Commentary

Beware the Sinking Dollar

Watch out for the declining dollar, it means that your purchasing power will decrease and your cost of living will rise sooner than you think. As the stock market gains ground lost in the early August meltdown, the US dollar continues to sink against major world currencies. The price of gold, long used to hedge against a declining dollar, is trading at over $700 an ounce, and oil surpassed $80 a barrel yesterday- a new record. All commodities are priced in dollars, so now it takes more depreciated dollars to buy them, and everything you buy at the store will soon cost more.

The dollar began a secular decline after the short 2001-02 bear market in US stocks, and picked up speed over the past several months. The recent unraveling of the market for subprime mortgage securities and the resulting destabilization of the credit markets has certainly not helped the greenback. Then came last week’s dismal jobs report, which, instead of registering the anticipated 100,000 increase in payrolls, showed a decline of 4,000 – and the numbers for the past two months were revised sharply lower.

But supposedly, there is no need to worry. The Federal Reserve, which was furiously adding liquidity to the paralyzed credit markets over the past few weeks, is now expected to come to the stock market’s rescue by reducing the Federal Funds Rate when it meets next week. The Wall Street economists and the clueless coconuts in the financial press are buzzing with excitement because the Fed is riding in to save the day. This reduction in interest rates, it is hoped, will aid everyone from the private equity crowd, which is witnessing the cancellation of deals, to the legions of over-extended homeowners, who are currently bathing in the debt they have unwittingly signed onto.

This, however, will provide nothing more than a temporary fix, or high, if you prefer, and will prolong the inevitable correction in asset prices. The action anticipated by the Fed will make the dollar less competitive against global currencies (investing here at lower interest rate means a lower return). And as the foundations underlying the US economy experience more stress, investors of all stripes- from domestic to foreign- will eventually flee US equity and corporate bond markets.

Easy money – the remedy that those with a vested interest in the financial markets are praying for is exactly what caused this mess in the first place. This will support prices in the short-term, but the fault lines in the economy run too deep, and this action will only result in a further weakening of the dollar.

America is about to come face to face with the consequences of the feckless financial behavior that swept this land from coast to over-indebted coast. Our insane spending is causing the dollar to sink in value, increasing inflation, which will lead to a decrease in living standards. The sad part is that many prefer one last drink as opposed to a sober assessment of the situation and serious policy discussions regarding the best way forward.

© 2007 Splendid Marbles.