Dollars and Deficits

Deficit spending and inflation are out of control…but there might be hope for the dollar.

We have two problems. One is domestic inflation, and the other is the value of the dollar outside the United States. As far as domestic inflation is concerned, the creator, the originator, of the inflation is not the overspending of the people, not the unions, not the nasty bankers charging outrageous interest rates, not the manufacturers—it is the government.

As long as we live with a government that has a deficit in the budget we will have inflation. The size of the inflation can be influenced by auxiliary things—by political news items, by economic developments in the country—but let's not kid ourselves: we cannot avoid inflation as long as the government has a deficit. If the government eliminates the deficit, we can cope with the problems.

Now, is it the administration that creates deficits? No. It is Congress authorizing expenditures. So we should not blame the administration; we should blame Congress. And, actually, we should not blame Congress; we should blame ourselves for sending to Congress representatives who approve expenditures in excess of the government's income. A banker friend of mine made a suggestion that the Constitution be amended to prohibit any member of Congress from running for reelection if during his tenure of office there was a deficit in the budget.

The inflation that we have in this country will continue because, in my humble opinion, the government cannot eliminate the deficit. And as long as we have inflation, we will have an erosion of the value of the dollar and the purchasing power of the dollar. It can be taken for granted that the dollar of today will not buy the same quantity of goods and services next year. How can you protect yourself? That is very difficult and I will discuss this later.

Now, let's take a look at the value of the dollar outside the country. Of course, it is affected by domestic inflation, but we could have a strong dollar despite the domestic inflation. Its value outside the country depends on the US balance of payments. By looking at the value of the dollar outside the country, we can determine whether the balance of payments is negative or positive; because if the dollar goes down, that means the balance of payments is negative, and if the dollar goes up the balance of payments is positive.

I am not speaking of the balance of trade, which is an entirely different type of animal. Let's not forget that our exports are only about 7 percent of our gross national product and thus rather insignificant in our total economy. Some of the European countries export 50 percent of their gross national product. For them it is important; for us it is not tremendously important.

The balance of trade is a contributory factor in the balance of payments, but it is the latter that is important. If our balance of payments is negative, the dollar goes down. There is no other way. It means that more dollars are being offered outside the country than there is a demand for. If we have overproduction of grain, the price of grain will go down. If we have overproduction of copper, the price of copper will go down. If we have "over offering"—an excess offering—of dollars outside the country because of the balance of payments being negative, the price of the dollar will go down. It is just that simple. If other countries were to continue to buy up our dollars, they would create domestic inflation, because they would have to increase the issue of and so inflate their own currency. They try to avoid that.

Recently an interesting development occurred. The Swiss franc is the strongest currency in the world. But recently the Swiss decided to buy German marks and issue Swiss francs, even if this carries with it the danger of inflation in Switzerland. Why? Because they depend so heavily on the German economy. More than half of their exports go to Germany, and more than half of their imports come from Germany. They have to maintain some sort of ratio between the franc and the mark, so they decided that they will buy German marks if the mark tends to go down in relation to the Swiss franc.

Inflation in Germany is about three percent and in Switzerland it is about one percent, so the Swiss inflation will go up. It will go up one or two percent in order to adjust itself to the German situation. And since Germany is supporting the other countries in the European monetary system—like Belgium, Luxembourg, Holland, Denmark—actually the Swiss monetary system will depend very much on what is happening in the other European countries. There is a certain weakness now in the Swiss currency for the first time in many years.

THE DOLLAR'S FUTURE

When people ask me what is going to happen to the dollar tomorrow or next week or next month, I say that I don't know. I only know what the trend is. Since our balance of payments is negative, since the offering of dollars abroad has been heavier than the demand, the value of the dollar must go down. Our smartest action in this country in the last few months was the increase of the discount rate by the Federal Reserve, because this made the interest structure in this country go up, and that attracts money. So money came into this country to earn the high interest. The trend reversed itself, improved our balance of payments. Whenever you see the interest rate go up, you can reasonably assume that the dollar will get stronger abroad and inflation will increase, because the interest rate creates additional pressure on prices.

So we know that inflation will continue here and we know that we are also facing a balance-of-payments problem. There is no solution to the inflation; there is a possible solution to the balance of payments and hence to the value of the dollar in certain countries. If our policy is to continue with high interest rates to attract money from outside the country—and we'd add to this a reduction of government interference in our economy to attract money to this country—then there will be demand for dollars for the high yield and the good possibilities of investing in industries and commerce. If you watch the interest rate, and you watch government restrictions, you can arrive at a conclusion about what is going to happen to the dollar abroad.

There is another aspect that we have to watch carefully. We have witnessed a major development in Iran. There could be similar developments in other countries. There are problems in the Far East. If some foreign countries undergo political upheavals—and economic upheavals—-and we continue in this country to maintain our good, solid government, then monies from those countries will come to us, improving the balance of payments and strengthening the dollar. I cannot foresee at the present time in the strong-money countries like Japan, West Germany, France, and a number of other western European countries, such major developments. But it is conceivable. In Spain there are strikes, and a lot of Spaniards might try to get their money to the United States or into dollars because they would feel more comfortable, and that is understandable. All these are contributory factors toward a stronger dollar.

WHAT TO DO WITH DOLLARS

Now let's go back and ask just how we can protect ourselves against the erosion of the value of the dollar inside the country, against the loss of purchasing power of the dollar. If you are well versed in diamonds and you know exactly the qualities of the stones and you know where to go to buy and to sell, then it is perfectly all right for you to buy diamonds, because you know you can turn around at any time and sell them at a good price. But if you are not knowledgeable, stay away from it. If you are an expert in art and know where to buy and sell art, then fine. The price of art goes up.

But those who are not on top of these fields have to concentrate on other things that are readily marketable, that can be bought and sold at any time at a published price without taking a beating. I am not going to talk about stocks because I could write books about my ignorance about stocks. But I know something about gold and silver and foreign currencies.

If you buy gold intelligently, meaning that you buy gold in such a form that you know you can turn around and sell without loss because there is a ready, quoted market, that would perhaps be a reasonably good investment. You can take it home with you if you buy so-called bullion-type gold coins, or you can put it in a bank safe, or you can buy it abroad and leave it abroad. You can buy silver, but silver you cannot take home because it is too heavy; so you have to leave it with the broker from whom you buy it or at a bank, and you just get a certificate. You can also get a certificate for gold, without ever seeing the gold.

Or, if you believe that the inflation here will continue to affect the value of the dollar abroad and the balance of payments is not quite what it should be, then you can buy Swiss francs. You can buy Swiss franc bank notes and put them away, which is not very smart; or you can buy Swiss franc travelers checks and put them away; or you can just transfer dollars and hold Swiss francs in a bank abroad. There are certain restrictions with Switzerland, but those can be overcome without violating the Swiss regulations. You can have Swiss francs, for instance, in a Dutch bank or in an account in an Austrian bank, and there are no restrictions. But in Switzerland itself you cannot have more than 100,000 Swiss francs in an account because you would be hit with so-called negative interest rates.

THE STRONG AND THE WEAK

As I was preparing my comments here I was thinking about how I could compare inflation or the overspending in this country with something tangible, and it occurred to me that I should take an example of a very heavy, overweight man. Imagine a man of 300 pounds and next to him a thin fellow of 130 pounds. Now both of them, let's assume, need 2,000 calories to carry on, but they are getting only 500 calories a day. The thin fellow will perish because he has no reserves. The heavy-set fellow can go on for a long time; and that is how I feel about the United States. The United States is the heavy-set fellow. But if the United States is exposed for a long period of time to overspending, to expending more calories than it is taking in, eventually it will get into trouble.

The United States is a tremendously rich country. We have the respect of the entire world for our productive capacities, for our inventiveness, for our capacity for hard work, if we want to do it; and people all over the world respect us. They are, though, losing respect for the dollar. Unfortunately, all our activity is measured in or built on dollars, and if our monetary system collapses we will have major social and economic upheavals, as we have seen in other countries.

In my long life I have gone through such things in several European countries. When it happens in a country like Chile where the money collapsed, or in Argentina, or in Indonesia, it affects that particular country. But when it happens in the United States it will affect the whole world, and that is why the entire world is concerned about the dollar. Furthermore, the dollar is the reserve currency of the world—not so much because people have respect for the dollar but because nothing else could take its place. And the central banks of foreign countries are very much concerned because their major reserves are in dollars, in addition to some gold. And with the dollar losing value, that reserve is evaporating.

Don't misunderstand me. I am not proposing that we are a weak country. We are a very strong country, but with a weak currency. And the currency is no good if we know that it is not a store of value, if we know it will buy less next year than it buys now. Because then we want to get rid of it; we want to put it in something else. And that is not good for the economy. But it is human nature to try to hold on to something that has a stable value and try to get rid of something that does not have a stable value. And the dollar today doesn't have a stable value.

But my final and major message is that in an inflationary world the best protection is to keep working and stay in business. Don't try to live on past earnings; work! As the inflation increases, your earnings will increase as long as you provide services and goods that are needed by the public. Try to swim with the current. Try not to stop working; try not to stop earning money; be active. And good luck!

Nicholas Deak is president and founder of the Deak-Perera Group, a foreign currency exchange firm with offices around the world. Mr. Deak is a frequent speaker at investment conferences.