Thursday, December 17, 2009

Focus on the Trade-Weighted Dollar Index, not the DXY

Much is made of the weakness of the Euro and perhaps the yen vs. the dollar. OK, these are frail currencies.

So the DXY artificial, limited dollar index is rising. Reflexively perhaps, gold and stocks have fallen today. However, the real world has currencies to exchange in trade in goods and services. The St. Louis Fed keeps track of the broad, trade-weighted index. The nearby chart shows this visually (click on it for greater detail).
There has been NO rebound in the dollar as a currency when measured in terms of trade balances. It remains a flawed currency with dangerous fiscal policies and a Fed whose balance sheet contains an unknown quantity of impaired assets.
The zero interest-rate policy is suppressing value of the dollar where it counts, in trade. This is one of the sources of the fake boom/boomlet now underway that economists/personalities such as Larry Kudlow tout and serious players such as ECRI point out.
The downside of all this is price inflation. It's a classic trade-off. Now that the trade-weighted dollar index is around 100, where it was 2 years ago, recall what inflation was doing 2 years ago. Gold was surging to hit above $1000/ounce in March 2008; it is only up another about 10% since then despite all the financial chaos and money-printing.
If the economy has actually turned and employment is going to finally rise significantly (something not noticed by ordinary workers per the poll as recently as today's report), price inflation is going to far exceed interest rates paid by money market funds or most bank accounts. This will lead to more and more speculation in financial instruments. Only tight regulation (absent) and/or much higher real interests is likely to prevent said speculation.
The speculation here is that precious metals will be a beneficiary of price inflation that exceeds prevailing short-term interest rates, and that should inflation equal or exceed the 5-10 year Treasury interest rate, all heck could break loose, including new records in a variety of commodities.
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