New Weak Dollar Spin

The latest spin on CNBC is that the weak dollar is good for U.S. businesses. Who wants to know more? I know I do.

The above statement is true in the short run. What it does, is it makes U.S. goods cheaper for foreign nations to buy. It has allowed for an increase in exports. This is exactly what CNBC, and CEOs across the nation have been saying. Their domestic sales have been weak, but global sales, especially to Latin America and Europe have been doing very well. This all makes perfect sense so where's the problem?

Well this problem hits on three different levels. It will carry negative impacts on the U.S. consumers, business, and monetary policy.

First off, the consumer. A weak currency can be looked at in two different ways. The rise in the domestic price of goods, or the decline against foreign currencies. Call it six or a half dozen, it's essentially the same thing. They trend together, but not necessarily at the same exact time.

According to the governments core CPI, inflation is running at around 2%. Well, inflation computed by the pre-Clinton era, would put the CPI at around 6.5-7%, and that wasn't too long ago. CNBC dismisses the whole notion of domestic inflation because of the low core CPI. So, essentially price inflation is very small in the U.S. Well I wonder if Larry Kudlow has been to the grocery store or gas station recently. Listen, the dollars the average Joe holds are becoming worth less and less. His salary is shrinking. HE IS BEING TAXED BY INFLATION.

I would also like to take a look at the domestic stock markets. With the DOW up just 7.5% since 2000, S&P about even, and the same story for the NASDAQ, these are losing bets. Not only is the NYSE a bad investment, but it's not even a good store of value. Inflation has given all of the major indices in the U.S. a NEGATIVE RETURN, over the last 7 years.

Alright onto the corporate level. We have to remember, that from the consumer level we are seeing price inflation. Sure corporate earnings look great right now because of an increased amount of exports due to a weak dollar. Look at base metals and energy prices. They are on the up and up. As the prices of the input rise, the prices of the final good will rise as well. That is how the producers pass on the costs of inflation. In full, initially, a weak currency will lead to increased exports. When the value of the weak dollar begins to creep into the prices of commodities, we see the producers pass on the costs of inflation back to the consumer. This will cause less demand for their goods as wage levels continue be unable to keep up with price inflation.

The final level has to do with the U.S. monetary policy. Let's start out with the good. From a fiscal stand point, a weak dollar equates to less debt. In other words, as the value of the currency falls, so does the real value of the outstanding debt. Already from that brief scenario, you see a counter interest in reference to the U.S. government and its citizens, but that's a story for another day.

In the previous post, I mentioned that the U.S. requires $3 billion dollars in foreign investment just to stay running. Foreign governments and their citizens will be less willing to buy U.S. debt as the USD exchange rate against a basket of currencies continues to fall. So what happens when the USD index breaks the 80 level and begins to free fall? First off, not only will foriegn central banks not be buying treasuries, but they will also be ridding their current forex reserves of USDs. They will use the euro and gold to fill their reserves. The government is left with the choice of pulling out all of its troops, cutting spending and actually running a balanced account, OR printing money and monetizing the debt, which happen to essentially be the same thing. I'm betting on the 'OR'.

Let's bring this whole matter in full circle. Joe Smith's modest factory wage is now worth less because milk, eggs, meat, vegetables, and gas costs are much more expensive than they were a year ago and the year before that. That's even if he's lucky enough to have his job being that all of his factory buddies have been laid off because of the mess that the U.S. manufacturing sector is in.

Higher energy and base metal costs are also whacking the manufacturing sector. Instead of taking a profit loss, they will raise the prices of their final goods. Whack, Joe Smith takes another hit. Now his toasters, shoes, and basic utility bills are getting more expensive.

What Joe Smith doesn't know is that the gears are turning on a global level. China and Russia have publicly stated that they are diversifying away from the U.S. dollar.We are now entering hypothetical land, but a scenario the I figure to be more than likely. Japan will follow suit. As these dollars hit the currency exchange, they will begin to put more downward pressure on the dollar. The Plunge Protection Team is helpless. Foreign central banks no longer find it necessary to buy USDs in order to help the greenback hold its value. The dollar pushes down. The buying of US treasuries and bonds hits multi year lows. The government begins to print more money, pushing inflation higher, just to pay the bills. Now OPEC countries demand euros instead of dollars as payment for their oil. Wham, the dollar dies. We are unable to sell any treasuries and can only print money. We can't raise taxes because they are at ridiculous levels already. If the green back could talk, its dying words would be, "I was dead in 1971, murdered by 40 years of fiscal and monetary irresponsibility." Just think about how Joe Smith is effected by all of this

This piece speaks to a very important economic notion taught in the most basic macro economic class. It is one of the very few items that they discuss that have any relevance to TRUE modern macroeconomics. The notion is that growth in money supply equals the EXACT growth in price inflation.

The counter argument here is, well ethanol demand and corn subsidies have pushed the price of corn, wheat, meat, eggs, and other agricultural goods up. It wasn't monetary inflation. Not true, because if the money supply was held steady, where we see price inflation in one sector, we would see it off set by decreasing prices in another sector, and that is not the case at all.