US Dollar Deflation

The recent good news-bad news about the housing market also has to do with US dollar deflation and Forex markets. The good news for the economy in general is that there are more housing starts in the USA. The good news for home buyers is that when the price of new and existing homes falls it makes it easier for new buyers to enter the housing market. The bad news is that the same process brings down the value of existing homes. Home values have already taken a real beating over the last few years. Thus a further decline is home values will further reduce the asset and credit base of American families. This could, in theory, lead to a deflationary spiral. US dollar deflation would also raise the value of the dollar versus other currencies.

Since the housing bubble burst in 2006 the average loss in home value across the USA has been a third. Because many new homes are unsold and because there are many mortgage foreclosure homes on the market there is a downward pressure on home prices. Economists contend that the housing market is still correcting from the bubble of the early 2000’s. Although the decline in housing values is general there are a few exceptions such as Phoenix where, it would appear, folks who still have money are moving. Economists are typically not concerned about a slow rate of inflation but even a slow rate of US dollar deflation gets them to worry. The concern is that the decreased wealth effect associated with low housing values results in decreased spending which in turn results in less production, fewer jobs, and a further decrease in wealth. While this can be a disaster for US citizens it can be very profitable for those who have US dollars and, especially, those who trade Forex. A stronger US dollar increases buying power abroad. It was in the 1980’s when the US dollar was strong that many US companies bought large stakes in foreign competitors. US dollar deflation increases the real value of the US dollar over time. This is great if you have US dollars and want to buy assets in the US or elsewhere. It is a problem if you are a US manufacturer who wants to compete in foreign markets. It is especially a problem if you are a US worker who is priced out of a job because it is cheaper to hire someone overseas and pay them in a foreign currency.

US dollar deflation comes from there being less available money. Less available money comes from less savings, tighter credit, lower wages, and excessive debt. This last issue may be central to both the US and Europe. The two largest economies in the world are both heavily in debt and both have tight credit as a response to the worse economic downturn in three quarters of a century. The problem can be alleviated in the short run by increasing credit and providing economic stimulus, essentially by printing money. However, these approaches drive up debt and can lead back to the same fix we are in and US dollar deflation, at least in the US housing market.