The dollar is in something of a pickle these days. On one hand, it would benefit greatly if policymakers moved to close the deficit, increase interest rates and eliminate much of the U.S.'s national debt. On the other hand, the U.S. economy is in no position to stomach any of that in the near future. In the meantime, it looks as though the dollar is going to suffer from an inevitable decline. But what if there was some way to ease the market's fears about its future?

I began thinking about such a possibility after reading this article from the Wall Street Journal yesterday. It explains that, if you think the federal deficit looks bad now, then the next decade won't make you feel much better, as this chart shows:

deficit 2009-10.gif


So anyone who worries about the dollar isn't going to have his or her fears calmed if we stay on course. Yet, in this economic climate, that path cannot easily be altered without disastrous consequences. I think there could be a way out of this catch-22 that might give the market a better view of the future of the dollar.

What if a constitutional amendment were passed about deficit control and debt elimination, but specified that the plan would not go into effect until after the economy improved? Here's an example. (The figures below are meant to be theoretical placeholders for the kind of thing I'd envision, so don't take the specifics too seriously.)

The following actions will be taken immediately by the U.S. as soon as its economy experiences five straight quarters of growth that each exceed an annualized rate 1.5%, and the national unemployment rate has fallen below 7%:

- Budget growth will not exceed the increase in the prior year's Consumer Price Index.
- Any new spending measures must be budget neutral.
- A Value-Added Tax of 3% will be imposed on all goods and services to pay down the debt.

These measures will remain in effect until the national debt declines to be less than $1 trillion or the U.S. economy experiences a quarterly contraction resulting in GDP growth of less than an annualized rate of 1%. They will return if the national debt again (under the described circumstances) exceeds $1 trillion.


Then there's the Federal Reserve. That's a little harder, since it's independent. It would need to develop a strict inflation target, somewhere in the ballpark of 1% to 2%. Again, things could get bad if it attempted to do this right now, but again, it could do so under the same kind of circumstances that the federal government action above takes effect. The Fed would have to make a strong policy statement as such.

I believe these suggestions would simultaneously allow the economy to continue to heal while preventing the dollar from falling off of a cliff in the months that follow. Markets need some indication that the U.S. will, at least eventually, have some fiscal responsibility. Otherwise, they're right to assume that the dollar is junk.

Is there any chance of Washington taking such action? Unfortunately, I doubt it. Democrats would hate it, because it would constrain their spending. Republicans would hate it because it would increase taxes. And "compromise" isn't in the vocabulary of many politicians in Washington, even if there's a legitimately valuable goal at stake.

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