Interest Rate Roundup

Wednesday, March 05, 2008

Bonfire of the U.S. dollar

We all spend a lot of time focusing on the housing and mortgage mess. But I can't help but point out -- again -- that the U.S. dollar continues to sink toward oblivion. The Dollar Index was recently down another 27 bps or so to 73.39. That's just off the March 3 low of 73.35, which was the lowest level for the index in history (the data goes back to 1967).

If you're not aware, the DXY tracks the dollar's performance against six major world currencies. The euro has the biggest weighting at 57.6%, followed by the Japanese yen, British pound, Canadian dollar, Swedish Krona, and Swiss Franc. It is one of the best measures of the purchasing power of our country's currency. And it's heading lower and lower and lower, as I've been talking about for a long time (here, here, and here).

Why? Because the Fed is slashing short-term interest rates at the same time many other central banks around the world are either sitting tight (for example, the European Central Bank) or raising them (the Reserve Bank of Australia). That lowers the relative yield that international investors can earn in dollar-based assets versus assets denominated in other currencies. And that causes those investors to send their money elsewhere.

The Federal Reserve would rather just bury its head in the sand and ignore this. The Treasury apparently could care less, despite its supposed "strong dollar" policy (hardy-har-har). And many mainstream economists simply don't seem to be paying attention. But this is having a very real impact on inflation.

Do you REALLY think oil is at $104-a-barrel because of simple supply and demand issues? Do you really believe copper prices are closing in on $4 a pound because of demand for the metal from key copper-using industries like construction? Or that gold is just shy of $1,000 an ounce because a bunch of people want to get married and need to buy rings?

No, it's because many global commodities (including those cited above) are priced in dollars. As the purchasing power of the dollar falls on the world currency market, global commodity producers need to be paid MORE dollars for every barrel of oil, ingot of gold, or other raw material they sell us. Ergo, the dollar price that we pay here in the States for all these goods surges.

It's not just raw materials, either. As I noted recently, the cost of cheap Chinese imports is also going up as the dollar declines against the yuan. Is it any wonder, then, that overall import prices rose at the fastest rate in recorded history in January ... or that producer prices are rocketing ahead at a 7.4% year-over-year rate, the most since 1981.

Long story short, Mr. Bernanke and Mr. Paulson can continue to ignore the dollar. They can continue to take the "We'll worry about that later" path. But the market is definitely paying attention, and extracting its pound of flesh from all of us every time we fill up our tanks or go to the grocery store.


Post a Comment

<< Home

Site Meter