Dollar's Decline a Crisis of Solvency - Not Liquidity

The U.S. dollar has hit a 35-year low when compared to a basket of currencies, adding fuel to rising fears of inflation. Prices of gold, crude, and other commodities are soaring to near all-time highs despite the fact that the U.S. economy is in the midst of a slowdown. Interestingly, those elevated commodity prices are not included in the standard inflationary data sets of CPI or PPI. The Federal Reserve’s most important task is to keep our currency healthy and stable, so how can Chairman Bernanke justify another rate cut at the FOMC’s next meeting?

Chairman Bernanke has aggressively cut rates in a Herculean effort to counter the credit crisis and the likely recession that it could engender. However, every time he cuts rates, inflation becomes more of a problem and the U.S. dollar depreciates further. This is a de facto tax on people holding and spending dollars. Fed policy should be a balancing act between restraining inflation and maintaining conditions favorable for sustainable economic growth. However, Bernanke’s actions of late have been anything but balanced.

Pleasing Wall Street by continually easing monetary policy could be disastrous for the economy. The dollar has reached its lowest value since this currency basket metric was started in 1973, and further easing will lead to further devaluation. Has the easing really helped the economy anyway? Long term mortgage rates remain virtually unchanged from where they were when the easing process began. It is probably too early to tell, but as many claim and we agree, this is not a crisis of liquidity but of solvency. Consider that the carry between Chinese and U.S. interest rates is now negative, thus making Chinese investment in U.S. treasuries far less attractive. The massive amount of treasuries that the Chinese already own are losing value due to the dollar’s decline and the yuan’s appreciation. This will make the largest current account deficit in history even harder to finance with the loss of attractive yields.

We expect the stock market to continue to be negatively impacted by the dollar’s ongoing weakness and valid inflation concerns.

Comments

[SavCD:]

Agree completely.......the only thing you have to watch is the dollar right now. There is no substantive work being done on the current account deficit, SS and Medicare, or the National Debt.

2008 Mar 06 11:18 PM

[sbenard:]

Ditto everything above!

2008 Mar 07 12:13 AM

[elwind45:]

What would keep the world from dollar carry trade? I find it amusing how everybody is riding the dollar on flat tires. Conditions require 1.5% fed fund rate decrease to bring banks back in business. I see the central bank defending the dollar. The US is embarking on a journey to alloww commondities to increase to levels which will destroy production. Washington will have to loan money to fannie and freddie. The mortgage backed assets are indirectly backed by treasury. How high would rates need to move to stop dollar slide?

2008 Mar 07 06:34 AM

[Mr Pasadena:]

This is really going to eventually hurt everyone, if not already. Inflation is real. If the Fed and our US government just let the market speak, then this will be just a short and quick downturn. The start of this crisis is real estate. Not commercial or business activity. It started with people living on credit from their ATM house. For those of us that have real savings, we are looking at lower home pricing and then spending our money on a new home purchase. That will definitely jump start the economy. There are millions of us prune and cautious people that did not get caught in the real estate ponzi scheme. But we are not going to spend our hard earn money on someone else's mistake of overpaying for real estate. Bernanke, let the prices fall and I will spend again.

2008 Mar 07 08:42 AM

[fed follower:]

The real insult is that the FED saw this comming years ago, and their only reaction was to quit tracking the M3 money supply - you know, the statistic that would let us know how many new dollars they are printing to deflate the debt by inflating the currency

2008 Mar 07 11:34 AM

[BargainHunt...:]

Last Housing Bear Market in the early 90's took 52 months to hit top to bottom. What makes us think that this one will last only 24 months.
This is much worse than the last bear market and should last at least
64 months. We are only 16 months in the bear market, so aave your money because the real bargain is 4 years from now! Let the dummies buy 1st! Patience is a virtue, so buy when the time is right, that is when 3 X household yearly income = right price value for an average home. So Wait it out! Don't buy yet! Save now to buy Later!!

2008 Mar 08 12:59 AM