Can The Fed Crush The US Dollar?

Judging by the buzz generated by the rumors presaging the end of the dollar era, some of you may be tempted to begin stocking up on gold and Euro soon. The dollar is in a very precarious position, it is claimed, and sooner or later the U.S. economy will enter a hyper inflationary phase, where the value of the U.S. currency plummets with great speed. On the one hand, there are the blaring trumpets of those who declare the end of the dollar era, and on the other, the quiet, but powerful picture of fundamentals that contradicts the loud claims of the doom sayers.

Some argue that the bear case for the dollar is already closed. The U.S. is running an enormous fiscal deficit, along with a still massive current account deficit. The U.S. Treasury is flooding the bond market with large amounts of new issues to finance the budget black hole and to sponsor the various programs initiated by the U.S. Federal Reserve to contain the damage wrought by this recession. The Federal Reserve, for its part, is buying Treasury paper, which means that spending is not sterilized, and inflationary in the simplest meaning of the word. On the other side of the equation, the major buyer of U.S. Treasury paper, China, keeps grumbling about the weakness of the dollar as a global currency, and powerful commodity producers like Russia, and Iran make declarations about the advantages of an alternative global reserve currency. While there is no sign of rampant inflation at this stage, commodity prices have staged a mighty rally recently, and there are indications that prices may continue to press forward in the absence of any shocks. Based on all these, and the occasional rumors of central banks here or there dropping the dollar peg, many traders subscribe to the belief that the end of the dollar era may come within the next decade.

But though the bears focus on the alarming inflationary impetus on the supply side, they are blind to the massive contraction in money demand all around the world. Although the U.S. is printing money, the money doesn’t manage to create an oversupply of dollars, because all the channels that circulate dollars around the world markets are constricted. It is well-known that bank lending is very limited at this stage, but this is not the only artery that has been obstructed in the recent crisis. Trade volume is falling. Corporate mergers and acquisitions are harder to finance. New construction projects are a lot harder to find sponsors, and new ideas have to go far and wide to reach the appropriate venture capitalist. Even the art market has seen prices falling, and entertainment venues that cater the wealthy are not at all immune to the new conservatism of consumers. And most important of all, all these events are occurring at the same time. In this environment, today’s higher supply of central bank dollars is necessary just to sustain the present level of activity, and based on what we observe in data releases every week, it is not very successful even in that task.

Very few would contest the notion that we need interest rates at a lower level than where they were when the FED slashed them for the last time. Not many would protest if the FED could slash rates more in January, March, or April, if they had room to do so. Most people are aware that such policy action would hardly be inflationary due to the fact that demand is falling, unemployment is rising, and bankruptcies and defaults are skyrocketing. But of course the FED can’t reduce rates because they are already at zero, and as they and everybody else argue that they have to expand credit, they are doing so by expanding, or at least attempting to expand the money supply directly. When reducing rates they were making the banks print money by offering low interest loans. Now the Federal Reserve is printing money directly, and the difference is just a matter of description. Yes, of course, printing money is a dangerous practice, but not now, because the inflationary potential of this smashed, downtrodden economy is negligible.

It is also true that the budget deficit of the U.S. is alarmingly high, and probably unsustainable unless addressed in a convincing manner sometime during the next decade. But that is hardly a concern in the chaotic environment of this crisis. Japan has been running a huge budget deficit for quite a long time, and the notion that budget deficits lead to currency depreciation automatically is not supported by historical data. Even if we contrast the double deficit of the U.S. with the current account surplus of Japan, the reserve currency status of the dollar remains a powerful supporting factor against depreciation.

In sum, we believe that the fears about a dollar collapse are born of incomplete analysis, since the rumors, and hearsay swirling around the markets does not have much fundamental support to back them. One-sided analysis can be misleading, and even more harmful than faulty analysis, because it appears to have good reasons backing its conclusions. You can find other examples of this situation by studying the commentaries of analysts in the financial media. In many cases, conflicting opinions are espoused with equal vigor, because both sides use the data selectively, and focus on what they find most favorable to their own views.

To avoid these problems, and to learn how to perform good stock market and forex analysis, you need to get a good forex course where you can absorb the necessary attitude. Without education, there are too many pits and traps on the road to success, as shown by the continuous failures of many famed and seasoned analysts and traders.

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