People worry the rising deficit will make the dollar drop in value. The annual federal deficit is 5% of GDP, about $1Trillion a year. The long run average federal tax revenue is 18% of GDP. Assuming a 2% CPI adjustment is applied to the deficit then the deficit is growing by 3% of GDP a year in real terms. For example, a debt of $21Trillion if it increases by 2% a year when inflation is also 2% is basically not an increase in real terms.
Eliminating the Federal Budget Deficit Could Help Raising taxes by 3% from 18% of GDP to 21% would be enough to fix the problem. A compromise is to raise taxes by 1.5% of GDP and cut spending by a corresponding amount. Perhaps a federal sales tax of 1.5% (collected by state governments as part of their sales tax collection process) with no exemptions could be used. Surely an extra tax of 1.5% would not be the end of the world. Raising taxes would act to suppress growth and dampen inflation, thus making the dollar (and dollar based bonds) more attractive as a “hard money” currency.
Our country has lower taxes than other developed countries and less debt to GDP, so we have a better opportunity to fix the deficit. Thus currency investors should not assume the dollar is fated to suffer from mismanagement and debt crisis leading to a runaway devaluation.
The critics of the US dollar assume that because the dollar is used as a funding conduit to pay international payments this acts as a “float” generation mechanism that ties up funds into dollar holdings by those parties processing a payment thus generating artificial demand for the dollar. These critics then assume that this float is a temporary, undeserved advantage which will soon stop being used, causing the marketplace to reduce their holdings of the dollar and thus triggering a sell off of the dollar. This fear is similar to the belief that foreign central banks that hold the dollar as a form of reserves will decide to avoid the dollar, causing a massive sell off of the dollar that results in a deep devaluation.
These unfounded fears are analogous to a gold bug that is afraid that all bank owned loan assets are worthless because they are simply loan contracts that is just a piece of paper, as if to say that all loans will become worthless! Yet US banks usually underwrite strictly (after they learned their lesson in the 2008 crash!) and thus there is a reasonable probability that bank loans will get paid off in full when due rather than becoming worthless.
In modern times much of the source of wealth and the source of the best companies’ wealth is in the form of intangible intellectual property: patents, copyrights, goodwill, software, contracts, permits from government, insurance, etc. No one would ask rhetorically “what if all these corporate assets were worthless because they are intangible?”, yet the critics of the dollar currency seem to imply that the dollar is worthless because intangible bank loans back up the value of bank deposits. There is no practical, credible alternative to the dollar’s role as a central bank reserve asset and as a payment facilitation tool for an international medium of exchange.
Investors need independent financial advice about the true nature of the dollar’s role as a global currency.