Gold9472
05-18-2006, 08:48 AM
The disappearing US dollar
http://www.jamaica-gleaner.com/gleaner/20060518/cleisure/cleisure3.html
John Rapley
published: Thursday | May 18, 2006
AFTER A brief rebound earlier this year, the U.S. dollar has resumed sliding against its major trading partners' currencies. America's persistent deficits, low saving and the shift of foreign reserves out of dollars and into euros seem to be driving the process.
So far, the decline has been more or less orderly. But if it were to gain speed, the consequences for the U.S. economy could be grave. Rising import prices would fuel inflation, which in turn would drive up interest rates. This could then provoke a recession, with painful effects for the world economy.
Moreover, there may be more to this story than a mere decline in the U.S. dollar. While the yen and euro are strengthening against the greenback, the real story appears to be that virtually all currencies are weakening against 'real assets,' and especially commodities. Oil is surging, metals have gone off the charts: all over the world, investors appear to be abandoning 'paper' assets for what is tangible, and thus apparently more secure.
CONVENTIONAL EXPLANATION
The conventional explanation for this is that the roaring Chinese economy is driving demand for primary inputs. However, another theory sees deeper underlying causes. Some observers suggest that the world is awash with money. So much of it has been 'printed' these two decades, a process accelerated by the ultra-loose monetary policies used recently to fight recessions in Japan and the U.S., that too much money is chasing too few goods.
In this analysis, excess liquidity will lead ultimately to price inflation. The reason this hasn't happened yet is that China's booming factories have ramped up supply to keep pace with runaway demand. However, with signs that China may be nearing the limits of its present capacity, evidence is emerging that inflation is starting to creep upwards in the U.S.
This raises the prospect of a scenario I wrote about last year: stagflation. With the U.S. economy showing some signs of slowing just as prices are rising, the U.S. Federal Reserve Board faces a dilemma. Either it attacks inflation by raising interest rates, thereby risking a recession or it tries to forestall a recession by keeping interest rates from rising further, risking a jump in inflation.
The new Fed chairman, Ben Bernanke, has been sending confusing and seemingly mixed signals. However, in recent weeks, the Fed seemed to suggest it would land on the side of liberality, restraining further interest rate rises until it was confident the economy would not slide into recession.
Commodity prices began soaring and the dollar began sinking. It would appear that investors, judging the Fed was not going to defend the dollar, began to abandon it and park their money in something that could not be printed: either more 'conservative' currencies, or commodities.
CONFIDENCE LOST
If it is the case that the Fed has lost the confidence of the markets, it will need to overshoot to use Wall Street parlance - in order to restore it. That is to say, like the Fed of two decades ago, it will need to drive interest rates much higher than it normally would just to persuade investors to come back into dollar assets. The pain to the economy would be great.
If the Fed doesn't do that, markets may continue to behave the way they have. As money leaves the U.S., banks will have to raise their own interest rates just to attract investors and stay ahead of inflation.
It isn't Ben Bernanke's fault that things got to be this way. He inherited this economy. But it is a nasty way to have to cut one's teeth as a central banker.
http://www.jamaica-gleaner.com/gleaner/20060518/cleisure/cleisure3.html
John Rapley
published: Thursday | May 18, 2006
AFTER A brief rebound earlier this year, the U.S. dollar has resumed sliding against its major trading partners' currencies. America's persistent deficits, low saving and the shift of foreign reserves out of dollars and into euros seem to be driving the process.
So far, the decline has been more or less orderly. But if it were to gain speed, the consequences for the U.S. economy could be grave. Rising import prices would fuel inflation, which in turn would drive up interest rates. This could then provoke a recession, with painful effects for the world economy.
Moreover, there may be more to this story than a mere decline in the U.S. dollar. While the yen and euro are strengthening against the greenback, the real story appears to be that virtually all currencies are weakening against 'real assets,' and especially commodities. Oil is surging, metals have gone off the charts: all over the world, investors appear to be abandoning 'paper' assets for what is tangible, and thus apparently more secure.
CONVENTIONAL EXPLANATION
The conventional explanation for this is that the roaring Chinese economy is driving demand for primary inputs. However, another theory sees deeper underlying causes. Some observers suggest that the world is awash with money. So much of it has been 'printed' these two decades, a process accelerated by the ultra-loose monetary policies used recently to fight recessions in Japan and the U.S., that too much money is chasing too few goods.
In this analysis, excess liquidity will lead ultimately to price inflation. The reason this hasn't happened yet is that China's booming factories have ramped up supply to keep pace with runaway demand. However, with signs that China may be nearing the limits of its present capacity, evidence is emerging that inflation is starting to creep upwards in the U.S.
This raises the prospect of a scenario I wrote about last year: stagflation. With the U.S. economy showing some signs of slowing just as prices are rising, the U.S. Federal Reserve Board faces a dilemma. Either it attacks inflation by raising interest rates, thereby risking a recession or it tries to forestall a recession by keeping interest rates from rising further, risking a jump in inflation.
The new Fed chairman, Ben Bernanke, has been sending confusing and seemingly mixed signals. However, in recent weeks, the Fed seemed to suggest it would land on the side of liberality, restraining further interest rate rises until it was confident the economy would not slide into recession.
Commodity prices began soaring and the dollar began sinking. It would appear that investors, judging the Fed was not going to defend the dollar, began to abandon it and park their money in something that could not be printed: either more 'conservative' currencies, or commodities.
CONFIDENCE LOST
If it is the case that the Fed has lost the confidence of the markets, it will need to overshoot to use Wall Street parlance - in order to restore it. That is to say, like the Fed of two decades ago, it will need to drive interest rates much higher than it normally would just to persuade investors to come back into dollar assets. The pain to the economy would be great.
If the Fed doesn't do that, markets may continue to behave the way they have. As money leaves the U.S., banks will have to raise their own interest rates just to attract investors and stay ahead of inflation.
It isn't Ben Bernanke's fault that things got to be this way. He inherited this economy. But it is a nasty way to have to cut one's teeth as a central banker.