Watch the dollar!
This abstraction… this green piece of paper… this strange invention – the dollar is backed only by full faith in America’s faithless central bankers… who have only wiped out half the dollar’s value in the last 20 years and the credit of the world’s biggest debtor. What is it worth? No one really knows.
But whatever it was worth yesterday, there is general agreement that it is worth less today. We say that because we’ve noticed it slipping – yesterday, it was trading at just less than $1.29 per euro – at a 5 month low.
Currencies go up and down, it is true. And this isn’t the first time the dollar was at $1.29 per euro. But if our memory is right, the last time it was at this level the fed funds rate was 425 basis points lower. Now, despite much higher short term rates, the dollar is falling again.
As the fed raised rates, the dollar rose too. But where will it go now? The US central bank is already giving lenders considerably more for their money than either the bank of Japan or the bank of Europe. The ECB’s key lending rate is still only 4.25% (marginal lending facility effective October 11).
Japan’s equivalent rate is only 0.25%.
If these higher returns fail to bring in enough wampum, what is the Fed to do? The US must borrow. It depends on the kindness of foreign lenders to keep going. And when the foreign lenders fail, the dollar falls.
As a theoretical matter, the Fed could raise rates some more to attract lenders and support the dollar. But as a practical matter, two of the major industries in the country are already desperate for lower rates, not higher ones. US housing and car-making are both in trouble. The housing industry, alone, represents a huge threat. It could drag the whole US economy down with it; frankly, we’re surprised it hasn’t done so already. It would take an unusually bold, or unusually reckless Fed to raise rates now.
So keep your eye on the dollar. For many, many months it has defied the most fundamental principles of international commerce – going up, even as the current account deficit rose to $800 billion a year. But markets always do what they’re supposed to do; just never when you expect it. When people expected the dollar to fall – it rose. Now, no one is watching it. They’re all convinced that the dollar is indestructible… as eternal and unblemished as granite countertops.
And yet, a fall in the dollar is just what you’d expect. It is the normal way to balance out America’s trade and current accounts. It is the normal way to undermine Americans’ wealth with hardly anyone noticing. And what better way to stop people from living beyond their means – cut their means down even further!
Few Americans pay any attention to the value of their currency on world markets. They earn their money in dollars… and spend in dollars. Only we poor exiles have to suffer the consequences of the buckling buck on a daily basis. We go to buy a bottle of wine and we find it costs more than it did, in dollar terms, last week. We go out to dinner and we’re shocked at how much we spent. We pay for our new granite countertops and wonder how prices could have shot up so much.
Back in the US, the fall in the dollar is cushioned by a number of things. Most expenses are home-grown; they don’t go up just because the dollar has gone down on global markets. And even imports do not fully react to the lower currency, because so many of them come from China, which holds its own money close to the American brand. What’s more, Wal-Mart and other discounters are finding new and better ways to cut costs… somewhat softening the blow.
In terms of gold and euros, the dollar is already worth less than half what it was a few years ago. Keep your eye on it; a few years from now, it will probably be worth only half what it is today.