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Posted 2/23/2004
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The sliding dollar is already costing you
The dollars plunge is having subtle yet tangible effects on our lives now. Want proof? Start with what it costs to fill your gas tank.
By Bill Fleckenstein
For a change this week, I'd like to talk about the dollar (very big grin) -- not just about the "end game" but also the ongoing game.
In terms of the former, two important developments have recently emerged. Last Tuesday, the Reserve Bank of India stated that it was "exploring the option of replacing a part of the central bank's investment in short-term U.S. securities with European gilts." For those who don't know, the Reserve Bank of India has a growing cash hoard of around $107 billion these days, making it roughly the sixth-largest holder of foreign currency reserves.
Dollar gives off a pariah patina
This follows on the heels of what Japanese Finance Minister Sadakazu Tanigaki said two weeks ago, that Japan would consider diversifying the composition of its reserves. So, at a minimum, there have been a couple of important shots across the bow showing our movement through the stages of the currency crisis I articulated in last week's Contrarian Chronicles. Though we don't know at what rate things will change, it does seem that momentum is starting to build. One thing you can be sure of: When momentum gets going in the foreign-exchange arena, it tends to keep going. Nothing quite "trends" like the currencies.
With the pressure continuing to build toward the end game, one might ask what that final phase will look like. To that, I would answer, it's anyone's guess, since today's distortions are so much larger than ever before. But it is worth noting that, back in 1978, the Carter administration was forced to do a tremendous amount of heavy lifting to rescue the dollar. In addition to a handful of other measures, it was forced to borrow $10 billion worth of Treasurys denominated in foreign currencies.
Furthermore, our trade deficit was 0.7% of GDP at the time rather than the 5% it is now. Said differently, today's is seven times bigger. (We had quite an inflation problem then, which is one of the main reasons that the Carter administration acted.)
Inflation has been cleverly defined away
Of course today, we don't see any inflation -- not because it isn't there, but because it's been so cleverly defined away, via hedonics and the makeup of the Consumer Price Index, etc. (Speaking of fun and games with numbers, I note that the January Producer Price Index report scheduled for release last Thursday has been delayed due to a new classification system by the Bureau of Labor Statistics.)
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And of course, Bubblevision and Wall Street like to delude themselves even further by looking at the CPI excluding food and energy (or ex any other offending item), which when you step back a minute is one of the silliest notions of all time. You probably spend money every day on food and energy. Energy is so ubiquitous that even a box of Corn Flakes has a high energy component when you think about all the different things that go into the cost of production. The price of oil works its way into just about everything.
That is one of the most obvious near-term and ongoing problems of our currency debasement scheme. In the last two years, the price of oil has risen from about $21 per barrel to just over $35 per barrel. OPEC's recent decision to cut production was partially due to the depreciation of the dollar. As Iran's oil minister, Bijan Namdar Zanganeh, told Bloomberg News at the time: "The dollar devaluation of the past year loses some of our purchasing power.
3 ways youre already feeling the dollars effects
Now, I am not saying that the price of oil would not have gone up in dollar terms anyway, if the dollar hadnt slid. But perhaps it would not have gone up as much. As you will see, a strong currency thwarts price increases; a weak currency causes and exacerbates price increases. In the last two years, the euro has rallied from about 86 cents to around $1.28. At the same time, Europeans have seen their price of oil go from about 24.5 euros per barrel to about 27.5 euros per barrel. That 12% increase is obviously a lot less than the 66%-plus increase that has occurred in dollar terms. So, the decline in the dollar has affected folks in subtle yet expensive ways that they don't quite recognize.
Lets use the same methodology to look at a slightly different commodity -- in this case, copper. Copper is up 73% in dollar terms. In euro terms over the same period, the increase is closer to 17%. Naturally, copper doesn't enter folks' everyday life in the same way as energy, but the analysis is applicable to most other markets.
Another tasty example (if less ubiquitous) is the price of wine from Europe. I myself like good wine, and I can tell you that the drop in the dollar has affected and will affect even further the price that Americans pay for European wine.
In some way, what's happened with wine has been seen in many areas, and middlemen have absorbed much of the pain thus far. This is about to change, however, and prices are going to escalate. I could cite many more examples, but I think you get the point: When the dollar goes down, it costs you money basically every day. But in some cases, there are lags before the impact really starts to be felt.
Lowball Inflation Data Sends Central Banks Astray
Returning to a point I made earlier about how government statistics mask the inflation that eats away at your money, I would like to spend a minute on another problem that can result from massaged inflation statistics -- central bank bubbles. One reason why central bankers can create a financial bubble is that they are so attuned to recognizing only one kind of inflation, i.e., CPI inflation. When there is an absence of CPI inflation (either because it doesn't exist or it's been defined away), central banks can keep the spigots open and precipitate a bubble.
That was the case in the United States in the 1920s. That was the case during the late-1990s mania. That was the case in Japan in the 1980s. And it is the case currently as the wrong-way Fed worries about deflation at a time when just the opposite is happening. Last week in The Wall Street Journal, Otmar Issing, a former board member of the German Bundesbank and now chief economist for the European Central Bank, wrote an excellent op-ed piece about asset inflation. It appears that the column was intended as a clear shot across Fed Chairman Alan Greenspan's bow.
Issing began with the argument for why central banks have avoided asset prices in conducting monetary policy. Thats wrongheaded, he argues because huge swings in asset valuations can imply significant misallocations of resources in the economy."
This is, of course, what happened during the late 1990s and again after the bubble burst. Greenspan's response was to print more dollars and push interest rates nearly to zero. These moves will precipitate the problems that we shall face in housing, and they have fomented this most recent stock market bubble.
Prevention is the best medicine
He went on to state: "Prevention is the best way to minimize costs for society from a longer-term perspective." I am going to say that again -- "Prevention is the best way to minimize costs for society from a longer-term perspective."
This is absolutely the most important thing I have heard anyone associated with central banking say since Paul Volcker ran the Fed from 1979 until 1987. This is the reason why one should not go down the path of bubble-blowing, because it is impossible to painlessly unwind a bubble once blown. The only way to solve a bubble with not much pain is to not let it get started in the first place.
Issing did justice to the complicated nature of trying to gauge how much asset inflation is too much. He likened it to plain-vanilla inflation by saying: "Asset-price inflation could similarly be characterized as 'too much money chasing too few assets,' thereby laying the mania right where it belong -- at the doorstep of the central bank. That is not to say the public is completely absolved of responsibility, especially if it falls for the same story line twice, as many have in this last go-round.
Spare the discipline, despoil the dollar
Nevertheless, the primary responsibility belongs to the Fed. Its policymakers have created an environment in which the financial system has "broken," in which the massive imbalances it has created are helping to destroy our currency, and the summation of which will collectively make our lives and our children's lives more difficult prospectively. That is why I continually have such vile and bile when I discuss Easy Al and his clueless band at the Fed.
One last comment about Otmar Issing. In this day of wet-noodle central bankers, he appears quite hawkish. But he was anything but a hawk compared to the old stalwarts at the Bundesbank. About the closest thing we have to real stand-up folks who appear willing to look ahead and solve problems before they get worse (i.e., take away the punchbowl) are the men from down under running the central banks in Oz and Kiwi land -- Australia and New Zealand.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
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