The Federal Reserve and Washington political leadership have a plan to work our way out of our economic problems. It relies on zero interest rates, massive deficits and quantitative easing - all designed to bring down the value of the U.S. dollar and generate inflation.
Even as Treasury Secretary Timothy Geithner vows that he really means it this time when he says the U.S. supports a strong dollar policy, our government is at the
very same time begging the Chinese to allow the dollar to fall against the renminbi. The hopes our leaders are placing in a lower dollar are woefully misguided. All that is being accomplished is to put in place once again the same conditions that brought the global financial system to its knees over the past two years.
Secretary Geithner and Fed Chairman Ben Bernanke have been successful in bringing down the value of our currency. In fact, many of the negative factors that were in place before the global economic meltdown have returned in full force.
The trade deficit for September surged 18% to $36 billion. That gap was the largest since the beginning of 2009 and largely due to imports surging 5.8% to $168 billion, which was the biggest increase since 1993. The news must have been greeted with cheers in D.C. After all, the deficit would mean more dollar weakness and the resurgence of the borrow-and-spend consumer.
The news also demonstrates that the strategy of balancing trade by destroying the dollar is not based on sound economics. The U.S. dollar fell from 78.5 on the DXY index, a measure of its value against a trade-weighted basket of currencies, to about 77 during the month of September. In fact, the U.S. dollar has lost more than 16% of its value since March. If a weak dollar discouraged imports and boosted exports why, you might ask, did imports surge by the most in 16 years?
Sorry Ben and Tim, the so-called benefits of a falling dollar didn't materialize as planned. The inflation you created in order to bring the dollar down is reflected in the soaring price levels for commodities over the past 11 months. The result is that, not only has the U.S. done nothing to stimulate domestic production, it has discouraged foreign investment while destroying the purchasing power of the dollar, which will eventually send prices for domestic and foreign purchases out of reach for the average consumer.
The Treasury and the Fed have also managed to bring risk appetites back to 2007 levels. The massive increase in the government's printing of money and writing of guarantees has reduced credit spreads to razor-thin levels. The LIBOR OIS spread measures the spread between the London Interbank Offered Rate for dollars over three months and what traders expect the Fed funds target rate will be during the term of the contract. The gap fell to 0.1 percentage point this quarter, and, according to Bloomberg, it was below the average between December 2001 and July 2007. The record-high LIBOR-OIS spread was 3.64% in September of 2008.
Likewise, the Ted spread is back to the "good old days" as well. Last November the gap between the three-month Treasuries and three-month LIBOR was 1.99 percentage points. Today it's just 0.21 points. Even so, the mispricing of risk that helped bring down the financial sector in 2007 and 2008 is not boosting bank lending to private enterprise. Bank lending to the likes of Fluor Corp., Dupont and Deere &Co. for the purpose of creating capital goods and new businesses is plummeting. However, money of zero maturity (a measure of the supply of financial assets redeemable at par on demand) is up 8% year-on-year. That's because banks are lending to the U. S. government, which is the only insatiable borrower still out there.
Bottom line, benefits from a crumbling currency have not materialized. However, the ravages of pursuing such a flawed policy have started to arrive. The price of oil has soared and gold is setting new highs daily. Credit spreads are indicating that investors are mispricing risk yet again while the ballooning trade deficit indicates we once again are pursuing the notion that we can consume much more than we produce.
The stock market is dancing on top of a $2 trillion monetary base and that latent liquidity has sent commodities higher while the dollar sinks. My guess is that Wall Street and Washington believe things are getting much better. Unfortunately, I've seen this movie before, and I don't like how it ends. As the Consumer Price Index edges higher, and becomes increasingly difficult for the Fed to ignore, it will be forced to remove the life-support provided by its free-money policy. When that happens we will see the return of economic calamity. And maybe then we will have the courage to face up to the real problem and deal with it. News flash to Washington and Wall Street: The risk to our financial system is not the misperception of an overvalued dollar, but rather it is our overriding debt.