took a back seat to the Congressional battle over funding Planned Parenthood.

The Global Markets React
We don’t watch global exchange rates in our daily lives here. We think in dollars, get paid in dollars, and plan for retirement in dollars. But the US dollar is the center of the world’s financial system. And when the world loses respect for America, it shows its displeasure by selling dollars.

Where does all that money go when dollars are sold? For starters, it turned to gold, which made new highs around $1,475 an ounce on Friday. That’s a trend long predicted in this column, as the global money markets seek diversification from the dollar.

Where will it all end? Unless fiscal sanity is restored, it can only end with much higher gold prices, and perhaps even with the United States making the dollar convertible into gold again—at substantially higher prices—in order to regain respect for our currency.

Another market that shows a direct correlation with loss of respect for the dollar is the oil market. Oil is priced globally in dollars. When the dollar is worth less and less, oil prices move higher to compensate. So it’s no wonder that crude oil prices soared to nearly $113 a barrel.

It’s Not Over Yet
No matter what your beliefs are about how the US budget should be managed, there must be a better way of getting to some fiscal consensus. This was just the opening battle in a war that will escalate during the next month, when Congress must vote to raise the ceiling on the national debt.

If the world thought it amusing that our government might be shut down for a few days, they won’t take it so lightly when the next debate calls into question our ability to pay interest on all those IOUs the United States has spread around the world.

That’s what’s at stake in the debt ceiling battle: our ability to pay interest on our current debt, and to pay our bills by borrowing more. That discussion will have an even greater and more immediate impact on the value of the dollar.

You may think this is all economic jargon, and that it somehow will be “worked out” as it always has. But this time, we’re nearing the edge. “Dollar” and “default” should never be used in the same sentence.

You’re about to feel the impact personally.

The Impact on You
The combination of the Fed’s recent round of credit creation and the very public political wrangling over the budget and debt ceiling will continue to impact the value of the dollar. Here’s how it will impact you:

  • Higher Interest Rates: The world will demand higher interest rates on US debt to offset the risk of dollar devaluation. Higher rates ahead could impact the cost of mortgages, the financing for businesses, and the value of bonds in your portfolio (when interest rates rise, bond prices fall). Of course, it could also mean better returns for savers.
  • Higher Energy Prices: You’ve already seen the impact at the gas pump, but that was from supply fears during the Libyan crisis. The next round of higher oil prices will come as a result of the falling dollar. And rising oil prices will impact not only your commute to work, but the airline fares you pay. As well, it will impact the price of stuff you buy, since every product has a transportation cost component.
  • A Slowing Economy: All of those added costs will be a drag on the economic recovery. People who have to pay more to drive to work won’t be able to shop for other goods and services. That leads to bleak prospects for job creation.

All of this is bad news for you, and bad news for the American economy. This time the blame must be placed squarely where it belongs: On Congress—both sides of the aisle—and on President Obama.

Maybe we need a little more “parental planning” to put some grownups in charge of America’s future.

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