Asbytec

Changing My Stance on the Dollar

Well, seems Japanese and EU "easing" have breathed new life into the dollar. Also, a recent check of the index indicated the Bush Big 2 Bail out did likewise. More to come, I guess...

Changing My Stance on the Dollar

Okay, back to fundamentals. Inflation is a monetary phenomenon, right? If you can buy a home for $1 today and sell it for $2 tomorrow, it is probably due to the value of the dollar falling by half (demand driven prices aside for now.)

Now, this sounds like a great investment, double your money in a day. We tend to hold the value of a dollar steady in our mind and valuate asset prices around that "pegged" and undefinable value. Assets, such as homes, look more valuable. So in reality, demand driven prices aside, the seller may have more dollars except each has at less value.

This is inflation and it cause folks to borrow money on hopes asset prices will rise...which looks like wealth. He or she might feel richer by saying they have twice as many dollars as before.

Well, deflation is the opposite. If prices are falling, well, no one want's to lose the number of dollars they have. No one wants to buy a house at $2 today and sell it for $1 tomorrow despite the real value of the currency...which makes the home more expensive, really. And banks certainly won't loan anyone the money to default on such a deal.

But, in this case, the currency is getting stronger. The "real" value of the home hasn't really changed much, provided supply or demand haven't driven the price. The home still has 2 bedrooms, 2 baths, and a view. Nothing has changed. The asset is still there.

So, in deflation, one is actually better off if holding dollars and not in debt...or has the rare courage to stick with it during deflation. Our paychecks have benefited from decades of keeping pace with inflation and our level of money should be pretty good. So, we have more money at a higher value, each dollar.

This is a form of wealth, as opposed to illiquid borrowing someone else's money on that second mortgage.

So, we say we're in a deflationary spiral. Well, I guess the threat is certainly real. So, if the dollar is becoming more valuable despite the efforts to fight deflation, then why not hold it and pray for a bit more? Just a bit more, be thankful. Hold onto that home, refinance if at all possible.

Well, that is, hope for more deflation until the economy totally collapses because the credit markets completely freeze solid. They will, they have, because in our system...money is debt, not wealth. But, while deflation lasts, it is wealth. And someone doesn't like that.

But, I'm not sold on the deflationary spiral just, yet. Once the first of the sub prime mortgages began to fail, home prices (pseudo values) were driven down by supply and demand, not deflation. However, with oil prices and it seems other commodities pretty much flat, maybe we are on the verge of deflation...which means a stronger currency relative to assets.

Yes, stronger currencies through the world, except Zimbabwe, of course...and strength measured relative to each other.

The Fed created a mini rally on Fed day and killed the dollar against the euro and yen...and the Aussie, and every other major. They did not succeed in halting market volatility or currency volatility. What we saw in the dollar was a volatile reaction.

But, other nations (developed and emerging) should be undergoing the same deflationary cycle and credit squeeze we are to varying degrees of severity. They have to act or face ruin, and the euro zone is pretty much down that path as we are. They are debt based currencies, too, just like the dollar. They thrive on debt creation (of money) and inflation.

The ECB has the mandate of price control. Fine. Deflation is a price concern, just like inflation, only for very different reasons and in the opposite direction. So, if the ECB will not hesitate to fight inflation through tightening, they should be willing to fight deflation through easing, albeit hawkishly.

Again, what we saw in the dollar (and the markets) I suspect was a volatile reaction to Fed rate cuts. They scared the proverbial poo out of everyone, including me. The dollar index might support that claim of volatility and future strength. Future rate cuts by central banks lagging the US will bear this out. We live in volatile times, expect volatility.

But, as I've argued, deflation is supporting (or will support) the dollar. If deflation is among us, it should become more valuable as other central banks race to inflate. Is that fundamental enough? :-P

Changing My Stance on the Dollar

Limey, good point. I really have no idea either, just a (pseudo) educated guess.

I understand the ECB mandate and their course of action. In fact, I was hoping the Fed would not sink rates to zero. Aggressive rate cuts have not helped move credit markets. And I'd understand if the ECB held steady, too. There is plenty of liquidity, just not enough lending. I'm a proponent of the liquidity trap theory.

But, I guess it depends on the ECB stance on price stability. Does such a stance include falling prices? I am sure you'd agree our banking system is designed to function under inflation. And, that's the point, in my view. Will falling prices lead to foreclosures and other (possible) deflationary evils in Europe?

I am betting the ECB will get on the deflation train, albeit hawkishly because of the hyperinflation threat as you point out. However, they may have to induce some inflation. Besides, this coordinated (and presumably agreed upon) effort is well understood on both sides of the Atlantic. That's the basis of my call on EU rates.

As for gold, well, man...that's anyone's call at this point. Yes, it's gone up a bit. But, there are growing arguments to sell, and they are deflation based arguments.

Changing My Stance on the Dollar

User, right on.

The dollar is in trouble, there is no doubt. But, these are volatile times. What we witnessed was volatility...panic, fear, something. The Fed rate cut certainly spurred the markets for a day, but they will return (or already have returned) to their volatile ways. Risk appetite gives way to aversion and back again. Both give way to yield which may give way to more panic(?) when the EU cuts rates.

It is telling commodity prices remain relatively flat despite the dollar's plunge. (I said relatively.) The drastic measures the Fed is taking are also telling. The global economy is in more trouble than those politely worded central bank statements will attest to. "Downside risk," my back side! Yaaaaa betcha!