McCain Bad for the Dollar?

The Republican presidential candidate's tax cutting statements risks his credibility, and if elected, the dollar.
By John Fout ,

Sen. John McCain (R., Ariz.) has two major planks in his bid to become the 44th President of the United States: continued commitment to the conflict in Iraq and cutting taxes to cure the economy. Both policies put pressure on the federal deficit, threaten to increase the already $9 trillion national debt and could put a crimp in the nascent stabilization of the U.S. dollar.

A lack of fiscal restraint has hammered the dollar over the last few years, which accelerated following the

Federal Reserve's

decision to cut interest rates dramatically in the wake of a credit crisis.

McCain commented Sunday during an appearance on

ABC's

"This Week": "When economies are rough, then you've got to reduce the tax burden on people."

This clarifies statements he made last week on

his economic plan; McCain said he favors tax cuts before budget cuts. Nevertheless, he claims the country would be on a "road to a balanced budget." Tucker Bounds, a McCain campaign spokesperson, said, "Sen. McCain believes conceptually in balancing the budget and hopes to accomplish it by the end of his second term."

Complicating things, if McCain becomes president, he will likely face a Democratic Congress. Almost 10% of Republicans have announced retirement from their seats and Democrats have been competitive in many districts long thought safe for Republicans. This includes former House Speaker Dennis Hastert of Illinois. Democrats would fight his stated budget priorities.

McCain's plan lacked concise numbers on how much his tax cuts would cost, and he has no plans to cut defense spending. In the short run, his plan would add to the deficit and the national debt; this could exacerbate a negative image of the U.S. to foreign investors." The U.S. dollar is a barometer of our economic health," says Chip Hanlon, President of Delta Global Advisers and a contributor to

RealMoney.com

. "We clearly need to get our fiscal house in order."

Richard Sylla, a professor of economics at New York University, thinks an increase of government debt seems irresponsible and deters lending needed for private industry to grow the economy. He notes our national debt hasn't gotten out of control when compared to other industrial nations. "The deficit has no direct economic effect on the dollar," he says. "I don't lose sleep worrying about an increase in the national debt. It remains at a reasonable ratio to Gross Domestic Product." Sylla did acknowledge that psychology can play a part in the price of the dollar.

Some analysts have said the dollar has bottomed. Hanlon questions this assessment, seeing as the dollar hasn't "gone anywhere from its recent oversold condition." Michael Strauss, Chief Economist for

Commonfund

, says "The purchasing power of the U.S. dollar against G5 countries (Europe, Canada and Japan) has had an effect and started to stabilize the dollar because the purchasing parity vs. the G5 is cheap."

But Strauss adds the bottoming theory on the dollar faces another challenge. "The dollar remains undervalued vs. the currencies of the developing world, such as China and India," he says. "As those countries continue to grow, it could cause dollar weakness." Of course, those are some of the countries that have helped finance U.S. deficit and debt.

A weak dollar has one effect -- an increase in exports. Strauss notes that exports are clearly positive and he says manufacturing has held up reasonably well, helping to keep some jobs in the U.S. He notes the U.S. leads in building infrastructure, which has strong demand from developing countries. If exports continue to excel, it could keep the economy out of a severe recession. This would help McCain and the Republicans who favor free market and free trade. McCain lashed out at Democrats: "They are out of touch when they want to raise taxes at the worst possible time when we're in a recession."

Strauss sees the deficit picture getting worse, regardless of Iraq and unsound budget practices. He has concerns about the aging U.S. population. Baby boomers will soon tap into entitlement programs, Medicare and Social Security, straining government resources for years to come.

The next president faces daunting challenges. Democrats argue McCain will be nothing more than a third term of President George Bush, who has presided over a massive decline in the dollar. McCain will have to answer this charge to win in November. Hanlon said: "I like half of McCain's plan because it could grow the country out of deficit. But McCain has to be careful not to lose credibility on fiscal responsibility."

McCain's position on taxes could prove popular with the electorate. But if the world perceives a continuation of poor fiscal policy, look for market psychology to doom a dollar rally.

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