Fed Continues to Punish the Dollar, Blind to Inflation

by Louis Navellier | April 11, 2011 5:12 pm

At the last minute Friday night, the federal government dodged a bullet and avoided closing down. The market was flat last week, so it’s safe to say that the impending shutdown was not as scary to Wall Street as it was to those expecting their regular government services. Of course, nothing was solved for the long-term, and the U.S. dollar will continue to slide — based on Washington’s inability to control spending — while the U.S. economy has been humming along just fine, with or without federal government help.

Dollar Sinks to the Bottom of the Currency Ladder

The euro hit a 15-month high to the U.S. dollar last week after the European Central Bank (ECB) raised its key rate by 0.25% to 1.25%. The People’s Bank of China also raised its key rate last week, up 0.25% to 3.25%. Meanwhile the Fed continues to maintain its 0% interest rate policy and quantitative easing.

The euro-zone is a mixed bag of good and bad news. On the positive side, Germany’s factory orders rose by 2.4% in February. That helped to strengthen the euro. On the other extreme, Portugal had to pay six-month interest rates of 5.11%, up from 2.98% just a month ago, so a bailout of Portugal (similar to the previous rescue plans in Greece and Ireland) may be necessary, pushing the euro-zone deeper into debt.

So far this year, 18 developing economies have raised interest rates, but last week Australia, Britain and Japan decided to leave their interest rates alone. On Tuesday, Australia announced a surprising February trade deficit – due largely to Queensland’s devastating floods — so it is no surprise that Australia left its key rate unchanged at 4.75%. But the Bank of England surprised observers by leaving its key interest rate unchanged at 0.5%, despite the fact that inflation is now running at 4.4%, more than double it 2% target. Also, Japan’s central bank left its key rate at 0% in the wake of its devastating earthquake and tsunami.

The global power shift now favors currencies with higher interest rates and rich deposits of high-priced natural resources, such as Australia and Brazil. Last week, the dollar lost 2.7% to the Brazilian real and 1.4% to the Australian dollar. Since last May, the U.S. dollar has fallen 23% to the Australian dollar and 16% to the Brazilian real, but last Wednesday, Brazil’s Finance Minister Guido Mantega proposed a series of currency controls, including an extension of a 6% tax to keep U.S. dollars out of Brazil, to slow the real’s appreciation. Mantega seemed outraged that rich countries like the United States are fighting a currency “war” to keep the dollar weak, causing a rush of capital into currencies throughout the developing world.

From our perspective, a weak U.S. dollar is clearly stimulating U.S. economic growth and boosting corporate profits, especially in multi-national companies. That is the good news. The bad news is that most of the world’s commodities are priced in U.S. dollars, so commodity prices continue to rise as the U.S. dollar falls. However, the stock market is shrugging off this threat, since a weak U.S. dollar also boosts earnings of many companies with overseas operations, making stocks a great inflation hedge!

Speaking of inflation, the minutes from the Fed’s Federal Open Market Committee (FOMC) meeting on March 15 were released last week, and it was crystal clear that the inflation “doves” remain in charge of the FOMC. In fact, the FOMC minutes discussed how the Fed “saw no need” to stop quantitative easing. They also openly discussed how the Fed might have to keep interest rates near zero well beyond 2011!

Only a minority of FOMC members discussed the possibility of raising key interest rates. The FOMC minutes dismissed these dissidents by saying that “a few participants indicated that economic conditions might warrant a move toward less accommodative monetary policy this year,” while adding that “a few others noted that exceptional policy accommodation could be appropriate beyond 2011.” The Fed seems to be ignoring any inflation threats, because they know that higher rates would increase the cost of debt service for the federal government’s $14-plus trillion deficit, thereby offsetting any potential spending cuts.

In the meantime, Fed Chairman Ben Bernanke implied that inflation is just a temporary nuisance, saying that commodity prices are being driven primarily by global supply and demand. Mr. Bernanke thinks that rising commodity prices do not represent a foretaste of accelerating inflation. Specifically, he said, “I think the increase will be transitory, that it will pass, and we will go back to a level of inflation that is consistent with our price stability mandate.” But in truth, gold and oil are not rising that much in terms of stronger currencies like the Brazilian real or Australian dollar, so commodity price inflation is not just “supply and demand,” but the sinking value of the currency in which these commodities are quoted.

The Fed Chairman also predicted a high level of foreclosures in 2011. Since the Fed is in charge of the banking system, it must remain accommodative until the banking industry cleans up its bad loans, which may take years, due to the fact that 11% of all homes in the U.S. are unoccupied. Mr. Bernanke said that he hoped foreclosures would start to fall in 2012, but until the foreclosure activity dries up, the Fed will likely remain very accommodative, since its key job is to keep the banking industry afloat!

This week, we will see the major March inflation indicators released (Producer Prices on Thursday and Consumer Prices on Friday), along with March industrial production and retail sales. It will be interesting to see how the Fed downplays any high-and-rising inflation numbers. How much longer will the Fed choose to protect our weak banks and profligate government at the expense of the once-King Dollar?

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