Devaluation of US Currency - The Most Important Causative Factors

In this article we examine the most important causative factors which have contributed to the fall in value of the US currency. What our research has found is that while there are variable opinions as to why we have seen massive devaluation of the US currency, at the end of the day, all indications are that it really is a simple supply and demand issue, which comes from the conceptual understanding of supply side economics.

But what has caused such a large supply and a weakened demand for the US currency, resulting in devaluation. First we will look at the demand side and later will examine the supply side. Lets examine these issues.

There are three basic forms of demand that can exist for the US currency. The first is the US economy itself. To what degree are consumers spending and borrowing money. What we currently see, given the poor US economy, is very little spending on the consumer side. Mortgages and various consumer loans are down. The Federal Reserve (Fed) has tried to stimulate consumer borrowing by lowering the interest rate, which is a classic method by the Fed. But this seems to not have worked very well, and consumer as well as business borrowing of money remains low.

In a robust economy, where consumer spending is up, and people are getting loans to buy homes, there is what can be called an internal demand for the US currency. Also, in a robust economy, business expansion through the borrowing of money takes place. Currently, consumer and business borrowing is down, which is what you would expect in a bad economy. The net result is less internal demand on the US currency.

The second form of demand comes from outside the US. That is foreign investment. While any investor wants to buy when the price is low, whether it is stocks in a company, or in this case, US currency, currently foreign investors believe that the US currency is not worth the risk. Commodities such as gold currently appear more attractive to the investor. This results in a decrease in demand for the US currency.

The third form of demand comes from massive oil transactions, using US currency, by countries around the world. The currency normally used in these transactions has been the US currency. But now there is talk about the possibility of some other form of currency to be used by OPEC ( Organization of Petroleum-Exporting Countries). The discussion itself by OPEC members, about not using US dollars for oil transactions, is enough to weaken the demand on the US dollar. Time will tell as to whether fruition of this change over to a different form of currency will take place by OPEC. In any case, current talks about a possible change of currency is enough to decrease the demand on the US dollar. If this actually happens, demand on the US currency will be even less.

Let's now examine the supply side for the US dollar. This really comes down to the degree to which the Federal Reserve prints more money. Actually, the US Treasury, more specifically, the  Bureau of Engraving and Printing (BEP) within the US Treasury, prints the money, and the Federal Reserve manages the nation's money supply through monetary policy. The Federal Reserve determines how much money goes into the system. The Federal Reserve maintains what is called an elastic money supply, and can contract or expand the nations money supply as needed. The details of how the Fed does this is outside the purview of this article. But for our discussion, simply understand that the Fed controls the money supply. The important point here is that the Fed has been increasing the nations money supply. The question is why?

The Fed has been using money printed by the BEP of the US Treasury, to buy US Treasury Bonds.  When the public or in this case the Fed, buys US Treasury Bonds, in essence this is a loan to the US government. This process of financing government spending is called monetizing the debt. So essentially what is happening here is that the government is really lending money to itself. The net result is an increase in the nations supply of money. With more money entering the system, supply side economics dictates that there will be a devaluation of the dollar if coupled to a decrease in demand. And this is exactly what we have seen in the United States.

This increase in influx of US currency into the US and world economy worries potential foreign investors because of the devaluation it brings to the US currency.  The greater the influx, the greater the devaluation. This brings us back to the demand side of the equation, and results in a decrease in demand on the US currency by foreign investors. Devaluation of the US dollar also leads to inflation in the United States.

To conclude, the devaluation of the US currency, from a supply side economics perspective, is due to a decrease in demand coupled to a large increase in supply. The demand comes from the US economy itself, foreign investment in the US currency, and usage of the US currency as the currency of choice among OPEC members. The problem is the US economy is doing poorly, there is a decrease in foreign investment of the US currency, and now there is talk among OPEC members about not using the US currency for oil transactions. The net result is a decrease in demand.

On the supply side, the US Treasury keeps printing more money, the Fed uses this money to purchase more US Treasury bonds, in an attempt to monetize the nations debt. This results in an influx of money into the US and world economy. The government is in essence lending money to itself. With a high supply and low demand for the US currency, over an extended period of time, this results in the US currency losing it's value.