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

The Feds Have No Faith In Recovery
Mr. Geithner: Stop Passing The Buck On the Dollar
Building The Labor Force With Forced Labor

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.

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: iShares 10-20 Year Treasury Bond

    Learn about the iShares 1-20 Year Treasury Bond ETF and its holdings, and understand why investors may be better served to look at other bond funds.
  2. Credit & Loans

    5 Signs a Reverse Mortgage Is a Bad Idea

    Here are the key situations when you should probably pass on this type of home loan.
  3. Active Trading Fundamentals

    The Top 5 Impact Investing Firms

    Learn what impact investing is and obtain information on some of the top impact investing firms ranked by total assets under management.
  4. Credit & Loans

    5 Signs a Reverse Mortgage Is a Good Idea

    If these five criteria describe your situation, a reverse mortgage might be a good idea for you.
  5. Mutual Funds & ETFs

    4 Mutual Funds to Consider If Interest Rates Rise

    Learn what mutual funds will perform best if interest rates rise. Interest rates can rise due to inflation or to an improving economy.
  6. Credit & Loans

    Guidelines for FHA Reverse Mortgages

    FHA guidelines protect borrowers from major mistakes, prevent lenders from taking advantage of borrowers and encourage lenders to offer reverse mortgages.
  7. Investing News

    China's Government to Stop Intervening in Stock Markets

    China’s stock market, measured by Shanghai Composite Index, lost about 17% of its value in the first three days of week ending August 28, 2015 before recovering its value by 11% in the last two ...
  8. Investing News

    Monday Intel: China, The Fed and Jackson Hole

    This weekend followed some of the most volatile market action in recent history as world markets were roiled by the Chinese market crash and its attempts to devalue the yuan. The past week also ...
  9. Investing Basics

    Explaining Trade Liberalization

    Trade liberalization is the process of removing or reducing obstacles that impede the exchange of goods and services between nations.
  10. Investing

    What’s Holding Back the U.S. Consumer

    Even as job growth has surged and gasoline prices have plunged, U.S. consumers are proving slow to respond and repair their overextended balance sheets.
RELATED TERMS
  1. Purchasing Power

    The value of a currency expressed in terms of the amount of goods ...
  2. Monetary Policy

    The actions of a central bank, currency board or other regulatory ...
  3. Cost, Insurance and Freight - CIF

    A trade term requiring the seller to arrange for the carriage ...
  4. International Monetary Fund - IMF

    An international organization created for the purpose of standardizing ...
  5. Inflation

    The rate at which the general level of prices for goods and services ...
  6. Delivered Duty Unpaid - DDU

    A transaction in international trade where the seller is responsible ...
RELATED FAQS
  1. What are the best ways to sell an annuity?

    The best ways to sell an annuity are to locate buyers from insurance agents or companies that specialize in connecting buyers ... Read Full Answer >>
  2. How is the Federal Reserve audited?

    Contrary to conventional wisdom, the Federal Reserve is extensively audited. Politicians on the left and right of a populist ... Read Full Answer >>
  3. Who decides when to print money in the US?

    The U.S. Treasury decides to print money in the United States as it owns and operates printing presses. However, the Federal ... Read Full Answer >>
  4. Why do some people claim the Federal Reserve is unconstitutional?

    The U.S. Constitution does not mention the need for a central bank, nor does it explicitly grant the government the power ... Read Full Answer >>
  5. How can the federal reserve increase aggregate demand?

    The Federal Reserve can increase aggregate demand in indirect ways by lowering interest rates. Aggregate demand is a measure ... Read Full Answer >>
  6. How does the stock market react to changes in the Federal Funds Rate?

    The stock market reacts to changes in the federal funds rate in various ways depending on where it is in the business cycle. ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!