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The Weak US Dollar & Fixed Incomes

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A friend from up in Albany emailed me the following questions. I thought my answers may help others: ”I think I understand the basics of why the dollar has fallen so fast of late but I know you will know the details. It seems like there is always controversy about the economic future but consensus on reasons for the past. I believe the present dollar drop has to do with the ever growing US debt brought about from spending more than revenue received. The housing bust situation has added to the debt and the world has little confidence in us to turn it around any time soon. What is the best answer? Some seem to feel that a weakened dollar is the answer to our recovery? Did our government do things to help weaken the dollar to help our economy? Who does it help? I can not see it helping me but I guess if my investments in the stock market go up greatly and greater than the increase in the cost of living I will be better off? Our pensions will not go up though. It seems like they are saying with a weaker dollar we will be able to sell more American products and thus pay our debt, more jobs, etc. But who will profit? Will increased profits be shared with the stockholders and the workers? Will the corporate leaders share profits significantly with workers and professional staff and pay more taxes to government or will they take the profits and not share significantly with shareholders, workers, and professional staff but move operations out of US and/or bring in cheaper labor and professionals from other countries to work in US? Will they avoid paying more taxes through loopholes? I know I can not change anything but thought I should try to understand what is happening.” Schwartz Answers: Guess you’re wondering about the dollar and how its weakness affects you. The US Dollar. The greenback. The US dollar has been dropping against other major currencies going back decades with a couple big multiyear counterswing rallies along the way. It rallied from 1980 to 1984 when then Federal Reserve Chairman Paul Volker broke the back of runaway inflation by raising interest rates through the roof. Then it again rallied from 1996 to the end of the 1990s when President Bill Clinton focused on balancing the budget. But in 2001 when President Bush II cut taxes and the twin deficits (trade and budget) ballooned the buck started a major decline which in February 2008 finally broke major support from 1979, 1990, 1991, 1992, 1995, 2004 and 2005. Yes, this decline has corresponded with us running major budget and trade deficits but that’s nothing new. And it has rallied from time to time in the midst of our budgets getting worse. It rallied for most of 2005 surprising everyone including the richest man in the world Warren Buffet who lost some money. Typical counterswing rallies occur when everyone has bet on one side, in this when everyone got on board the buck dropping. When a trade gets too crowded, it’s a natural phenomenon to counterswing, partially because everyone who wants in is “all in.” After the 2005 rally, the buck then resumed its decline and has been pretty much straight down ever since. And as I said it just recently broke decades old major support. Now some say if the US economic slowdown turns into recession, and then the Us-based recession spreads out globally, the US dollar will strengthen as in past slowdowns, as its been looked at as an investment haven of last resort. Generally though, the rest of the whole world is stuck with tons of US dollars and doesn’t quite know what to do with them. Some countries have stated they are going to diversify their holdings of foreign currency reserves into other currencies like the euro. Other countries with dollars flowing in from exports have started up these so called Sovereign Wealth Funds (pools of dollars) and taken to investing elsewhere other than US Treasuries. Which all points to an US dollar with even less support going forward. The US government does seem to like the strategy of saying they favor a strong dollar but acting otherwise. Obviously, as you mention, a weaker US dollar makes American goods less expensive for foreigners (who get more dollars from their pounds, euros, francs, yen, etc.). So it causes many to visit American cities like New York, Atlanta and Miami and buy the same goods at half price or buy real estate as 2^nd homes, all of which buttresses our firms’ near term profits. And the weak US dollar also makes our exports more competitive so we sell more and that’s helping keeping this economic slowdown, American consumer spending slowing, from morphing into a deep recession. Thus higher than otherwise corporate earnings does help keep a floor under US stock prices so your retirement portfolio, your investments, are higher than they would be. And other countries, notably Japan and the Asian Tigers, Singapore, Hong Kong, South Korea and Taiwan have followed an economic policy of keeping their currencies down, and that’s helped to drive their exports and make them prosper. So keeping one’s currency down has helped in the past. Now whether it’s a sound strategy for the United States, with the dollar being the world’s reserve currency, is another question. Jim Rogers, the long term investment seer extraordinaire, whose books I’ve advised you to read, says not. I particularly trust his long term views after studying up on his amazing background. Just like you, he’s visited China, by the way. Anyway he says debasing a country’s currency may help short term but in the long term it’s disastrous and he’s publicly trying to get all his investments and assets out of US dollars for the last year or so. He even sold his New York city townhouse and has moved to Asia! And, as to your follow-up concern, of course any increased profits gained from a weak dollar will go into corporate coffers, and may help shareholders by higher stock prices, but certainly will not be shared with workers. Sharing wealth equally was America’s way of operating back in the 1950s and 1960s when unions had some power, regulatory authorities were looked upon as good things performing necessary tasks, America’s big companies had no global competition and we had corporate statesmen who felt their responsibility were to share corporate wealth equitably. That’s no longer the case today, where bottom line profit drives everyone. So forget about that equitable sharing until somehow the country moves back to a better balance between capitalism and democracy. I’m not sure your choice, Hillary, will be able to move us in that direction even though she professes so. She may fervently want to but like most other politicians she is more prepared to battle the other party, fight, fight, fight, rather than get along and compromise. Schwartz View: As to your concern about now having to live on a fixed income, after retiring (thank goodness you have a couple pensions coming in!) there’s a big debate on about what strikes next, deflation or inflation. I mean many are worried about an economic slump turning into a big recession. And then big job losses and a period where prices including the cost of money, interest rates, stay low, but no one has the wherewithal to buy much. Many well-paying American jobs have indeed moved overseas, as you say, and that trend will continue. Business leaders today have to remain focused on the bottom line (or they will lose their jobs) and thus will look for the cheapest labor costs and ways to manufacture. Thus many worry that, similar to the 1930s, we’re in for a period of low employment or at least not enough livable wage jobs. But there is also the other camp which says the global economy is too strong, what with the size of the global economy having mushroomed with millions more people around the world moving now enjoying a bit more wealth, to go into a sustained recession now, that first inflation is going to be the next bogeyman. They say that gas and food prices are not going to come down, give us any relief, for a long time yet to come. I’d put Jim Rogers in that camp. Since he predicts this commodity bull market, commodities going way up in price, is going to last for at least another five to ten years, it could be that rising inflation is the next problem to take center stage, that’s what’s going to really pinch America and Americans. I go back and forth about which next, inflation or deflation. But I do sense myself developing an inflationary mindset recently. Watching Chinese export prices rise, I’ve taken to stockpiling presents, clothes, for next Christmas now. And I keep stockpiling meats at today’s still reasonable prices in the freezer. Obviously higher inflation doesn’t sit well for anyone with a fixed income. So keep up your teaching English as a second language. My best to you and family, Richard

Posted 04-22-2008 9:34 AM by Richard Schwartz

Filed under: Principles of the Stock Market, Richard Schwartz, Inflation, US Dollar, US Economy, Macroeconomics, Historical Perspectve, Perspective, The Principle of History, Deflation, Fixed Income

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