The Dollar Bears Are Still Wrong

 | Mar 06, 2013 | 5:30 PM EST  | Comments
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The weak-dollar meme has been around for as long as the hyperinflation meme, perhaps longer. Ever since the Federal Reserve started to engage in "extraordinary measures" to bring interest rates down, the dollar bears have come out of hibernation to predict the imminent collapse of the currency.

Their argument was always the same: The Fed was printing money and thus debasing the currency. The problem is, if you look at the Dollar Index over the period that the Fed has been engaging in these measures, it has gone up, not down. The dollar index was at 79 in 2008, when the crisis really started to unfold, and it's at 84 today -- a gain of about 5%.

Some might not consider a 5% gain in five years to be huge, but the point is that it's up, not down. Moreover, look at what the Fed did: It increased its balance sheet from $800 billion to over $3 trillion in that same period. So much "money printing"! This is what the debt-doomsday, inflationista, debasement camp had been warning us about the whole time. And guess what? It happened, and the dollar went up.

I've seen some recent articles about how the U.S. stock market rally will be bullish for the dollar. Perhaps. Clearly, one can argue that a strong U.S. stock market might spur some dollar-buying by foreigners who want to get in. However, the dollar is more likely to rise for another, far more powerful reason: austerity.

Just as deficit spending results in the creation of more dollars (a rising dollar supply), austerity results in the destruction or removal of the net supply of dollars from the global economy. By spending less, taxing more and reducing deficits, the U.S. government, which is the monopoly issuer of the currency, is reducing the growth and, ultimately, the supply of dollars. It is removing dollars from the private sector.

Forget the Fed and its monetary operations. What the "debasement-ites" fail to understand is that monetary operations, quantitative easing and rate reductions don't result in an increase in the net supply of dollar-denominated financial assets. These actions only change the composition of the dollars that the public holds: less dollar bonds, more dollar reserves, less dollar reserves, more dollar bonds, etc.

The only entity that can increase the net supply of dollar-denominated financial assets is the government, and it can do that only via deficit spending. When the deficit swells, there is pressure on the dollar, simply because the government is creating more dollars. That's when it is correct to say it is "printing money." On the other hand, when the budget deficit gets reduced or moves to surplus, the government is removing dollars from the system. Thus, the supply of dollars gets tight.

A good illustration would be farming. Imagine a bumper crop of something -- wheat, corn, it doesn't matter. If a much larger than expected supply of that commodity is produced, what happens to the price? It goes down. Now imagine a crop failure due to drought, insects or disease. A much smaller supply of that commodity is produced, and the price goes up. Government budget deficits are bumper crops, whereas shrinking deficits or surpluses are crop failures.

From the mid-1990s until 2001, the U.S. government sharply reduced its budget deficit and eventually moved to a positive balance, a surplus. The dollar surged over that period of time. Then from 2001 to 2009, the surplus shifted back to a deficit, culminating in record deficit (bumper crop) in 2009, and the dollar collapsed. Since then, the deficit has been declining (down $500 billion since 2009), and the dollar has been rising (crop failure).

Austerity means the crop failure will continue and even intensify. You can forget the Fed, even if it conducts another round of QE, which is possible as the economy slows. The reason, again, is that monetary operations do nothing to the net supply of dollars. If the Fed eases, do yourself a favor and take some money from the folks who continue to rely on myth instead of fact: Buy any dollar selloff that occurs in reaction to additional Fed easing.

Let's face it, the arguments of the dollar bears have been wrong for some time, just like the arguments of the inflationistas, but both groups keep saying, "One day." One day, one day, one day. It's like saying one day the earth won't revolve around the sun. This is useless information. Do yourself a favor and tune them out. Better yet, watch them go extinct and make yourself some money at the same time.

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