The U.S. Dollar vs Inflation, Americans Vote for the Dollar

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A new Bloomberg/Los Angeles Times report finds that, “76 percent of Americans think the government should do something to halt the falling dollar. Among those with incomes of $100,000 or more, seven in 10 favoured aiding the currency.”

In words, if not in deeds, U.S. Treasury Secretary Henry Paulson favours a ‘strong dollar.’ But his counterparts at the Fed, in both deeds and words, clearly do not (see below). For two or three years the weak dollar did not bother Americans because it didn’t affect their purchasing power. It only affected people like your editor, who were paid in dollars but lived abroad.

Now that inflation has crept into the American economy with rising food and fuel prices, the real consequences of weak dollar are coming home to roost. And it seems to be bothering Americans psychologically as well as economically.

“It’s not just the economic impact,” Paul Burt, the head of Westlake Financial Group, tells Bloomberg. “The perception of the decline in the dollar is as important as the decline itself. The dollar needs to be respected in the world, and the government needs to realize that.”

The value of all paper currencies is based on perception. If investors perceive that the U.S. dollar is the unbacked liability of a bankrupt government, the dollar will fall to its intrinsic value, which is a lot lower than where you find it today. Demanding respect won’t help.

Respect is something you earn. Currencies earn respect when the economies they come from have real savings, high rates of investment and capital formation, and real wealth creation. The monetary and fiscal policies of the U.S. government are the enemy of real wealth creation. Those policies are impoverishing America, not making it richer. Many Americans are just starting to realise this. And they aren’t too happy about it.

They probably wouldn’t be too happy if they saw the chart below either. It comes, via http://calculatedrisk.blogspot.com, from Fed Governor Janet Yellen. It shows you how much non-tradeable, hard-to-valuable mortgage-backed (and maybe credit-card backed) garbage bonds the Fed has taken custody of through its tool-bag of “lending facilities.”

Theoretically, there is no limit to the amount of U.S. Treasuries the Fed can exchange for increasingly dodgy collateral from commercial and investment banks. If it runs out of its stock of Treasuries, it can just print more money. But we reckon that the more depleted the Fed’s Treasury stock gets, and the more investors realise new money will have to be printed to purchase bad debt, the worse it will be for the dollar.

Chart: http://www.dailyreckoning.com.au/images/20080515DRC.png

Source:http://calculatedrisk.blogspot.com

 

“Conditions in financial markets are still far from normal,” Fed Chairman Ben Bernanke told Congress yesterday. Just how much more abnormal will they get? $300 billion worse? $500 billion worse? Worse?

Nobody knows. But three years from now, we reckon gold will be higher, the dollar will be lower, and Australia will still be lucky.

Dan Denning
The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. Hey Dan, how about a piece on exactly how Australia will still be lucky? All these articles about America are interesting, but how relevant are they to the Australian economy?

    Reply
  2. Very interesting.. nice article.. I would like to know more.. I wonder, do US Treasury prices over time move up while the dollar currency is going down? Or vice versa? I know that yields and bond prices are inversely related but I wonder ultimately if there is a bubble building in treasury prices because once the Fed starts aggresively buying back all their treasuries, but also that the Fed is even more aggressively printing money, I feel like bond investors may just SELL SELL SELL in order to capture profits on the back of the US tax payer. Even if that is not the case, I imagine many investors may wind up seeing it profitable to short treasuries and the US dollar, not to mention shorting the GM (Government Motor) IPO launching soon.. hehehe

    Reply

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