The Dollar Conundrum
Board: Macro Economics
[Ed's Note: The Post of the Day will be on hiatus from March 31 through April 5.]
First of all, let me start by requesting that this thread does not end up talking about all fiat currencies going to zero and only gold/silver being what should be held. It is about the relationships between fiat currencies :-)
Most of us watch the US dollar in terms of the "dollar index" (currently at 76.25) which is a market basket of currency values compared to the greenback. While still above its historical low (April 2008) by about 7%, it is at essentially its low of the last three years (briefly touched 75 at the beginning of 2010).
Let’s step aside for a moment and consider the major competitors included in the index:
1) The Euro has obvious structural problems in that a number of its constituent entities (the infamous PIIGS) are failing to one extent or another.
2) The Japanese Yen is tied to a country which has had financial problems for a couple of decades with little economic growth and is currently dealing with a VERY expensive disaster.
3) The British pound is tied to an economy which shared our financial meltdown in many parallel ways.
Each of the central banks involved has taken a strategy that they feel best suits their needs.
Currencies are valued on a supply/demand basis as demands for that currency for trade and investing are made. The values are also "assisted" by the actions of both the domestic and foreign central banks.
It is "comforting" to think that the US dollars drop has been "crafted" by the actions of the Fed, but I think greater reflection is required.
Trade is what it is and seems to be growing. That provides a headwind. The tailwind is supplied by the Fed's QE, supplying currency into that portion of the equation.
The part of the system that I think requires exploring is how much of the drop is related to a loss of confidence in the USD being able to hold its value in the future and movements out of the currency forming a self fulfilling prophesy.
Charliebonds has explored some of the ways that inflation may be measured. People have observed by looking at Japan that a zero rate of return can exist for an extended period of time without financial collapse.
I am going to combine these two by pointing out that Japan has existed with zero interest rates during a period of mild deflation, while Charlie has pointed out (despite his calling both the BLS and the "alternative" methods of measuring inflation "right") that we are seeing an increase in inflationary pressure.
So here's the $64K question: What is the result to the value of a currency offering low returns (for bonds/cash) at the same time as its supply exceeds the requirements of trade or investing? While in domestic terms, some investments such as equities which appear to offer better returns are benefiting, we have to remove ourselves and observe our "economic system" from the standpoint of foreign eyes.
One interpretation may be the drop in the dollar as compared to other currencies with obvious flaws has to be viewed as other entities (whether foreign sovereign states, hedge funds, or investors) having a greater level of disease with our currency than we tend to have on a personal basis.
I've often tried an experiment when I've gone to the beach. I close my eyes and listen to English being spoken. I try to judge what the "sound" of our language would be to a foreigner. I know that French and Italian are melodic. I know that Japanese and Arabic are guttural. But I have to confess, I've yet to be successful in "hearing" English as a foreigner would hear the "tonality" of our language.
In a similar fashion, it is difficult for most Americans to contemplate money as being anything but greenbacks. While it's well known that I "dabble" in other currencies, I always find myself evaluating my holdings in terms of US dollars (to do otherwise, considering the dollar's drop would likely be depressing :-).
We are so used to evaluating whether we are "winning or losing" in terms of US dollars that we neglect to even consider how we are doing in "global" terms of purchasing power.
While I have preferences for specific currencies, the easiest method to use is to take your total asset value and multiply it by the US dollar index. Plot that value over time (say the last five or ten years). There will likely be some "exciting" results. You may find, for example that the fall in your asset valuation in late 2008 and mid 2009 were not as drastic as it might have appeared. OTOH, much of your current "gains" may be taken away by this approach. This purely quantitative method will allow you to "hear" the value of your assets in a way that I still have not been successful in hearing our language spoken.
This is the way others see their US investments and it will be an eye opener to you (as well as causing considerable nausea).
As you prepare for whatever monetary events you expect the future to hold, bear in mind that we are not alone and while the Fed is the biggest, baddest guy on the block, there is a finite limit to everything and the change in the value of our currency may be the canary in the coal mine whose music is becoming quieter.
As I have covered them in eye glazing detail in other posts, I won't extend this one by going into foreign currency hedges against the drop in the dollar (on a relative basis compared to other currencies), but that is one obvious method. Another might be foreign equities or bonds valued in stronger currencies. Precious metals offer another method of protection, but as I've pointed out in the past, they can behave in unexpected fashion when things hit the fan (as they are a valuable, easy to sell commodity, rather than money). Another tack might be stock in companies which mine, pump or farm commodities.
Whether you agree that you should be concerned or not, the above described method allows you to easily keep your eye on the ball rather than be complacent.