More On The Dropping Dollar (Why It's better for us at the moment to let it decline)

Well, it had to happen sooner or later. I finally saw a column on the Internet that said what I told you in my May 11th column ("The Pluses of the Dollar Decline"). A lower dollar ain't all that bad!! And from no less than Bloomberg News!! Well, let's talk about that just a bit more.

In an article dated July 23rd, Bloomberg finally became the most prominent member of the small club of analysts and financial writers that point out the most obvious fact out there: the dollar is in the rifle sights of just about every other country on this globe. They all want to plunder our markets and suck out the national wealth we have accumulated for years by our hard work and invention.

Yet, in the end, they all realize that they must eventually look to the U.S. dollar for economic leadership and our prudent exercise of its dominant power in the world of fiat money. (That's right, fiat money! Nobody of any economic consequence uses asset-based money anymore.)

How important is the dollar? Well, tell me how many countries tie their currency value to, oh let's say, Sweden. Or maybe, Honduras? Or how about that powerhouse of the EU, Germany. You got it — NOBODY!!

Now there has to be a good reason that China "pegs" its currency to the dollar or that Japan is constantly "rigging" its currency by buying or selling yen in the open market to "keep the right proportion" to the U.S. dollar. The good reason in both cases is simply that our economy is the 800-pound gorilla in the Starbuck Café! Everybody knows that what we do MATTERS A LOT!

Now, please don't take me wrong here. I am not waving the flag of power or ego thumping. It is just that the simple fact is that people want our currency for all sorts of reasons. So, when China fixed their currency at 40 percent below our dollar in 1994, they did it for one very good reason — they intended to sweat the economic difference between China and the U.S. out of their own population so that they could sell nearly everything in the world cheaper than the U.S. and accumulate U.S. dollars for their Treasury.

Today China is a big factory, a sweat shop factory maybe, but nonetheless a factory. On the backs of their low paid people, they have built a manufacturing infrastructure that makes all kinds of goods at prices which no one else can, so far, compete with.

But, in 2002, the political powers that be in the U.S decided to give them a bit of their own economic medicine. We let our dollar begin to fall in value compared to other world currencies. Up until that time, our firm policy for many years was to defend the dollar's value at all cost and, if possible, up its value compared to others.

Several times in my columns, I have credited Federal Reserve Chairman Ben Bernanke for talking President Bush into lowering the dollar's value. Of course, it is only speculation on my part, but all the circumstances added up to that conclusion for me. I am convinced that Bernanke believes that a lower dollar will call China's hand and possibly even cost them their place as the manufacturer to the world.

At some point, I believe he reasons (and I agree), the facts of economic reality will overtake China - you can't produce at a loss forever — and China will have to substantially readjust their currency valuation imbalance with the U.S. dollar. Then, let's see just how well they can cope in a flatter playing field. I believe the U.S. will walk away with the game. Period.

Now, let's look at a chart of the U.S. dollar. How big is the decline we are talking about for the dollar since 2002? Well, the chart below really shows the "waterfall" effect quite well since 2002.

I see that growing demand for U.S. goods is met far more quickly today than most economists generally envision. The changes in the way manufacturing, distribution, and retailing have mega-shifted over the last 25 to 30 years — going to what is quaintly called the "just in time model" or reduction of costs for inventory, marketing, and the ability to ramp up production really fast compared to the old model — erases the time honored expectations of inflation, according to something called the "J Curve" theory ( it predicts eventual high inflation if currency is devalued).

Production and price competition is not a local phenomenon any more, as the J Curve theory describes. The economic environment when the J Curve theory was developed doesn't exist anymore. Columbus, Ohio competes directly in Indonesia as easily as it does in France today.

The reason for all this is that, for all practical purposes, national boundary considerations are gone — only the currency factor remains. The "new" economic model sees only demand and immediately creates competitive. The ability to do what China has done in 12 years to the world's manufacturing model is a good example.

But, a change in the U.S. currency input sells more U.S. goods worldwide and helps increase our export level (which is happening even as I write this article) and allows the U.S. to "soak up" demand by increasing production for export and our own needs. U.S. employment goes up and national income is enhanced - good for us.

In my view, this "product elasticity" displaces the old "J Curve" assumptions of inevitable inflation from currency devaluation. The ramp up of inflation on the "J curve" predicts it's going the way of the old "Phillips Curve" theory that said low unemployment absolutely leads to inflation increases. The world model changed over the last 40 years and the Phillips theory failed (note that all this stuff is theory, not absolutely hard unchangeable fact — that night will follow day, now that is fact.)

Thus, when Bloomberg reports that some economists are beginning to alter their comments on the effects of currency devaluation, many economists reading that report quickly disagree and warn of the coming dire inflation consequences.

This is not at all unlike the warnings in the 1980's that the Phillips Curve would catch up with us and inflation would ruin the U.S. It didn't. Why? Well, conditions changed. When certain theories (whose propositions were extracted from historical events) lead to certain unpleasant outcomes, you can be sure of one thing — always! Risk takers, the business folks of the world, don't just sit there watching and let it happen every time. They begin to adjust here and there.

They try different ways of doing things to beat the predictions. Want an example? Honda started making cars in the 1960's and Detroit laughed out loud. The general comment was something like, "Those tinny things? You've got to be kidding! No one will want them. They love our big flashy cars." But in less than 35 years, the laugh died out completely and bankruptcy stalks them all. Honda changed the way of thinking about how cars should be made. They didn't buy into the Detroit model and the outcome changed. I believe that this is also happening to the "J Curve" prediction.

Now, I am not picking a fight with any of the economists out there. I am not a "sand in your face" guy. I am just telling you that times change. And as they change, the old ideas must fade out. For my more complete analysis of this, I would send you again to the last portion of my article of May 11 (found in the archives under Experts Corner of MoneyNews) to read how I believe that interest rates ARE NOT KING ANYMORE when it comes to governing economic activity. His Money Supply theory has dethroned that once sacred idea, and Dr. Bernanke holds the new scepter as the ruling sovereign, disputing all traditional theories about what governs economic expansion and inflation.

My advice to those that disagree with him is to remember that he is now the single most powerful man on the world's economic scene. His America is the single most powerful economic force in the world by its very unit size. I believe he knows that in spite of the appearances of some of the less helpful financial features of the U.S., i.e. balance of trade, debt, etc., the world will keep beating a path to our door and try to get in.

Don't agree with him? Name me even one other country where that is happening on the scale it is here. There isn't one!

In closing, my humble advice to economists and financial types (like me) is let's keep some perspective here. Financial institutions need to be more flexible in their thinking. The old ways change as we grow in this world economy. Example of "old" thought? The BIS (Bank of International Settlements) in Basel, Switzerland recently sent out a report to the world telling us that the world is set up for a huge, gigantic, unbelievable, (add our own adjective) BUST! It blames the U.S. (of course) and capitalism (needs some adjustments, they said) for this terrible potential collapse of the world financial system.

Now, apart from the fact that this organization ( around since 1930 - was the facilitator of the old Versailles treaty cash exchanges - didn't that one work out well!) is a 55 world central bank membership governed by a 12 man secretariat and a 17 man (where is the female influence here?) board of directors, the non-European members of the Board are only 4 in number. They are Dr. Bernanke, TimothyGeithner — President of our New York Federal Reserve, and two others, one from Canada and one from Japan .

It seems to me that the BIS could use a bit more world representation here. Come on you guys, stick with the bank settlement problems of the world banks. There is plenty to keep you busy right there. You really do have better things to do than to cry "Fire" in the theater.

Yes, there are problems in the world's financial system, but there are also some very capable folks working to solve them. Will they? I don't know. But I do know that behind-the-scenes efforts gets the job done, not theatrics. Gentlemen, keep perspective. Get real, as my grandson says. Get real.

That's all for today. Hope you don't mind me venting a bit today, but it does help.

Bottomline? Devaluation is different now. It is better for us, AT THE MOMENT, to let the dollar decline. It will cure some ills we have suffered and bring more balance into the world financial dealings. The price to pay is not inflation. If we don't do this, the price to pay is the loss of more of our national treasure as others continue to take advantage of us. It's time they "pay the piper" something for the damage they have done to us — yes, to us!

So, I hope your coming investment week is a good one. In the meantime, you keep in touch. I do! See you next week.

(Why It's better for us at the moment to let it decline)

So we can pay $10 a gallon for gasoline and thus end global warming forever?........

Nope. No one will read this . . . too long, and too many big words. (I’m saving it for later myself).

Ordinary Americans defined as those who insist on buying imported products and traveling overseas?

I’m not so sure. I sell to the US and demand has dropped significantly, because with the dollar worth less the price (to you) of my products has rocketed. On the other hand, my friend plans to vacation in america next month, at least partly because she can get so many dollars for sterling. That in a nutshell is what this guy is talking about. Weak dollar means you buy less from other nations and they spend more with you. Which is good for the US.

Of course, this is on a macro economic level. I take your point that poor John Doe doesnt get to see much of the benefit of all this.

The decline is relative and expressed in other currencies. I have seen it play out here in Forida where we expect many Canadian snowbirds to winter here. When the Canadian dollar went to sixty cents the Canadians started saying that they couldn’t afford to come and many sold their winter homes. Now the Canadian and American dollars are at parity, and they will be back bringing those tourist dollars we like with them.

The NZ dollar has appreciated 84% since I invested there. Doesn’t even count the investment return itself.

Ordinary Americans whose savings devalue right along with the dollar even as it costs more to live in the USA.

The average American does not have a diversified portfolio of currencies and precious metals. When the dollar is devalued, their life savings are devalued. With increasing costs in any number of sectors, it means the average working American gets the short end of the stick.

Ordinary Americans whose savings devalue right along with the dollar even as it costs more to live in the USA.

You understand that a stronger Euro is a different issue than inflation eroding your savings?

A stronger Euro is not the issue. A weaker Zimbabwean dollar is not the issue.

A devalued dollar and the policies behind it that go back to the Federal Reserve Bank, which is a private corporation and not a government agency -- which private corporation has everything to do with the rate of inflation in this country.

A stronger Euro is not the issue.

It is if you read the article that started this thread.

A devalued dollar and the policies behind it that go back to the Federal Reserve Bank, which is a private corporation and not a government agency

Maybe you should mention that on an inflation thread?

If the Fed is a private corporation, who owns it?

It's a private corporation. Won't you be surprised if you dig into who owns it...

Right now is the time to cut the budget and start using the surpluses to retire bonds, offsetting the potential rise in rates due to a lower currency.

18 posted on 08/08/2007 1:49:24 PM PDT by Free Vulcan (Fight the illegal Mexican colonizers & imperialist conquistadors! Long live the resistance!)

It's a private corporation. Won't you be surprised if you dig into who owns it..

I was hoping you'd enlighten me. But seeing your confusion about exchange rates and inflation, I wasn't counting on it.

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