It’s easy to say “the dollar is declining,” but compared to what? Sure, the dollar has fallen against the euro in the last six months, but the dollar is rising against the Japanese yen. What’s really happening is that the world’s major central banks are taking turns killing their own currencies in a “race to the bottom” for trade advantages. The winner is the nation with the weakest currency, since weak currencies help boost exports.
By most measures, the dollar is winning the race to the bottom. In the last 12 years, gold is up from $255 per ounce to the mid-$1600s. Silver is up from $4.50 to $32 per ounce. Oil is up from under $30 a barrel to over $90 per barrel and the euro has grown from under $0.90 to almost $1.35, a 50% gain since 2001.
The dollar has been falling for almost 50 years, but it hasn’t fallen in each of those years. The dollar basically declined from 1965 to 1978, then strengthened from 1979 to 1985, then fell until 1995, gained strength until 2001, and has fallen for the last 12 years. The dollar’s chronic weakness since 2001 has helped U.S. exports grow faster than the overall economy. According to John Lonski, Moody’s chief capital market economist, U.S. exports are up an average 5.3% a year since mid-2002. In the previous seven years (1995 to 2002), when the dollar was strong and America was growing faster than in recent years, export growth was only 4% per year. In the late 1990s, exports totaled less than 10% of GDP, but today, our exports represent a record-high 14% of GDP, leading to a rebirth of American manufacturing.
The Fed’s Tool Kit of Dollar-Killing Strategies
Two weeks ago, I wrote about the centennial of the birth of the Fed and the IRSin 1913, so the Fed has been honing its craft for nearly a century. The Fed was inflationary from its birth. In fact, the Fed increased the money supply by 75% to fight World War I, and prices doubled from 1914 to 1920. In the century since the Fed’s founding, the CPI is up 2219%; a 1913 nickel bought more than a 2012 dollar.
Recently, the Fed has expanded its toolkit of currency-killing schemes. In the last four years, since the financial crisis of late 2008, the Fed has more than doubled its balance sheet and increased the money supply by 25%. The Fed is now buying $85 billion per month ($1.02 trillion per year) in Treasury and agency securities under its “QE-3” plan. The Fed has kept short-term interest rates near zero and has promised to keep them near zero until at least 2015. And in its latest meeting, the FOMC said it will maintain these policies as long as the unemployment rate is above 6.5% and inflation is below 2.5%.
Meanwhile, the U.S. Treasury has borrowed $5 trillion more in debt since 2008 – much of it borrowed from the Fed – creating a rapid 50% increase in the cumulative public debt of the U.S. Treasury. One reason interest rates must stay near zero is that rapidly rising interest-rate service on $16.5 trillion in debt could cripple the federal government’s ability to pay its other bills, leading to further credit downgrades.
But Why Hasn’t Monetary Inflation Caused More Price Inflation?
So far, the Fed’s plan to print money, lower rates, and add liquidity has not caused any measurable rise in inflation. In the U.S., the December inflation indexes showed a 0.2% decline in wholesale price inflation, a 0.1% gain in consumer prices (and “core” inflation), and less than 2% average annual inflation growth over the last five years – very low, by historical standards. Milton Friedman must be swirling in his grave. The central tenet of Friedman’s “monetarist” theory is that monetary inflation inevitably leads to price inflation, but it hasn’t happened yet – or has it? We certainly have seen high commodity price inflation and rapid stock market gains. The money has to go somewhere – but it doesn’t go everywhere equally.
To illustrate this point, here are the new “ABCs” of inflation – how some prices rise more than others:
Agflation refers to large increases in food prices due to agricultural shortages caused by weather or politics. Since all folks must eat, agflation hurts the poor more than those with excess disposable income.
Biflation is when inflation and deflation happen simultaneously, particularly after central bank easing adds new liquidity to the economy. That new money goes into commodity-based food and energy, while the prices of big-ticket, debt-encumbered purchases like big homes and luxury cars tend to fall in price.
Core Inflation is the direct result of agflation and biflation pushing food and energy costs up, while most other prices are flat or falling – including most big-ticket electronics, appliances, and home prices.
In short, the U.S. has quarantined inflation into just a few sectors, so the world is now following our lead.
The Rest of the World is Now Following the Fed
Like Lance Armstrong and his team of co-conspirators, the central bankers of the world are hooked on artificial steroids in a desperate attempt to keep their governments competitive. In the old days – like 25 years ago – most central bankers were stodgy old misers. They enforced strict austerity measures. They were mostly conservative and politically independent; their main goal was to keep a lid on inflation. Now, bankers are more liberal. They serve the progressives who appointed them, and they are less independent.
The European Central Bank (ECB) is as young as the euro, but it controls the world’s second biggest currency bloc. The ECB grew out of the postwar tradition of Germany’s ultra-conservative Bundesbank. Since Germany has suffered so much from two terrible postwar hyper-inflations (in 1923 and in the late 1940s), the German and French leaders of the ECB have been very sensitive to inflation, until recently.
Last July, the new ECB President, an Italian, Mario Draghi, added two sentences to the margins of an otherwise routine speech. Here’s the most important sentence he added: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro.” With those words, Draghi seems to have rescued the euro. The euro has surged from $1.20 last July to nearly $1.35 now, while the yields on formerly-troubled Spanish and Italian bonds have dropped from the 7% range to the mid-4’s. “Whatever it takes” doesn’t rank with “Mr. Gorbachev, tear down this wall” or “Win one for the Gipper,” but it certainly shocked the press, sounding more like a Godfather’s mandate than the normal “Fed-speak” gibberish we usually hear.
The Bank of Japan has made a belated entry into the currency-killing business. Japan’s reserve balances reached a record 39.8 trillion yen at the end of 2012, up 142% in the last two years of quantitative easing.
That process accelerated in November after the new Liberal Democratic Party Prime Minister Shinzo Abe won power based on a promise to cheapen the yen. Honest Abe hopes inflation will replace 23 years of chronic deflation. It worked! Just since November, the yen’s 12% decline has fueled a 25% rise in the Nikkei 225 index of Japanese stocks. Now, U.S. auto makers are complaining about Japanese
“currency manipulation” benefiting Japanese exports to America while hurting Detroit’s exports to Japan.
The Bank of England is the grandfather of central banks, founded in 1694. The BOE is the very model of a modern central bank, having fought both inflation and depression through the centuries until it, too, threw in the towel after the latest global financial crisis. England’s benchmark interest rate has been 0.5% since 2009, when the Bank of England began quantitative easing through their Asset Purchase Facility. Then, the Bank of England’s Governor Mervyn King rolled out his version of “QE2” in October 2011.
The Swiss National Bank (SNB) has also drunk the “QE” Kool-Aid. The Swiss franc was always the gold standard of currencies. From a base of $0.23 in 1971, the Swiss franc rose to $1.30 in 2011, but the strong Swiss franc was killing Switzerland’s economy. A front-page article in the January 8 Wall Street Journal reported that the Swissare now “printing and selling as many Swiss francs as needed to keep its currency from climbing against the euro, wagering an amount approaching Switzerland’s total national output, and in the process, turning from buttoned-down conservative to the globe’s biggest risk-taker.”
You see the same story in emerging markets. In 2010, Brazil accused our Federal Reserve of launching “currency wars” by deliberately devaluing the dollar. In the last year, Chile’s peso is up 10.2% to the U.S. dollar, and the Colombian peso is up 9.5%. Last week (on January 23, 2013), the Journal reported that “the recent rally in Latin American currencies has exporters in the region renewing calls for central bank and government action to slow the appreciation they fear will blunt their competitive edge….”
Older Americans will recall a time when the Yankee dollar was strong, and “banana republic” currencies were worthless, but that old-world mentality has been flipped on its noggin in recent decades. Now, we live in a world in which central bankers do “whatever it takes” to keep their economies competitive by keeping their currencies weak. As Ed Yardeni put it, “the ECB will do whatever it takes to defend the euro. The BOJ will do whatever it takes to stop deflation in Japan. The BOE will do whatever it takes to avert a recession in the UK,” and the Swisswill do whatever it takes to keep their franc below the euro.
As long as the world’s central banks choose to debauch their own paper, inflation will inevitably rise, but that’s not all bad. Some of that inflation will surface in the rise of global commodity and stock prices, so the new reality is that you must invest where inflation floats your boat – i.e., in commodities and stocks, in our opinion.
Louis Navellier is Chairman of the Board, Chief Executive Officer, and Chief Investment Officer of Navellier & Associates, Inc., located in Reno, Nevada. www.navellier.com Mr. Navellier has been active in the management of institutional and individual client accounts since 1987. He received a B.S. in business administration in 1978 and an M.B.A. in finance in 1979 from California State University - Hayward.
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