If the World’s Bubble Economy Is Hit Harder Than the U.S. Bubble Economy, Won’t That Be Good for the Dollar?
No! This is the most common misconception about the value of the dollar. Even if the rest of the world is pretty well devastated economically, and it will be, the value of the dollar will still fall relative to the euro, yen, and other major currencies. That’s because the value of a currency is not a reflection of whose overall economy is better relative to the others, but a matter of supply and demand (see Chapter 4).
If people see a risk that the dollar will decline in value due to inflation (rising supply) or to other investors becoming disenchanted with the poor performance of their U.S. investments (falling demand), they will stop buying dollar-denominated investments, thus reducing the demand for the dollar and further reducing the dollar’s value.
That initial concern about the dollar becomes a self-fulfilling prophecy because as a small number of investors stop buying dollars, the dollar will fall, causing other investors to become more concerned and stop buying dollars. At some point, the market can change quickly from people merely reducing their purchases of dollars to a full scale panic where they try to sell off whatever dollar-denominated investments they still have, causing a traumatic collapse in the dollar’s value. Unfortunately, the majority of investors will not be able to sell their dollars fast enough to get out, and their investment money will go to ...