Since the beginning of 2011, the US dollar index has depreciated by about 5%. The S&P500 has increased by about 5%.the net effect being that the US dollar purchasing power outside of its borders has been maintained.
Everyday there are numerous media reports of higher commodity prices and emerging market inflation. European, Asian, and South American central banks are being vocal as to their concerns and criticizing the US Federal Reserve for its loose monetary policy. Ben Bernanke, chairman of the Federal Reserve defends his expansionary policies by claiming that the United States inflation environment and expectations are well anchored. What is the investor to believe?
In a WSJ article “Bernanke’s Inflation Paradox’, it states that the Fed’s easy monetary policy:
- “rarely has been so obvious as it is today”
- is causing inflation in countries with links to the dollar?
- is prompting investors to seek returns in non-dollar assets and that might be a misallocation of capital
Easy monetary policy has become the general understanding and expectation today. Ben Bernanke is saying there is no problem regarding the current inflation environment and describing it as transitory.
When Fed officials are talking about inflation, we have to understand what indicators they are looking to for guidance. The Fed focuses on core inflation (PCE) which excludes gasoline and food. They do not focus on asset prices and defend their position that asset bubbles are not caused by loose monetary policies. They also do not react to the immediate numbers but instead try to forecast how the numbers affect the expectations for future product price increases and eventually employee wages. One should also note that the PCE and alternately the CPI calculation have many arbitrary adjustments to smooth and reduce the final number for a more palatable result.
Bernanke acknowledges pressure on commodity prices; he puts the blame on emerging economies. He says that the slack in both employment and production in the US will suppress prices, because corporations are going to absorb the higher commodity prices by reducing their profit. However, consumer product companies have announced plans to raise prices over 5%. International companies are benefitting from repatriation of profits because of the weaker dollar; they are raising prices indicating their costs are going up, especially in the food industry. Note: consumer goods companies stocks have rallied on the price increase announcements indicating that the market believes that the price increases will flow to profits and not be entirely absorbed by inflation.
The current consensus is that Bernanke is pro-business. Speculators and investors all over the world are jumping on this as we are seeing major moves against the US dollar. Ben Bernanke is like a father who likes to spoil his child. Loose monetary policy is a treat and should be used sparingly. The business community got so used to easy monetary policies over the last twenty five years that any withdrawal of the policy will be met with major resistance and difficult repercussions. However, as a parent this will not be sustainable, as for Bernanke it will probably get him through his current term but will not be sustainable down the road. (How Bernanke is different from Greenspan)
Conclusion
We expect the US dollar to continue its current downward momentum until there is a change in the government and/or Federal Reserve policies. We might have to wait until at least the next presidential election for this change of direction. The solution is to create a basket of currencies, with a 25% to 75% correlation to the US dollar, depending on one’s individual established criteria .
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