The Dollar and the Fed

The foreign exchange markets seem to have some of the same concerns about United States monetary policy that I do. See my “Oh, No! The Fed Has More Ideas for the Economy”, http://seekingalpha.com/article/226091-oh-no-the-fed-has-more-ideas-for-the-economy.

Yesterday the value of the United States dollar in foreign exchange markets fell. According to the Wall Street Journal, “The dollar fell against most rivals Monday as worries about a new round of economic stimulus prompted investors to adopt a defensive stance ahead of Tuesday’s meeting of the Federal Reserve.” (http://professional.wsj.com/article/SB10001424052748703989304575503301526427136.html?mod=WSJ_Currencies_LEFTTopNews&mg=reno-wsj)

The value of the dollar has been trending downward since early 2002 as the fiscal deficits in the United States piled up and the Federal Reserve kept interest rates down around one percent for an extended period of time. There was a respite from this trend as investors “flew to quality” during the financial collapse of September and October of 2008. As the environment calmed in the middle of 2009, the trend downward began again. In late 2009, investors once again came to the dollar as the situation in European bond markets deteriorated. This last “flight to quality” ended in early June 2010.

It is ironic that the basic “bet” in foreign exchange markets is against the dollar, yet in times of financial crisis investors flock to the dollar because of its “quality”.

Yet, once more we are facing a falling value of the United States dollar.

As readers of this blog know my “bet” is for the value of the dollar to continue to trend downwards. The reason for this is the fiscal and monetary disarray of the United States government. Fiscal deficits continue to rise in the United States. The last fiscal year produced a deficit of about $1.4 trillion. The latest estimates for this fiscal year is another deficit of about $1.4 trillion. My guess is that the cumulative fiscal deficits of the United States government over the next ten years or so runs around $15.0 trillion.

As for monetary policy we have a Federal Reserve that has pumped over $1.0 trillion of excess reserves into the banking system. Financial markets seem to be holding their breath waiting to see what the Fed will come up with next. Within the Fed there is concern over the strength of the recovery; there is fear of deflation; and there is an unspoken fear about the solvency of the banking system.

The consequence of all this is that market participants are concerned that the Fed might throwing “stuff” against the wall once again to see what sticks! Except for the time that Bill Miller (remember him) was the Chairman of the Board of Governors of the Federal Reserve System, I have never seen confidence in the leadership of the Fed at such a low point.

The current leader of the Fed was all in favor of the extraordinarily low interest rates in the 2002-2003 period. He totally missed the economic collapse because of his concern that inflation was the major issue in 2007 and 2008. Then once the financial collapse was upon us in the fall of 2008 he threw everything thing he had against the wall to see what would stick. He was hailed as a savior because the economy did not go into another Great Depression. Yet, now “helicopter Ben” seems to be wandering around in the dark once more.

The foreign exchange markets seem to be responding to this mis-management and uncertainty.
As mentioned, the last move into the dollar came in early June. The Wall Street Journal dollar index peaked on June 7, 2010 as did the Federal Reserve’s Trade Weighted Index of the dollar against major trading partners.

These measures dropped into early August when there was a slight rebound until…. Well, until Chairman Ben gave his talk at the Federal Reserve’s conference at Jackson Hole, Wyoming.

Guess what? Chairman Ben said that the Fed was considering how it could continue “quantitative easing” using funds running off from the Fed’s portfolio of mortgage-backed securities to buy more United States Treasury issues.

The value of the dollar reached it’s near term peak on Friday, August 24 in both the Wall Street Journal index and the Federal Reserve index. Monday, August 27, Chairman Ben spoke. The value of the dollar has declined in both of these indexes ever since.

And, foreign exchange markets are now showing concern over what might come out of the meeting of the Fed’s Open Market Committee meeting today.

The United States government doesn’t seem to get it. Although investors will flock to the dollar when there is an international financial crisis, the basic trend in the value of the dollar is downwards. This has basically been the case since the United States went off the gold standard in August 1971, with two relatively short interruptions. And, it has declined in both Republican and Democratic administrations.

The basic trend in the value of the dollar is downward because the international financial community finds the fundamental economic philosophy of the United States flawed. I happen to believe that the international financial community is correct. For some of my reasoning on this, I refer again to my post from yesterday.