Thursday, July 15, 2010

The dollar is weak because the world is not ending as expected



The title of this post is a bit tongue-in-cheek, but it's clear that the only time in recent years that the dollar has managed to rise above historical lows has been thanks to widespread concerns that the global economy was approaching an Armageddon of sorts. The most recent spike in the dollar was fueled by concerns that the Euro was about to collapse, but now we see that those fears were overblown.

The dollar's value since early 2008 has been pushed up by panic-driven demand for dollars, but it has been depressed by extremely expansive monetary policy. Given that fears still abound (witness 3% 10-year Treasury yields and $1200/oz. gold prices), the fact that the dollar is only about 10% above its historical lows against other major currencies, and only about 5% above its all-time lows in inflation-adjusted terms against all currencies, as the second chart shows, suggests that the Fed's willingness to supply dollars has on balance exceeded the world's demand to hold dollars. Thus, my continuing concerns that we will see higher inflation in the years to come, and my continued belief that if the U.S. economy is struggling it is not because of a general shortage of money. The problems out there center around the unprecedented expansion of the federal government, the threat of higher tax burdens, increasingly burdensome regulations, and and the general anti-business sentiment which seems to thrive in Washington these days. These are legitimate problems, to be sure, but they do not mean the end of the world.

5 comments:

  1. The U.S. has gotten away with "murder" because the dollar is a reserve currency. However, what is happening now is like confusing the weather with climate, Europe has not fallen off the cliff yet, but the forces are gathering.

    There is no escape for Greece, Spain and Portugal. The time of reckoning has only been delayed. As for inflation, there is no doubt that it will eventually rise, the question is when.

    My guess is that PPI will be the core component for american inflation going forwards. Yesterday's IAE projections for oil demand were very worrying, at 87.8 bbd, it would be 2% higher than the 2007 peak that gave us oil at $140. Cost inflation is a real risk. Between 2007 and 2010, OECD economies have reduced oil consumption by 10%, while non-OECD consumption has risen by 23%. As the non-OECD countries continue to grow (and China is in slow down mode at 10.3% -- Singapore revised GDP growth estimate for 2010 to 19%) demand (and price) for raw material will rise. That will be the driver for American inflation. Not labor costs

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  2. P.S. Calafia Beach -- Love your Blog, I always find new and interesting information & insight.

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  3. Spain offered E3 billion of 15yr bonds this week. Demand was 2.7X the amount sold. The spread to the German bund fell from 211 basis points to 199.6 compared to the last auction.

    I realize it is popluar to proclaim disaster but the data clearly show otherwise.

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  4. A few things of note today:

    1) BP has reported that oil has stopped leaking into the GOM!! The stock is up again today (congrats to Public Library who bought under $30.)

    2) The Senate passed the Financial Reg bill. The President will sign it soon. Removal of a big uncertainty for the banks.

    3) The SEC has apparantly reached a settlement with Goldman Sachs. The stock is up nicely today. It is possible that the administration is finally coming to the conclusion that confontation/hostility with/toward business is a huge loser.

    4) Earnings from JP Morgan show continued positive credit trends. Jamie Dimon said he would rather buy in stock than pay more dividends right now. Translation: He thinks the stock is cheap.

    5) If you are concerned about consumer spending, don't watch unemployment...watch RTH, the Retail Exchange Traded Fund. The market will give you a better sense of whats happening with the consumer than the Bureau of Labor Statistics.

    The economy continues to grow. Pessimists are in the majority by a wide margin IMO. The time to be bearish is when everyone is giddy and bullish. Hardly the case today.

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  5. @John. You know the buyer of bonds from Spanin and Greece. It´s the ECB !

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