It is simply amazing how much nonsense is being said and written about the dollar and the meaning of its demise.

Nonsense No 1. The President and the secretary of the Treasury have been going on record suggesting that the administration supports a strong dollar policy. What does it mean? What are the implications? I am not sure they know what the answers are.

Nonsense No 2. A weak dollar is good for the US because it makes our goods less expensive and more attractive to foreign customers. This is really a good one. I shiver every time I hear it.

Nonsense No. 3. The weak dollar is inflationary. It’s the other way around. It is the inflationary bias of our economy that weakens the dollar. Let’s start from the top.

The dollar/euro peaked at 0.86 in early 2002. At the same time the growth of the money supply topped at a torrid 20% pace, stocks were plunging, and credit spreads imploded from historical levels.

The synchronized peak in all these measures, by the way, is not a coincidence. It signaled the beginning of the cleansing of our system from the financial orgy of the late 1990s facilitated by the Fed. The decline of the dollar is just one expression of this cleansing.

Anyway, the dollar/euro is now at 1.33, a 54% decline. Commodities, meanwhile, soared almost 70%. (Not a coincidence. They rise when the dollar declines). The dollar declines because a) we sell dollars to buy foreign goods; and b) foreign and US investors sell dollars and invest the proceeds in other financially more attractive countries.

Why do we buy foreign goods? Because they are cheaper and more attractive. We sell dollars to buy the renminbis required to buy shoes or wind breakers made in China. We sell dollars to buy yens and euros needed to buy Lexus, Mercedes, and BMW cars.

What are the implications? The reason we buy foreign goods is because the majority of our industries cannot supply them. In other words, the reason we sell dollars to buy foreign goods is because the majority of our industries cannot make better products at a lower price when compared to our trading partners.

Some industries are advanced and they strive. The problem reflected by a declining dollar, however, is that most of our industries are not competitive.

A declining dollar is not going to solve the productivity/competitive problems. The dollar will strengthen again when the majority of our industries re-gains its competitive edge. This is the reason for the weak dollar. A weak dollar does not solve this problem. It is the symptom of the problem.

What does it mean from the consumer viewpoint?

The decline of the dollar signals a momentous loss in the purchasing power of the US consumer. The average Joe/Jane Doe is getting squeezed, and is forced to buy all he/she can at Wal*Mart.

The government keeps reminding us that inflation is close to 3%. But commodities have soared, including gas. And wages are not keeping up with inflation.

You and I know how to hedge the ominous decline of the dollar by buying commodity based stocks. But the average person does not know all this. How much purchasing power did we lose? Wealthy parents pay outrageous fees to send their kids to good schools. How many people can afford this kind of education? In Europe the same type of education is almost free. Our schools are a disaster and are the main cause of our loss of productivity and purchasing power.

The point is that wealthy investors know how to fight this environment. They have the money. The majority of the people is just floating, hoping to land somewhere.

Which brings up another issue, dear to my friend SNS. Income differential is increasing. Social friction is bound to exacerbate. I am wondering if the resurgence of fundamentalism in the US and in the world is not just one aspect of what I am talking about.

Let me recap the main points.

 The dollar is declining because we and foreign investors are selling dollars to buy foreign currencies.

 We are selling dollars because most of our industries have become less competitive in the world markets.

 Our wages and purchasing power are adjusting downward to match the available skill level in the world markets.

 The decline of the dollar is the outcome of this process and is not going to solve the competitive issue.

 The peak of the dollar coincided with the implosion of the late 1990s financial bubble.

 The decline in competitive edge against our trading partners is also mirrored by higher inflation and loss of purchasing power. There is no cause/effect relationship.

 The dollar is not the cause of higher inflation. Higher inflation is the outcome of the loss of competitive edge as reflected also by the inflationary monetary policy followed by the Fed to keep the economy afloat.

 One of the main causes for the loss of competitive edge is the dismal state of our educational system relative to that of our trading partners.

 The outcome is increasing wealth segregation. Only the wealthy are able to maintain their purchasing power (they have money to buy the knowledge needed to survive), squeezing the rest of the population.

(This Observations appeared in the 12/6/04 issue of The Peter Dag Portfolio ).

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

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