How the Dropping Dollar Affects 2008

The dollar is weakening and Hank Paulson couldn’t be happier. Remember, Paulson was hired as Treasury Secretary essentially to do one thing – convince the Chinese to revalue the yuan, in order to increase American exports, revive American manufacturing, and save the industrial heartland (Ohio, Pennsylvania, etc.) for the Republicans. Paulson had worked with the Chinese for years as an investment banker arranging deals for American companies wanting to get into the huge Chinese market, but as Treasury Secretary he has had no luck getting China to cooperate because he has had absolutely nothing to offer them.

Yet with interest rates relatively low in America relative to Europe, and the American economy slowing (housing and autos – the biggest sectors linked to almost everything else – are both in trouble), global investors are taking their money out of dollars and putting them into euros, British pounds, and Japanese yen. Presto: The dollar is dropping. As a result, the Chinese – who hold more dollars than almost anyone else – are losing lots of money. Hence, it will make more and more sense for them to stop buying dollars, start selling them, and allow their currency to rise relative to the dollar.

In other words, international currency markets are doing for Paulson what Paulson was supposed to do for the American economy and for Republicans in 2008. That’s okay so long as global investors, as well as China and OPEC (who still do most of their oil transactions in dollars), don’t get carried away and turn the current dollar sell-off into a run on the dollar. But if the dollar drops too far too fast, everything America buys from the rest of the world begins costing a lot more, real quickly. That pushes inflation. Meanwhile, the only way we can continue to finance our budget deficit and consumer buying spree is by yanking up our own interest rates. Result: stagflation – inflation combined with no or negative growth. Wall Street goes into a tailspin. Paulson leaves office as the Treasury Secretary who caused the crisis. And Republicans are unceremoniously kicked out of the White House in 2008.

It's starting to become a familiar story: Even though the global economy is taking decisions out of the hands of American officials, the public still credits or blames them for what happens.