The Weakening Value of the Dollar

by: Barry Ritholtz

This week's Up and Down Wall Street looks at a recent analysis out of QB Partners. It is a hedge fund run by Lee Quaintance and Paul Brodsky.

QB put together an analysis of the U.S. dollar, and why its ongoing weakness is both significant and ongoing. In their analysis they see the buck ultimately ending its run as the world's reserve currency.

The heart of the analysis is the quandary left for the current Fed chairman Ben Bernake by new PIMCO flack and former Fed Chair Alan Greenspan.

Poor Ben is confronted with a long term Hobson's choice: tighten the monetary and credit screws to bolster the dollar, go the other way -- loosen credit and lower rates even further to prop up asset prices. Why is this no choice at all? Because history has taught us the Central Bank will continue to "inflate the money supply and promote more credit, thereby sustaining asset prices at the expense of the purchasing power of the dollar."

Here's an excerpt:

That may seem the downward path to financial and eventually economic rack and ruin. But such a trivial consideration has never deterred Washington. You don't have to swallow whole QB Partners' gloomy diagnosis and prognosis for the beleaguered buck to find it valuable as well as provocative. Even though we agree there's plenty of sliding room left for the greenback, we're not convinced the outlook is as apocalyptic as the duo contends...

The pair point out that the vigorous monetary inflation manifest in the 30% decline in the value of the dollar in the foreign-exchange markets since 2002 is seeping inexorably into the economy: "Prices paid in the U.S. for goods, services, financial assets, real-estate assets and natural resources have risen in recent years significantly more than population growth and organic demand."

They then cite the findings of Shadow Government Statistics, an independent research outfit, that "U.S. prices have been increasing at annual rates ranging from 8% to 11% since 1996. This contrasts with the Bureau of Labor Statistics' core CPI, which has risen in the 1.5% to 4.5% area."

And they comment dryly that most Americans likely "intuit their rate of inflation more in line with the higher 'unofficial' rate than" the conveniently low numbers calculated by the BLS.

Timely, too, is their take on our increasingly leveraged markets, the inevitable result of all that cash and credit the government is so sedulously pumping into the economy. "Levered funding," they warn, "gives the public markets an embedded tendency to fall faster and harder than they otherwise would."

Leverage, they point out, enters markets leisurely but can exit quickly and violently. Might keep that in mind when some shill next tells you there's just too much liquidity around for stocks to ever go down.

For those of you who prefer Happy Talk to chatter of this sort, there's always USA Today . . .

The View From Mars
Alan Abelson
Barron's May 21, 2007