Banana Ben Strikes Again
Just when you thought it was safe to hold dollars, even for just a little while, Fed Chairman Ben Bernanke once again climbed aboard his helicopter and spread some more confetti (US dollars) across the sky.
Apparently having the world's reserve currency drop 13% since March, even as measured against a basket of other flawed fiat currencies isn't enough. And if you were to measure the dollar's performance against hard assets like copper since March, the currency has lost 50%. Yet despite those facts, Fed head Bernanke thought it wise to increase the size of the monetary base by $86 billion just last week alone! That brought the base total to over $1.73 trillion, the highest level since May and just $37 billion off its all time record high.
Maybe he thought the rally in the stock market was stalling. Or maybe he was afraid the price of oil was having trouble breaking above $75 a barrel. Either way, it's just plain disappointing to know that even after he no longer needs to worry about being nominated to another term, he's still playing politics.
I was fooled myself. I've written recently about an imminent dollar rally due to the fact that the monetary base had been dropping while bank lending was negative when measured on a YOY basis. I thought the Fed was worried about the huge build up of high powered money and had begun its exit strategy.
In the long run it seems the Fed has acquiesced to the plain truth that having an $11.7 trillion National Debt means that a loose monetary policy is a necessity. Perhaps it was no coincidence the Fed increased its balance sheet in the same week it was announced that the deficit would grow by at least $9 trillion over the next 10 years.
The economic reality is that when a country owes a tremendous debt; it becomes less burdensome and easier to pay off under an environment where the currency is losing value. Of course the citizens of that same country become poorer while they are taxed without their consent through inflation. It is also true that the holders of that country's debt become victims as well.
Is it any wonder the Chinese are seeking alternatives to the US dollar as they move their Treasury holdings to the short end of the curve in order to facilitate an easy exit? For me this is a very tenuous position for the Fed to hold. The world's reserve currency can't inflate its way to prosperity. The danger of causing a disorderly decline of the dollar is very high.
So perhaps there will be no rebound from the dollar's decline and maybe there won't be a well needed correction in the major averages -- at least for now. Debtors and the wealthy will prosper as savers, creditors and the middle class continue to go broke.
But no country in the history of planet earth was ever able to sharply devalue its currency while bringing about a stable economy and fostering real growth. That's because a strong currency is indicative of a strong country. One that is providing investors with solid economic growth, positive interest rates, a current account surplus and low inflation.
The opposite is evident in a country that is plagued with a chronically falling currency. But eventually a weak dollar will no longer mean the market goes higher. At some point it will result in not only the end of nominal gains in the averages but a violent move lower in bond prices as well. And unfortunately, it will also result in a much lower standard of living for most Americans.
The bottom line is this; a dollar rally and a coincident decrease in the value of hard assets may still occur in the short term due to their crowed trade status. But it will not be because the Fed has begun to reduce the money supply. The longer term trade has to be short the US dollar and long commodities. Precisely because the Fed has made it abundantly clear that it will rely on an inflationary monetary policy to help the government pay off its debt.