Today's Opinions, Tomorrow's Reality 

Spending Away the Dollar

By David G. Young

Washington, DC, December 7, 2004 --  

With mall-bound Americans whipped up in a spending frenzy by the Christmas holiday, credit card companies must be salivating at the profits to come. If there were any remaining doubt over the ubiquity of plastic, the Federal Reserve put it to rest this week when it announced that the number of credit and debit card transactions exceeded those by check for the first time in 2003.1 This easy money provided by modern credit has helped fuel American consumer spending, which hit the unprecedented annual level of $8.3 trillion in October.2

But as Americans gorge themselves on consumables, their debts pile up. The country's consumer debt in September amounted to $2 trillion3 -- over $7,000 for each man, woman and child in the country. And since much of this debt-financed spending has gone toward imported goods, that cash is ultimately owed to creditors in other countries. The world is now so flooded with American debt that few economists have been surprised that the U.S. dollar has taken a tumble against foreign currencies -- a loss of 35 percent against the Euro since 2002.4 The real debate is about how much further it will fall, and why this didn't happen sooner.

When considering the fall of the dollar, it is important to note that consumer spending is only part of the equation. Only three years ago, the U.S. government was running a surplus, causing the Treasury to pay back debt. Because of this, there was plenty of demand from overseas investors to finance the debts being racked up by consumer spending. But now that the U.S. government's surplus has turned into a large deficit -- thanks to President Bush's tax cuts and massive spending increases -- both the government and the consumers are competing for the same creditors.

The rapid change in its bottom line has made the U.S. government an easy target for blame in America's macroeconomic woes. If the federal government would only get its budget deficit under control, the argument goes, the dollar would be in much better shape on international markets. There is some merit to this argument, insofar as massive credit-financed spending increases have taken place since 2001.

But it is the irresponsibility of individual Americans, not the irresponsibility of their elected leaders, that should earn most of the blame for the dollar's decline. There is absolutely no reason that Bush's tax cuts should have hurt the dollar. Had taxpayers saved the money they got back rather than using it to fuel their spendthrift habits, the tax cuts' effect on international currency flows would have been zero. The federal deficit would have been financed by Americans' savings.

This, of course, did not happen. Not only did Americans' not save more after Bush's tax cuts, they actually saved less. Personal savings rates now stand at their lowest level in history -- 0.2 percent of disposable income.5 For a family earning $50,000 per year after taxes, this rate amounts to the saving only $2 per week. This is completely irresponsible.

But Americans' financial irresponsibility does not stop there. Aside from credit cards and tax cuts, Americans have found other creative ways to fuel their spending. The current housing boom has led large numbers of homeowners to take cash outs when refinancing their homes. In the typical case, a homeowner will get a new, much bigger mortgage based on recent increases in the value of the home. This is used to pay off the old mortgage, and then the owner gets to pocket the difference. This extra cash can then be used to pay off existing consumer debt, or finance new consumption. This accounting trick effectively hides consumer debt by shifting it to debt on the home. God help such Americans if the housing bubble bursts.

Consumer spending at current rates simply cannot continue. Two decades of changes in the financial industry have given Americans the ability to spend more and save less. But now that their savings rate has effectively reached zero, most Americans can no longer maintain the increases in consumer spending that they have learned to expect.

The only question now is how the end will come. Will Americans enjoy a soft landing and a gradual return to living within their means? Or will they face a full-blown financial crisis? The path of the dollar -- as it continues its fall -- will ultimately give the answer.


1. CNN, Paper Checks Going Bye-Bye? December 7, 2004

2. Department of Commerce Bureau of Economic Analysis, Personal Income and Outlays, December 1, 2004

3. Federal Reserve Board, Consumer Credit G.19 Release, November 4, 2004

4. Economist, The passing of the buck? December 2, 2004

5. Department of Commerce Bureau of Economic Analysis, Ibid.