Saturday, November 03, 2007
Anyone who has ever traveled outside the country is familiar with the concept of exchange rates, and how this rate of exchange is influenced by the relative value of the U.S. dollar compared to that of other foreign currencies. And over the past few years, a weakening dollar has made this rate of exchange quite unfavorable, meaning that U.S. dollars do not have nearly as much purchasing power as they once did.
However, as we become increasingly dependent upon global trade, the dollar's underlying value affects more than just world travelers; it has a profound impact on the purchasing power of each and every one of us. This is because many, if not most, of the things we buy are now produced in foreign countries.
Simply stated, a weakening dollar means rising prices, because as the value of dollars decrease, more dollars are needed to equal the same overall value as before. However, there are two competing perspectives to a dollar devaluation.
Take for example a pair of shoes that costs $50. Imagining a situation where the dollar were to decline by a factor of 50%, it would then take twice as many dollars to equal the same overall value, because each dollar would now be worth only half as much as before. Therefore, the pair of shoes that once cost $50 would likely now increase in cost to $100.
However, in that same scenario, a home that once cost $200,000 would now be worth $400,000, and a stock portfolio once worth $25,000 would now be worth $50,000. It would be pretty easy to overlook the extra cost of $50 for shoes when your home just appreciated by $200,000.
While such a situation may seem far-fetched, it is actually much closer to reality than most people realize. On January 2nd, 2002, the DXY, a benchmark for the U.S. Dollar, had a closing value of 115.78. On the same day, the INDU, which is the benchmark index for the Dow Jones Industrial Average, closed at 10,073.40.
Fast-forward almost 6 years, and the U.S. dollar index now stands at 76.31. Likewise, the Dow Jones stock index just closed at 13,595.10 as of November 2nd, 2007. Many people are glad to see their stock portfolios increasing, considering that the Dow has gained about 35% since January 2nd, 2002.
However, what most people fail to realize is that during this same period of time, the U.S. dollar has declined in value by 34%. If one were to normalize the value of the dollar to January 2nd, 2002 and then adjust the current price of the Dow Jones stock index accordingly, the value of the Dow would now be only 8,960.46. Therefore, the underlying stocks represented by this index did not increase in value by 35% over the past 6 years; they increased in price by 35%. There is a subtle, yet important difference.
After adjusting for the dollar's devaluation, the actual value of the Dow Jones decreased by 11% over the period. In fact, this is what makes a devaluing dollar so very deceptive, and also so very dangerous. People may feel as though their wealth continues to increase, when in reality, it is steadily decreasing.
While there are several factors for this decline in dollar value, chief among them may be our nation's debt levels. Interestingly enough, there seems to be an inverse relationship between our national debt and the value of our dollar. While the association is at times fairly loose, it basically means that as our national debt continues to increase, the value of our dollar depreciates accordingly.
On January 2nd, 2002, the total public debt was $5,932,932,561,034.54, and as of November 1st, 2007, the national debt now stands at $9,080,228,573,291.65. As our government continues to spend money with no apparent means of repaying it, it would stand to reason that the value of our dollar would depreciate--and it has.
In fact, the current national debt of $9,080,228,573,291.65, when revalued to its equivalent value in January 2nd, 2002 dollars, is $5,984,731,753,566.12. The ratio of this adjusted debt to the actual debt at the time, $5,932,932,561,034.54, is 1.008, which is just about a perfect inverse relationship.
Unfortunately, most people will fail to realize what is truly happening to our currency (and our country) until it is far too late. We are becoming poor by the illusion of increasing riches.
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