Weaker Dollar = Weaker US

Weaker Dollar = Weaker US? Are the consequences of a weakening currency all negative? Nope, click here for the glass half full version posted earlier this week. Now we get to be depressed (Joe Prozac) and discuss the negative aspects of a weakening currency. Okay great, is everybody nice and depressed and ready to read on?

Joe was depressed after trying unsuccessfully to convince JoAnn to accept a diamond ring before prices shot up. Things are looking better for Joe since the last post however, unlike the US Dollar. The dollar continues to inflate (Joe home-made hot air balloon) with out much of anything to bring it back down. (Joe wasn't inside)

Disadvantages of a Weak Dollar

Inflation - Everybody knows a weakening currency leads to inflation, which subsequently decreases your purchasing power. This was one of the main causes of our current recession. Inflation starts with investors bidding up commodities as a form of hedging against possible inflation - which ironically further aggravates inflation. Commodities such as oil are building blocks for manufacturing; and commodities such as corn, soybean, and wheat (Joe farmers market) are building blocks of food production. Prices of end products are affected as the increased prices of commodities filter up through the economy. Also, inflation is simply a tax on savers because the value of money decreases.

Treasury Auctions - Think the Chinese will be upset if the rate of inflation surpasses the interest on their treasury purchases? Inflation damages investments of fixed interest debt such as US Treasury notes and bonds. The Chinese and various oil-exporting countries are in a pinch right now. If they stop purchasing our US Treasury notes and bonds the interest rates on current auctions will have to increase to attract buyers. This will in turn drive up interest rates - further damaging our housing market and delay the recovery. If they keep purchasing our worthless debt, they increase their exposure to debt that may not be able to be repaid in full with dollars that are worth anything. If we default these notes, the Chinese will seek restitution Jackie Chan style. At what point do we have to start asking permission from our international creditors whether to sign stimulus legislation? We're slowly being bought by some very dangerous creditors. (Joe, check-N-go)

International Positioning - It's no secret that the US is starting to slip a little bit on the international scene. Once the world economic and military superpower, now we're essentially owned by a handful of third-world nations. What was once inconceivable (Joe, hiding in the attic for five hours) is now starting to be realized because of poor fiscal decisions and a financial collapse which lead to a global recession. What we need to do now, however is protect the dollar. We've already ticked off our creditor nations once because of our crashing economy. It might be wise to avoid doing it again by protecting our dollar.

Super Ben Saves the World from Collapse

While speaking to a group of economists and policy makers on Friday, Federal Reserve (Fed) Chairman Ben Bernanke proudly announced that the aggressive monetary policies implemented by the Fed and the Treasury department “saved the world” from a financial meltdown. (Joe Superman) While markets have indeed responded positively since early March ‘09, it’s not clear whether the rally has been based simply on Fed intervention or on strengthening fundamentals. While some economic indicators have shown signs of bottoming, we have yet to see real sustained growth. (Joe Rogaine) Super Benny has, however, managed several accomplishments which we’d like to discuss below.

He screwed small banks
Late last year, when many large banks were insolvent and broken, Super Benny wielded his power and influence over congress (Joe pull down the wool) and served up a large dish of TARP salad (Joe next Food Network Star), with side dishes of PPIP and TALF from the Treasury (Joe “Bam! Kick it up a notch!”). The central banksters and clueless bureaucrats in Washington not only approved immediate TARP funds and monetary injection into large financial institutions, but also pledged to continue to infuse money should the need arise in the future. Even though the Fed and large banksters helped shape this economic crisis due to lax policies and excessive risk taking in the first place, they have been granted the safety net of taxpayer funds while the smaller institutions continue to struggle on their own. (Joe upside down roly-poly) Additionally, nervous depositors at small banks are pulling funds and fleeing to the safety of the too-big-to-fail empire. (Joe Titanic)

He screwed China
Each week the US Treasury auctions off new debt in the form of Treasury bonds and notes. As demand on the bonds increases, the yield, or interest rate decreases. (Joe Econ 101) Therefore, buyers want as little competition as possible to get the best rate. The Fed announced a plan in March to buy 300 billion of US treasuries in an effort to keep US interest rates low. (The housing mortgage rates closely follow the 10 year bond, for more on this China situation click here) This Fed purchase plan undoubtedly angered China, who is the largest foreign purchaser of US debt. In other words, with each dollar of debt the Federal Reserve purchases, the interest rates on Chinese investments drop. This situation of the Fed buying from the Treasury is similar to when Joe Shareholder asked his Mexican investor friend Jose to help bid up the price on the diamond ring he placed on eBay after JoAnn shot him down. (Joe false start)

He screwed the US Dollar….and Taxpayer…..and Saver
Ben’s plan to avoid another depression is to induce inflation to combat the dreaded economic forces of deflation, which he claims caused the Great Depression. (For reasons why click here) The best way to induce inflation is to crank up the printing press and dump it onto the economy - hence the nickname Helicopter Ben. (For his own words on the topic, click here). Since Ben took the reigns in 2006, the US dollar has slipped roughly 16% and 20% to the Japanese Yen and Euro respectively, with both trading near all-time lows. Inflation on the dollar is essentially a tax on anyone saving money. In Ben’s defense, however, he’s had plenty of dollar destruction help from politicians loading debt on the back of the fragile/exhausted US dollar. The Congressional Budget Office announced on Tuesday that the budget deficit earlier estimated at 7.1 trillion by 2019 has been raised to 9 trillion. Can the US dollar sustain such levels of debt or will it begin a free fall? (Joe Petty, brother of Tom) Will countries continue buying our debt even while it’s climbing to new highs daily? If there comes a time when debt investors decide it’s just too risky to hold US debt, there could be a massive sell off which could get quite scary. (Joe, “stay behind the yellow tape kids, nothing to see here. ”)

So the Fed and Super Benny have stabilized the large financial institutions…..but at what cost? Only time will tell (Joe crystal ball) whether the negative impact on these periphery entities will come back to haunt him (Joe October 31st…..2010, 2011, 2012???). Speaking of Halloween, Joe Shareholder likes this time of year because he offers JoAnn his protection from anything scary that might be lurking out there. JoAnn insists that nothing bad ever happens in Joetown, Ohio. This year, however, Joe can remind her that as long as Super Benny is in charge, plenty of scary things could happen.

Joe Shareholder contemplates Treasuries v. Economic Growth

Everyone in the financial world is excited about a possible economic recovery in the third quarter. Signs of stabilization in domestic earnings and economic indicators seem to suggest the end of the recession is near. Economic recovery "Green Shoots" have many investors excited to dive head first back into the markets. Who cares about water depth, right, just dive in? Wrong, the economic recovery water is very shallow, and the concrete underneath the shallow water is the rising US national debt. (Joe Deficit)

As we all know the United States has a budget deficit of over one trillion dollars. So how do we finance expenditures if we're in the hole? We sell debt. The Treasury Department holds weekly auctions to sell US bonds to interested investors at about 3-4% interest. The weekly bond auctions are currently ranging from 30 billion to 200 billion per week. This money is extremely important because it subsidizes tax revenue shortfalls for all government programs, including employee pay and pensions, military expenditures, corporate bailouts (should this even be in the list), etc. So right now we need Treasury auctions because we're broke.

Anyway, suppose the economy starts to improve next quarter, which could happen. If the equity markets (stocks) start to boom, and the market’s expected return is say 10-20%, or even 50% over the next couple years, why would anyone invest in our US bonds at 3% yearly return? They wouldn’t, and either a vital source of revenue would dry up - or the more likely scenario - rates would be pushed higher during treasury auctions, to say 10% on the 10 year treasury bond to lure in buyers. There are several problems with that:

1. Every dollar the US gov borrows would be very expensive at 10% interest. US Treasury would have to lower the amount of US bonds at auctions, which would dry up funds. Who would bailout the banks next time? Who would pay entitlements? Nationalized Health Care? How would the military be financed? Cap and Trade? (Joe-bal warming)

2. The US housing market needs low interest rates. Housing mortgage rates follow the 10 year treasury bond very closely. If the yield on treasuries is driven up to 10% because of a lack of demand at auctions, then the rates on mortgages would be pushed up to about 12%, which would cripple a fragile housing market. You think you're upside down in your mortgage now? (Joe Housing .....spelled upside down)

3. Right now the Federal Funds rate (interest rate at which banks borrow from the Federal Reserve) has been cut to zero by the US Federal Reserve. When you buy a house, your bank/lender can borrow the money at zero interest and lend it to you at 5% interest. If the treasury yields skyrocket, however, the Fed won’t be able to hold these rates at zero long, because they’ll be paying 10% and loaning it out at 0%. Not sustainable for long. This rate increase will negatively impact business loans as well, and credit markets could easily seize up once again, separating borrowers and lender. (Joe minus Kate and the eight)

Enter the US debt into the picture. If we didn't have such a huge national debt, we wouldn’t depend on treasury auctions to pay soaring interest on existing debt, and the auctions would be scaled back significantly from 200 billion per week to almost zero. Under this scenario, depressed supply would meet low demand at low interest. However, since our government desperately needs revenue we will need large treasury auctions and the rates will likely be driven upward (low demand, high supply). The only way out of this debt trap is a booming economy, where tax revenues would offset the need for treasury auction revenue. Most economists suggest this is unlikely, especially with dangerously high levels of unemployment. (Joe Monster.com)

Why don't we just print money? Because just printing money not collateralized by interest would lead to hyperinflation and the US dollar - which is supporting a huge deficit - would simply go down the drain. (Joto Rooter)

In summary, our national debt has economic growth hamstrung right now because rising equity markets will spur interest rate hikes. The only sensible exit strategy is to ween the government off the important revenue stream of treasury auctions and cut the deficit. Because of the inverse relationship between debt and recovery, every dollar that we spend will actually hurt chances of recovery, not help.

So what does this mean for Joe Shareholder??? Joe Shareholder and his friends Joe Investor and JoAnn Trader desperately want to jump back into the market to make money to buy a boat, dirt bike, and maybe even a trailer to haul it. Maybe even a truck to pull it. F-350 Turbo Diesel maybe, with knobby tires. However, beware of this stock market rally. You might go broke. (Joe Soup Kitchen) The threat of rising interest rates due to our National Debt could cause more market shrinkage than a cold swimming pool nestled in the middle of the shrinking polar ice caps. (Joe Gore)