Observations

Budget deficits occur when governments spend more money than they take in. Many industrialized countries have about the same deficit as percent of GDP (the details appear on my blog). These countries have the same low inflation and same long-term interest rates and strong currencies. Why is the dollar weak?

Deficits make us poorer. We ask and the politicians give. This is no surprise. It is the main reason we voted for them. They sell bonds. The bondholders provide the money and the politicians deliver the goods we asked for. Now, you and I have to pay the interest to the bondholders.

We have to pay the bondholders for the goods and services provided by the government. There is a transfer of wealth from us to the bondholders.

Deficits do not cause inflation because industrialized countries have no problem in floating their bonds. Zimbabwe, instead, has to print money, and this is the reason their deficits cause inflation. Deficits, in other words, have little impact on inflation. Government spending does create inflation (see details later).

Why do European economies have a much stronger currency since 2004 with the same low inflation and similar deficits? Currencies reflect competitive differentials between countries. They have a stronger currency because their economies are more competitive. They fought the loss of purchasing power due to the deficits by becoming more efficient. The Euro is strong because Europe has more industries that are competitive in the global markets – more than we do.

My point is that in order to fight the loss of purchasing power caused by deficits, we need to become more productive. Only then will our standard of living rise and the dollar strengthen.

Meanwhile, our loss of purchasing power will translate into lower prices and possibly deflation because, as our standard of living declines, we can afford only to pay lower prices. If the Fed prints too much money, however, all the bets are off and inflation will rise.

The markets always win.

To find out more about my in depth views of the markets and my strategy just visit our website https://www.peterdag.com/ where you can review The Peter Dag Portfolio. You can also call me at 1-800-833-2782 to discuss your specific money management needs.

I will be happy to speak to your investment group on how the business cycle impacts investment strategies and the choice of asset classes.

George Dagnino, PhD
Editor, since 1977
Ranked Top Market Timer in 2009 by Timer Digest

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