With the U.S. Dollar Index breaking decisively below its long-term support level, the sun is finally setting on the golden age of American consumption. As America's economic dominance fades, so too will the faith in the central thesis that has explained its apparent success and has shaped the majority of recent economic theory.

At issue is the belief that a nation can grow and prosper by borrowing from abroad in order to consume imported goods. To consume at the pace that it has, America exchanges income producing assets, such as companies or property, or interest bearing IOUs, such as Treasury notes or mortgage-backed bonds, for foreign made clothes, toys and electronics. Economists call these transactions "growth". But rather than discovering a new path to prosperity, America has simply stumbled on a short cut to financial ruin.

For years America has convinced the emerging market countries that their prosperity is a function of our consumption. It is argued that their export oriented economies would falter if not for the insatiable American willingness to consume (a "virtue" that is assumed to be uniquely American). As the dollar falls into the abyss, this myth will be shattered.

My forecast is that over the next two to three years the U.S. Dollar index will fall to 40; half of its current value. As this happens, much of America's economic power will be transferred abroad. The chart below approximates current per capita U.S. dollar GDP for thirty nations, including the United States, listed in descending order.

A 50% decline in the value of the dollar will simultaneously increase interest rates, consumer prices and unemployment in the United States, while causing stock and real estate prices to fall. Consumption, which accounts for better than 70% of U.S. GDP, should collapse as a result, producing a significant recession. My forecast is that U.S. GDP will contract by at least 20%. (The Fed may seek to mitigate the nominal decline with expansive monetary policy, but such moves will only result in an even greater contraction in real GDP.)

Assuming a 50% decline in the value of the dollar and a 20% fall in U.S. GDP, the above chart would look something like this:

Obviously, these projections are very rough. Not all foreign currencies will rise in step and not all foreign GDPs will remain constant at today's levels in local currencies. However it is the concept that is important. Notice how America falls from 6th place to 21st. America's per capita GDP falls from 58% of Luxemburg's, the top nation on the list, to a mere 20%. America's per capita GDP falls from 14 times that of Peru, the lowest nation on the list, to only 5.6 times.

China is conspicuously absent from the list. Its current per capita GDP is only about $2,200. However, were China to allow its currency to float freely, my belief is that the yuan would rise far more significantly than other currencies. I have no idea how much more significantly that rise will be, but let us assume that its rise against the dollar would be double the rate of the typical currency in the Dollar Index. That would result in China's per capita GDP rising to $8,800, just above Peru's but still below Brazil's.

Factoring in China's enormous population means that such a significant rise in its per capita GDP would have a profound impact on global consumption. Consider the following table, in billions of U.S. dollars, of the GDPs of the G-7 nations plus China:

Now consider the table with my assumptions regarding exchange rates and a 20% decline in U.S. GDP.

Under this scenario, China supplants the United States as the world's largest economy, not in 30 or 40 years as is commonly believed, but perhaps as soon as before the end of this decade. The U.S. retains its lead over Japan for second place, yet the margin declines from over 300% to just 10%. (My prediction is that the yen will rise more significantly than most other currencies meaning that Japan's GDP will likely surpass U.S. GDP as well.) Further, the GDP of the thirteen nations sharing the euro is currently about 12.8 trillion dollars. After the dollar's decline it will rise to a staggering 25.6 trillion, more then twice that of the U.S. As a result, considering the EU as a single nation, the U.S. economy would then rank forth among the world's largest, with its GDP declining from 43% of world GDP to only 21%.

Current ideology holds that a recession in the United States as severe as the one I am forecasting would be catastrophic for the global economy. But this short-sighted view overlooks the effects of such tremendous dollar gains in the GDPs of the rest of the world. Wouldn't the increased consumption of everyone else offset the effects of the decreased consumption of Americans? It is not as if factories around the world would shut down if Americans stopped spending. All that would change would be the nationality of the buyers.

As American consumer spending declines, foreign spending will rise to take its place. With an explosion in foreign purchasing power, consumers around the world will see the dollar values of their incomes and savings soar. Globally, goods will fall in price and consumers around the world will snap up the bargains. Goods that were formerly out of reach for many foreign consumers will now be affordable. The reverse will occur in America. As production is diverted away from poorer Americans to more affluent foreigners, consumer prices in America will rise sharply. Goods that Americans used to easily "afford" will now be out of reach.

As gold surpasses $700 per ounce, oil tops $80 per barrel, and wheat prices exceed $9 per bushel, Americans are already getting a taste of things to come. Prices for these and other commodities are rising as a direct result of the weakness in the dollar. As this weakness intensifies in the months ahead, commodity price increases will accelerate. However, as their own currencies rise, many foreign buyers will actually experience price decreases. The result will be even greater demand for commodities from abroad just as domestic demand subsides.

Further, as the world stops exporting so much of its savings to America, there will be far more capital available to foreign entrepreneurs to invest productively. Think of the crowding out effect of so much of the world's savings being lent to American consumers. Now imagine the foreign investment boom that would follow as foreigners reclaim access to their own savings.

The American propensity to consume is not a unique talent. Any nation can emulate it so long as it finds willing lenders and suppliers. Production on the other hand is an entirely different matter. It requires free markets, limited government, the rule of law, savings, capital and hard work. The world economy will not be brought to its knees simply because Americans stop consuming. Rather it is America's service sector economy that will collapse once the rest of the world stops propping it up.

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