"Dollar Weakness - It's Time to Change Course"
Sydney M. Williams
In August 2007, the first indications of the oncoming credit crisis became apparent. In response to growing liquidity concerns, the Federal Reserve, on August 17th, cut the Discount Rate by 50 basis points – the first reduction of that magnitude in ten years. Despite rumblings in mortgage markets and already-falling home prices, the S&P 500 that August was 13% ahead of where it had been a year earlier. For two and a half months it continued to climb. However, during the following eighteen months, the markets provided a simile for prolonged, unending torture. Complacency, in markets as in war, can be your enemy.
Today, it is the blasé attitude of our government toward a continuing weakening dollar and the effect that weakness has on Treasuries and inflation that should concern us. In January 2002, the dollar stood at 120.14 (the Dollar Index.) The 1990s had been good for the dollar. It had risen 53% over the previous ten years. Yesterday it closed at 72.98, 39% below where it was nine years ago – and, worse, 13% lower than it was thirty years ago, according to David Wessel in today’s Wall Street Journal.
The dollar’s decline preceded the current administration by six years. Despite protestations to the contrary, the Bush administration pursued a weak dollar policy. During George Bush’s eight years in office, the inflationary consequences of too-low interest rates and too-aggressive spending caused the dollar to decline 22%. In January 2001, the Fed began a series of rate cuts. Over the next two and a half years, the Fed Funds rate was cut from 6.5% to 1.0% in June 2003. It remained at that level for a year, despite the fact that the mild recession of 2001 had ended in December of that year. Rates rose slowly for the next two years, but by the summer of 2007 Fed Funds remained 125 basis points below where they had been in 2000. The speculative boom in home prices has its roots in the Fed keeping rates too low for too long. During those same years, the surplus inherited by the Bush administration was turned into a deficit. The federal deficit during the Bush years, as a percent of GDP, rose from a negative 1.24% to a positive 3.19% in 2008 in 2008.
But a few bad decisions in the aughts should not legitimize continued weak dollar policies in the current administration. Like his predecessors, Treasury Secretary Tim Geithner has not walked his talk. He was recently quoted in Barron’s: “We will never embrace a strategy of trying to weaken our currency to gain economic advantage.” Nevertheless, under President Obama spending has increased so that the federal deficit is now close to 10% of GDP and Fed Funds have been kept close to zero. In the last two years the dollar has declined another 15%. Over the past few decades, our economy increasingly became dependent on a consumer who borrowed in order to maintain or improve his or her living style. That prodigal example was mirrored in a government with a belief in a never setting sun.
The official line from Washington is that a strong dollar is in America’s interests. I believe it is, and so do many others. But the administration does not, despite what they say. They crow about the rise in exports – up 21% in 2010, but they are only back to 2008 levels. The government continues to issue debt, with the Federal Reserve as the principal buyer, knowing that rates will eventually rise, as surely as the sun will set in the West, and that such increases will only pressure our deficits. It is an “eat, drink and be merry, for tomorrow we die” policy. Left to themselves, the administration would increase the debt ceiling with no restrictions on spending. So dollar debasement will persist, until a realistic road back is discovered.
The decision last week by the Treasury to exempt foreign exchange derivatives from the rigors of Dodd-Frank appear to be a preemptive move on the part of global corporations and banks to hedge (or speculate) on a further decline in the dollar. As Alan Rivoir of Brahman Securities recently wrote, regarding this decision, “whatever the explanation, there is more than the face value here. Something is certainly awry.” QE2 will be winding down next month, but a continued weak economy and a heavily indebted Treasury will persist in inflationary monetary tactics. Bill Gross of PIMCO wrote in his recent Investment Outlook”: “Investors in U.S. Treasuries are being shortchanged by 1-2% annually compared to historic norms.”
Inflation is not only punitive; it is insidious in the way it creeps up. In the forty-four years I have been in the securities business, the dollar has lost 85% of its value. In his April 8 issue of “Grant’s Interest Rate Observer”, Jim Grant contrasts official inflation releases to the far more realistic ones from Billion Prices Project, a daily real-time index compiled by two M.I.T. professors. The Billion Prices Project calculates inflation has compounded at 6.1% over the last six months versus estimates from the Bureau of Labor Statistics (BLS) of 2.8%. Anybody who buys gas or shops at a supermarket knows the official numbers are bogus. It has not always been this way. If one goes to the “Inflation Calculator”, it can be seen that the dollar doubled in value during the 19th Century. In contrast, it lost 95% of its value during the 20th Century.
As the nation faced an unprecedented credit crisis in 2007-2008, the Fed and Treasury acted swiftly and properly in liquefying the system and containing the damage. Over time, a strong currency reflects confidence; a falling currency denotes weakness. There are moments when a weak currency is beneficial, but it must be recognized as a tax on consumption, and it hurts the poor most of all.
Given the surge in asset prices such as commodities (at least until a couple of days ago) and in stocks, but not in wages or jobs, the question must be asked: Has a weak dollar policy overstayed its welcome?
Thought of the Day
“Dollar Weakness – It’s Time to Change Course”
May 5, 2011In August 2007, the first indications of the oncoming credit crisis became apparent. In response to growing liquidity concerns, the Federal Reserve, on August 17th, cut the Discount Rate by 50 basis points – the first reduction of that magnitude in ten years. Despite rumblings in mortgage markets and already-falling home prices, the S&P 500 that August was 13% ahead of where it had been a year earlier. For two and a half months it continued to climb. However, during the following eighteen months, the markets provided a simile for prolonged, unending torture. Complacency, in markets as in war, can be your enemy.
Today, it is the blasé attitude of our government toward a continuing weakening dollar and the effect that weakness has on Treasuries and inflation that should concern us. In January 2002, the dollar stood at 120.14 (the Dollar Index.) The 1990s had been good for the dollar. It had risen 53% over the previous ten years. Yesterday it closed at 72.98, 39% below where it was nine years ago – and, worse, 13% lower than it was thirty years ago, according to David Wessel in today’s Wall Street Journal.
The dollar’s decline preceded the current administration by six years. Despite protestations to the contrary, the Bush administration pursued a weak dollar policy. During George Bush’s eight years in office, the inflationary consequences of too-low interest rates and too-aggressive spending caused the dollar to decline 22%. In January 2001, the Fed began a series of rate cuts. Over the next two and a half years, the Fed Funds rate was cut from 6.5% to 1.0% in June 2003. It remained at that level for a year, despite the fact that the mild recession of 2001 had ended in December of that year. Rates rose slowly for the next two years, but by the summer of 2007 Fed Funds remained 125 basis points below where they had been in 2000. The speculative boom in home prices has its roots in the Fed keeping rates too low for too long. During those same years, the surplus inherited by the Bush administration was turned into a deficit. The federal deficit during the Bush years, as a percent of GDP, rose from a negative 1.24% to a positive 3.19% in 2008 in 2008.
But a few bad decisions in the aughts should not legitimize continued weak dollar policies in the current administration. Like his predecessors, Treasury Secretary Tim Geithner has not walked his talk. He was recently quoted in Barron’s: “We will never embrace a strategy of trying to weaken our currency to gain economic advantage.” Nevertheless, under President Obama spending has increased so that the federal deficit is now close to 10% of GDP and Fed Funds have been kept close to zero. In the last two years the dollar has declined another 15%. Over the past few decades, our economy increasingly became dependent on a consumer who borrowed in order to maintain or improve his or her living style. That prodigal example was mirrored in a government with a belief in a never setting sun.
The official line from Washington is that a strong dollar is in America’s interests. I believe it is, and so do many others. But the administration does not, despite what they say. They crow about the rise in exports – up 21% in 2010, but they are only back to 2008 levels. The government continues to issue debt, with the Federal Reserve as the principal buyer, knowing that rates will eventually rise, as surely as the sun will set in the West, and that such increases will only pressure our deficits. It is an “eat, drink and be merry, for tomorrow we die” policy. Left to themselves, the administration would increase the debt ceiling with no restrictions on spending. So dollar debasement will persist, until a realistic road back is discovered.
The decision last week by the Treasury to exempt foreign exchange derivatives from the rigors of Dodd-Frank appear to be a preemptive move on the part of global corporations and banks to hedge (or speculate) on a further decline in the dollar. As Alan Rivoir of Brahman Securities recently wrote, regarding this decision, “whatever the explanation, there is more than the face value here. Something is certainly awry.” QE2 will be winding down next month, but a continued weak economy and a heavily indebted Treasury will persist in inflationary monetary tactics. Bill Gross of PIMCO wrote in his recent Investment Outlook”: “Investors in U.S. Treasuries are being shortchanged by 1-2% annually compared to historic norms.”
Inflation is not only punitive; it is insidious in the way it creeps up. In the forty-four years I have been in the securities business, the dollar has lost 85% of its value. In his April 8 issue of “Grant’s Interest Rate Observer”, Jim Grant contrasts official inflation releases to the far more realistic ones from Billion Prices Project, a daily real-time index compiled by two M.I.T. professors. The Billion Prices Project calculates inflation has compounded at 6.1% over the last six months versus estimates from the Bureau of Labor Statistics (BLS) of 2.8%. Anybody who buys gas or shops at a supermarket knows the official numbers are bogus. It has not always been this way. If one goes to the “Inflation Calculator”, it can be seen that the dollar doubled in value during the 19th Century. In contrast, it lost 95% of its value during the 20th Century.
As the nation faced an unprecedented credit crisis in 2007-2008, the Fed and Treasury acted swiftly and properly in liquefying the system and containing the damage. Over time, a strong currency reflects confidence; a falling currency denotes weakness. There are moments when a weak currency is beneficial, but it must be recognized as a tax on consumption, and it hurts the poor most of all.
Given the surge in asset prices such as commodities (at least until a couple of days ago) and in stocks, but not in wages or jobs, the question must be asked: Has a weak dollar policy overstayed its welcome?
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