An acquaintance of mine recently returned from a business trip to the "real" United States, meaning, the one outside the big cities. He was astounded how cheap the cost of living there is, with the dollar trading at NIS 4 per $.

To the Israeli and certainly to the European tourist, gasoline, a decent American motel, and an edible diner meal accompanied by abysmal coffee, seem remarkably cheap. Makes them feel rich.

But when he shared his feeling with his American colleagues, he was astonished at the bitterness of their reaction: "The feeling that everything's cheap is usually felt by people coming from rich countries to poor ones, not the other way around. Imagine how I'll feel if I go to Europe with my dollars. Like a pauper."

Impoverishing the middle class

The weakness of the dollar in international markets has reduced many Americans to a bizarre situation, one that characterizes underdeveloped nations, usually. Large swathes of the population, the so-called middle class, is being reduced by the weak dollar to poverty, at least the moment they wander beyond America's borders.

Latin Americans and Israelis used to feel that way. Americans aren't used to it.

One would think, though, that it doesn't matter to the average American: most never leave the country. For years America behaved as though it stood alone and had no relationship with the rest of the world. Though it needed to import energy and certain raw materials - regarding the rest, it was self-sufficient: food, industrial products, services.

But the fact that Americans tend not to travel abroad doesn't mean that the weak dollar is not impacting their lives. It is.

One way is the scissors-pattern of prices. The price of domestic services that can't be imported, like education and healthcare and entertainment, has risen. So has the price of products that contain a large component of energy or raw materials. On the other hand, the price of products imported from Asia - clothing, electronics, furniture - has dropped.

The result has been brisk economic activity coupled with low inflation. Sounds ideal, but there's a snag: that pesky deficit in America's balance of payments.

The weakness of the dollar upsets the balance. The component of imports from the Far East, which are based on low labor costs and vast mass production, can only reduce prices so much, and no more. We have not yet reached that limit, but the weakness of the dollar and the rise in raw material prices brings is very close.

On the other hand, the price of imported commodities, denominated in dollars, has shot up for the U.S. - and by much less for other countries.

Let us demonstrate. A few years ago oil cost $40 per barrel and the dollar-euro was 1:1. Therefore it also cost 40 euros. Now, the price of oil per barrel is 65% more expensive in America ($66) but it's only 22% more expensive for Europeans, because the dollar-euro is at $1.35: a barrel of oil costs Europeans only 49 euros.

That applies to other goods too, such as seeds, metals and so on.

The need to import products for dollars, whose value is shrinking, means Americans do feel the weakness of their currency. They may not feel a need to see the rest of the world, but they bring the world to them through imports.

Dear Mr Market

Economics can be annoying. Most annoying is the fact that you can't have your cake and eat it too. For a while the markets will let you have something without paying, but one day, the bill will arrive.

The financial markets allowed America to build up trade deficits for a long time, but lately, they're demanding payment, in the form of the shrinking greenback. The world has yet to demand truly high interest on American bonds, but if the dollar's weakness persists, Mr Market may get a message it won't like.

The message will be, "Dear Mr Market, We don't feel like continuing to buy U.S. treasuries at yields of less than 5%, while losing 5% a year on the currency. We therefore demand that you raise yields on bonds to levels that justify the currency risk in holding them. Thank you for your prompt attention, International Investors."

Mr Market in other countries has generally jumped to attention and changed asset prices or yields as needed. Naturally, rising yields would slow the American economy, depress consumption, and later, reduce imports and the trade deficit. That's how Mr Market corrects distortions and deficits. It isn't fun.

American policymakers, the Fed at their head, face a dilemma. They could try an ounce of prevention and deliberately cool down the economy, by raising interest rates and cutting budgets, which would reduce the deficit in the balance of payments. Their aim would be to prevent a more painful slowdown in the future, forced by the financial markets.

But that would be unpopular, especially given the rocky state of the real estate market and the other signs of slowdown already in view. To deliberately cool down the economy to prevent a worse situation in the future, that might or might not develop, would be hard for voters, and therefore politicians, to accept.

A second possibility is precisely the opposite: to try to prevent the slowdown and lower interest rates. But the impact of that on the dollar, and therefore on American inflation, could be horrible.

Tough one, that dilemma. It's like the guy caught between a hungry lion and a livid bear. Whichever way he flees, he's in trouble. Ten to one, he does nothing: let the lion and bear figure it out.

America's leaders seem likely to adopt the lion/bear policy and freeze like a deer in the headlights, though who knows. Anything's possible.

Doront@bezeqint.net

The author is the CEO of Compass Mutual Funds. The information herein is under no circumstances to be construed as a recommendation to buy or sell securities. The author and/or the company in  which he works may hold various securities, including securities mentioned herein.  In any case, this article is not to be seen as advice to buy or sell securities.