Many people are very upset that the dollar has been declining the past few months. The call is out for the Fed to raise interest rates (see Barron's headline, October 19, 2009).
But there is a flip side to this argument. Asset valuation (whether real estate, baseball cards or stock equities) is never about fact, but always a matter of opinion. Facts, like the P/E ratio, might support the opinion, but value is an attitude or belief, it is not an absolute truth. Because valuation is an opinion, it is subject to psychology. When people feel good about an object and can support that feeling with some fact, it has higher value. When they feel poorly about the same object it has lower value. But the object itself doesn't physically change. Value is psychic.
And what is the point of this observation?
The same is true for currency of any kind, including the maligned dollar and revered Gold. When people want it, the unit price is higher, when people don't want it, the unit price is lower. To turn what is obvious on its head, maybe it isn't that house prices went down the past three years, but that the value of the dollars used to buy the house went up with demand from the world for a safe harbor.
The American currency remains the safest form of wealth the world knows. After all, contrary to its reputation, the price of gold declined during the worst of the panic. It did so as the price of the dollar in the form of short term US Treasuries, increased to record levels (as interest rates went to zero).
So, it was the currency "safety trade" and a highly valued dollar that was a primary source of our real estate woes. Put in this light, it makes much more sense that the Fed is working a policy to lower the value of the dollar back to where it was before the crash began. By lowering the value of the dollar, all physical assets priced in dollars will increase in apparent value. This will add to the wealth effect and eventually, business leaders will start hiring and consumers will start spending. That is and always has been the sequence of economic events.
The easiest way to devalue the dollar and thereby reflate the economy is by creating a flood of currency liquidity. The Fed has the power to do this and it is. This action is right out of the anti-Great Depression playbook and was used in the 1930s to great effect until the Fed lost its nerve in 1937 and raised interest rates by shutting off liquidity (tightening money supply in other words); prematurely as history has proved.
So what Andrew Bary in the Barron's piece is calling for is really the recipe for a Double Dip Recession or perhaps even to tip the economy over into the Depression we just narrowly avoided. To raise interest rates or reduce financial liquidity at this point would destroy the economic comeback, one which is unprecedented in its speed and amplitude.
It is time to appreciate Ben Bernanke's insight and command of monetary policy. It is his (and the Treasury's) knowledge and courage that have kept the global economy from capsizing. We took on some water, but Bernanke and company kicked the bilge pumps into high gear and we are beginning to float high and unfurl the sails once again. He should have no problem trimming those sails once the wind comes up.
