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Wait a second, I thought a dollar bill was worth one dollar? Iapos;m so confused - what is he talking about?�


There are two ways to value�all of your�money.�

1. (The most common way) is to count all of the dollars you have - thatapos;s called "Nominal Value"
2. The second, is called "Real Value"...

Real Value -
Itapos;s true that $1 = $1 but itapos;s also true that 1 Yen = 1 Yen and 1 Euro = 1 Euro.� What about exchange rates between currencies though?�
Today $1 = (about) 100 Yen but 1 year ago $1 could be exchanged for about 115 Yen.� Since most of us donapos;t wake up and check the exchange rate between the dollar and global currencies when we wake up in the morning, this may be the first time you consider why these values change...

What IS a dollar bill?
If you stop�to think about it, a dollar bill is nothing but a piece of paper with ink on it and threads interwoven into it.� Same with all other paper currencies around the world.� So when you go to the store to get groceries - youapos;re handing the cashier a bunch of�threaded paper with printed ink on it for a whole cart full of groceries (seems like youapos;re making out like a bandit).� So why does the cashier accept this paper and why do you feel that itapos;s apos;okapos; to hand someone paper in exchange for all that stuff?

Perception

If you buy a carton of milk for $5 then both you and the cashier perceive that the carton of milk and the piece of paper with the number apos;5apos; printed onto it�to be�a fair exchange.� Have you ever asked yourself why this is? Or why last year when you handed the clerk $5 for the same exact carton of milk he handed you $1 back?� Or why next year when you, again, purchase the exact same carton of milk and hand the clerk a $5 bill he will ask for an additional $1?

This is because the "Real Value" of the dollar changes from year to year, actually day to day, and minute by minute.� There are certainly other�reasons why the cost of milk can change such as a major disease killing a portion of the worldapos;s cattle so there is less milk available to everyone - this creates a bit of a shortage so the price of milk will go up.� Or perhaps a new study comes out showing that milk may cause people to develop a fever.� The demand for milk would drop drastically if that were the case and suppliers would need to drop the price dramatically to�induce people to buy any of it (if anyone would be crazy enough to buy it at any price anyway).

But what about bottled water? Or your heating bill?� Why does that change on a�month to month basis?� Water canapos;t catch a disease and people�donapos;t suddenly decide that they want less heat in the winter.� Or�the price of gasoline?� People have to drive to work every day.� Trucks, ships, and airplanes use fuel every day and businesses and factories run on energy�just the same every day of the year (except holidays of course).� Also, although oil is finite and limited, there is still plenty of it so why are�the�price of oil and gasoline�so parabolic?��

The Constantly Changing apos;Realapos; Value�Of�The Dollar -
The dollar is nothing but an "I.O.U."� It was first developed by banks as a deposit receipt for gold coins, silver, or other goods so that you could store your belongings safely and exchange them later.� In 1975 the US decided to drop the gold standard - which linked the value of these debt receipts (the dollar) to solid�commodities.� Meaning that the paper currency is backed only by the perception of itapos;s value.� No need to panic - the dollar and itapos;s value is so interwoven into the fabric of our society (and the rest of the world for that matter) that we donapos;t have to fear that one morning weapos;ll wake up and decide that paper money is no more valuable than monopoly money.� Also, most currencies around the world are also valued in paper money.� Paper money is just a much easier medium for exchange - thatapos;s why it is used instead (just imagine paying for a car with bricks of gold).�

What creates changes in the underlying value of one currency vs. Another is actually much less complicated than one might think.� Three things.�

1.�If the USapos;s economy is growing at 5 per year while India grows at 20 per year (all else equal) the value of the dollar will drop in value compared to the Indian Rupee.� One would much rather own a currency of a country that is growing rapidly than of one that is growing slowly because there are better opportunities for investment.� The way to measure growth in an economy is called GDP (Gross Domestic Product) - Iapos;ll save that for another discussion.� (Check the dollar vs. The Chinese Yuan, Indian Rupee, Brazilian Real, or the Russian Ruble during 2002 - 2007 while the global economy was booming... The dollar lost value vs. These currencies making products and goods in the US�more and more expensive... Remember when oil was at $147/barrel or when gasoline was well over $4 per gallon?� That was why.)

2.� Interest Rates.� Interest rates measure the cost of borrowing money.� The lower a countryapos;s central bank keeps interest rates, the less money you will need to pay back later to borrow that money.� All else equal, if the U.S. Can grow itapos;s economy at 5 (GDP) and Japan can grow itapos;s economy at 5 (GDP) but the US�has interests rates of 5 and Japan�has interest rates of 1, then the US economy appears to be stronger because we can generate just as much growth even�at higher borrowing costs.� This also means that as an individual, if you loan out your money, you will get�more back for it in the�US (5) than in Japan (1), so�a smart individual will always loan�their money out in the country�that provides them with the greatest�return on their principal.

3.� Default Risk.��Default risk is measured by a countryapos;s�ability to finance itself - I.E. Pay for itapos;s projects and governmentapos;s debt.� The more debt that a government takes on, the�less ability is has to pay for it later.� Itapos;s not that the US will ever default (infact that would be next to impossible) but if not just our government but our entire economy generates a total net profit of around $10 trillion per year (GDP), and we have a total national deficit of (now) $10 trillion dollars - something about that makes other countries uneasy about wanting to loan us more money... Regardless of how many times our government reiterates that national deficits donapos;t affect us.� Iapos;ll add to that that the entire net size of our economy is in the neighborhood of $40 trillion dollars.� That means that our debt is 25 of the size of our economy.� If you were China - how safe would you feel about loaning the US MORE money?� This is why national deficits are not an apos;OKapos; solution for fixing short term problems (cough, $700 billion bank bailout and $5.1 trillion�debt for Fannie Mae and Freddie Mac bailout).�

As I mentioned earlier, the US will never default on itapos;s debt BUT, the question is, if weapos;re doing so well, then why do we need to borrow money in the first place?� Before the US would ever default on itapos;s payments it would raise taxes to let US foot the bill for its fiscal irresponsibility.� That means the more debt we take on, the higher the possibility becomes that taxes will be raised in the future to fund our spending binge today.� That means our economy will be slower in the future (high taxes means less money for individuals to spend) which is why a high national deficit�gets reflected by the value of the dollar going down.�

The other option is that�our government�would do whatapos;s called "Monetize the Debt".� That means the Federal Reserve would simply turn on itapos;s printing presses and print the amount of money neccesary to pay for our debt.� Letapos;s say the US owes $10 trillion dollars that it canapos;t pay back.� If we have to print $10 trillion dollars this will allow us to pay back the $10 trillion NOMINAL�dollars that we owe but the REAL value of our currency will decline.� The reason the REAL value of the dollar would decline is because youapos;re instantaenously adding $10 trillion of supply to the global marketplace while demand for dollars stays relatively unchanged. Simple economics explains that any time you add a ton of supply without increasing the demand for that extra supply, the price or VALUE will have to drop in order for supply and demand to get back into balance.� So again, the dollar drops in REAL�VALUE when the government adds to our national deficit because when we pay back our debts to a country that loaned us money, they may recieve the NOMINAL�value they were expecting in return but the REAL VALUE of what theyapos;re being paid back in will be declining.

Bottom Line - When our economy gets into trouble, ever since 1975, we have lowered interest rates to fuel an economic boom, or added to our national deficit to fund our economy in the short-term but the problems are ALWAYS felt again later in terms of the REAL VALUE of the US Dollar.� That is why I am against bailouts and low interest rates.� I would much rather take the pain of a poor economy today then pay for it for years to come in the form of a weaker dollar and MUCH higher inflation in the future...

As always I invite any and all comments, questions, and criicsm.� If there is anything you donapos;t understand Iapos;d be more than happy to explain it or if youapos;d like to learn more Iapos;d also be happy to provide further details.� I hope this was helpful and informative.

�- Brent Bonstingl
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