The big thing that happened last week was that the Dow drew closer to what must be its all-time high. And the dollar? It began to sink.
Of course, this could be nothing but a theory – and an empty theory at that. We have become suspicious of theories. Give us a theory – and we’ll give it right back to you.
But you have to have a theory. Otherwise the facts are dumb; they do not speak. Nor do they even point you in the right direction.
Our theory is that there is not much left in the Dow. Stocks are high. They’ve been high for many years – following a brief pullback from ’02-’03. Earnings are at record levels – and probably coming down. And now the dollar is coming down too. Sooner or later, the Dow has to find its top. It has to reach the point where it no longer makes sense to buy stocks, where people will have better uses for their money – if only, perhaps, just to pay down debt.
Of course, a lower dollar could make U.S. firms more competitive on world markets.
“But wait,” said old friend Mark Skousen, who had listened patiently to our little talk on Rome. “I’ve just spent a couple of days in Paris. Things are already expensive in Paris. On a purchasing power parity basis the dollar ought to be going up, not down.”
Mark is right. It has always bothered us that the dollar is so cheap. It confronts us with two mutually exclusive theories about the way the dollar should be priced. On the one hand, Mark’s point is that there is no inherent reason why a steak dinner should cost $30 in Dallas and $60 in London. The market for beef is worldwide.
“And not just food, practically everything you buy,” Mark continued. “I was looking at prices of computers…printers…and that sort of thing. They are twice as expensive here as they are in the United States. It makes no sense, because they’re all made in Asia and traded on global markets.”
According to price parity theory, big price differences will be resolved by entrepreneurs and traders. They’ll buy in the cheap country and sell in the expensive one – until the gap almost disappears. The effect: the cheap currency will rise; the expensive currency will fall.
But that doesn’t seem to happen.
Meanwhile, the balance of trade theory holds that if one country runs a big deficit and another a big surplus, the currency of the former will fall while the currency of the latter will rise. In fact, for many years the United States has run the biggest trade deficits in history…and for much of that time the, U.S. currency actually went up!
Well, go figure.
By one theory the dollar should go down. By the other it should go up. Take your pick.
Our guess: the trade deficit will trump purchasing power parity. The dollar will fall. As a result, global prices, denominated in dollars, will rise. This will have the effect of increasing prices in the United States, but not abroad. Result: a lower dollar, but higher prices in the homeland.
The Daily Reckoning Australia