Dollar Devaluation, Stagflation, and How “You’re Getting Screwed”

“Remain calm, all is well!!”

Such would seem to be the message put forth this morning by The Wall Street Journal’s lead headline, Officials Unfazed by Dollar Slide,

In recent days, the nation’s top two economic policy makers—Federal Reserve Chairman Ben Bernanke and Treasury Secretary Tim Geithner—have publicly expressed their desire for a strong dollar. But there is little indication of a change in policy from either the Fed or Treasury—or in underlying economic conditions—that would alter the currency’s downward course.

When thinking of Bernanke and Geithner, who do you think of first, Abbott and Costello or Laurel and Hardy? I am more in the former camp. “Hey, Abbbbbotttttt!!”

In such a fashion, Big Ben deferred to ‘his boy’ Tim when questioned about the declining value of our greenback at his recent press conference.

The New York Times sounds a slightly more guarded tone in writing, For the Fed, A Narrowing of Options. I gagged on my coffee, though , when I read the summation to the NY Times‘ article,

Let’s hope that Mr. Bernanke is right to think both the slow growth rate of the first quarter and the rise in inflation are transitory phenomena.

Why did I gag? One of my basic disciplines in trading and investing is to embrace the fact that “hope is a lousy hedge.” While some may care to simply put their faith and hope in the likes of Bernanke and Geithner, I would encourage you not to be so cavalier.

Prudence dictates that we acknowledge the fact that we will likely experience a continued devaluation in the dollar, increased prospects of stagflation, and a continued ‘screwing’ of American consumers and taxpayers in the process. On these notes, let’s revisit risks and recommendations embedded in three commentaries from 2009 and 2010 in which I addressed these very real concerns.

Be mindful that the dynamics at work in our economy today are poised to play out for a very, very long time. I wrote then and continue to very much believe in the risks highlighted in the following commentaries.

1. Dollar Devaluation Is a Very Dangerous Game, (October 8, 2009)

Going back to the G20 in London last Spring, the Obama administration has attempted to curry political favor with emerging economies, especially the BRIC nations, by ceding dollar sovereigncy as the preeminent international reserve currency in return for support of global economic stimulus programs. Why does Washington believe a weak currency serves our economic interests? A weak currency generates and supports the following:

1. Promotes inflation as imports decline. Washington would like some inflation, given the massive deflationary pressures presented by falling wages and declines in the value of commercial and residential real estate.

2. Promotes exports for corporations with a multi-national presence.

3. Supports labor by making it more attractive for companies to keep jobs here as opposed to opening factories or sending work overseas.

So, in light of our current economic crisis, why wouldn’t we want a substantially cheaper dollar to maximize these benefits?

Recall that economists always need to keep certain variables static in order to study the impact of a change in another variable or multiple variables. This approach, known as ‘ceteris paribus,’ is not quite as easy as some may think. Why? Variables are NEVER static, or ‘ceteris is NEVER paribus.’

While the above three developments very likely will occur in the face of a decline in the value of the dollar, there is another very critical factor that must be weighed. I tried to highlight this yesterday in writing, “U.S. Markets Play Follow the Leader.” I wrote:

My gut instinct tells me that overall pools of capital will be flowing away from the United States and, as such, people and private corporations will have to pay more to attract capital here in our country. I think those entities which focus the bulk of their economic activity here in the United States will be forced to pay higher rates to attract funding.

2. Inflation, Deflation, or Stagflation? (June 1, 2009)

The debate between analysts touting prospects for inflation versus deflation is ongoing. Those concerned with deflation highlight increasing levels of unemployment pressuring wages, falling asset valuations, and slack consumer demand. Those concerned with inflation point toward the unprecedented levels of liquidity injected into our system via all of the government programs. The inflation hawks maintain the economy merely needs a small spark and inflation will spread in an uncontrollable arson-like fashion.

I actually believe there is a very real chance we get developments from both camps leading to the scourge known as stagflation. How may this play out?

Many respected analysts are promoting the concept of a new “normal” economy. This scenario entails an economy operating with enormous government deficits, an elevated level of unemployment, and little to no shadow banking system (securitization of loans and other assets).

In this new “normal” economy, GDP may only eke out small positive growth given these heightened pressures. Pimco’s Mohamed El-Erian writes of A New Normal:

This reflects a growing realization that some of the recent abrupt changes to markets, households, institutions, and government policies are unlikely to be reversed in the next few years. Global growth will be subdued for a while and unemployment high; a heavy hand of government will be evident in several sectors; the core of the global system will be less cohesive and, with the magnet of the Anglo-Saxon model in retreat, finance will no longer be accorded a preeminent role in post-industrial economies. Moreover, the balance of risk will tilt over time toward higher sovereign risk, growing inflationary expectations and stagflation.

Even as we come out of this recession, our economy will run increased risks of slipping into another recession given the lack of cushion provided by a strong consumer, the burdens of heavy government debts, and inability to easily access credit.

As our global economy transitions to this new “normal,” I believe the likelihood of stagflation is quite high. For those who recall the perils of our economy in the early 1980s, stagflation is not a pretty picture. How does one manage investments and personal finances in an environment of stagflation?

Let’s deal with the component parts. Given sluggish growth, limited credit, and lessened opportunities, it is of paramount importance to cut expenses and minimize debt as much as possible. Servicing debt will be an ongoing challenge and increasingly problematic. Be proactive at this point in time in adjusting your finances to this reality.

Where will the inflation come from and how does one address it? In my opinion, the inflation “train” will arrive sooner than we think.

How can people protect themselves from the inflation monster? Increase exposure to the following:

– precious metals and commodities

– critical infrastructure (power plants, agriculture, water, transportation)

– necessary life items (drugs, medicines, food)

– stronger and more fiscally prudent foreign markets

This stagflation story will have many chapters and I will be writing extensively on it.

3. America’s Hidden Inflation and How You’re Getting Screwed, (March, 23, 2010)

Are we experiencing this decline in prices for housing and wages on one side versus an increase in prices for consumer goods, fuel, and services on the other? Let’s dig a little deeper.

In a back corner of The WSJ’s “Heard on the Street” section today, we learn:

If you remove housing costs from the consumer price index, inflation looks positively resurgent. In January, the CPI was up an annualized 5.8%, excluding owners-equivalent rent, which is a rough proxy for housing costs.

Inflation is dead? Perhaps in housing (and also wages) it is, but certainly not in the other components of the consumer price index. How do you think increased healthcare costs for businesses will be handled? A combination of layoffs and lessened hiring along with passing the costs down to consumers. Feel like you’re getting screwed? You are.

Our friends in Washington, on Wall Street, and especially at the Federal Reserve have no interest in highlighting this reality, but your friend here at Sense on Cents is solely concerned with helping you navigate the economic landscape.

The forces at work back in 2009 and 2010 remain very much at work today. In fact, I believe the impact and momentum of these forces have gotten stronger. The Federal Reserve and Treasury have one real weapon with which to attack these underlying forces. Crush the dollar in an attempt to monetize our national debts and redistribute the costs and pain from within our financial institutions to across our society and the global economy.

As it was in the beginning, is now and ever will be, world without end, Amen!!

About Larry Doyle 522 Articles

Larry Doyle embarked on his Wall Street career in 1983 as a mortgage-backed securities trader for The First Boston Corporation. He was involved in the growth and development of the secondary mortgage market from its near infancy.

After close to 7 years at First Boston, Larry joined Bear Stearns in early 1990 as a mortgage trader. In 1993, Larry was named a Senior Managing Director at the firm. He left Bear to join Union Bank of Switzerland in late 1996 as Head of Mortgage Trading.

In 1998, after 15 years of trading and precipitated by Swiss Bank’s takeover of UBS, Larry moved from trading to sales as a senior salesperson at Bank of America. His move into sales led him to the role as National Sales Manager for Securitized Products at JP Morgan Chase in 2000. He was integrally involved in developing the department, hiring 40 salespeople, and generating $300 million in sales revenue. He left JP Morgan in 2006.

Throughout his career, Larry eagerly engaged clients and colleagues. He has mentored dozens of junior colleagues, recruited at a number of colleges and universities, and interviewed hundreds. He has also had extensive public speaking experience. Additionally, Larry served as Chair of the Mortgage Trading Committee for the Public Securities Association (PSA) in the mid-90s.

Larry graduated Cum Laude, Phi Beta Kappa in 1983 from the College of the Holy Cross.

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