Inflation Effects On Dollar

Discussion in 'Forex' started by phenforum, Oct 4, 2005.

  1. Hey, I was wondering what effect Fischer's
    statement is supposed to have on
    the dollar value.
    He said inflation is at the Fed's upper limit
    and that they won't hold rates down.

    Should I expect the dollar to continue its uptrend
    or go down as a result of such talk?
  2. In a vacuum (if you took out everything else in the world that would affect the USD) that statement would cause the further strengthening of the USD. The higher inflation, the higher rates go. The higher rates go, the higher the cost of lending is, and the more money to be made in holding USD denominated instruments in yield.

    In theory, of course.
  3. plugger


    Inflation will make the dollar stronger as long as the Fed is looked upon as credible. That is, they will raise interest rates to choke off inflation as the situation dictates. As soon as the Fed fails to meet market expectations on inflation control, watch out. The Fed will lose all credibility that started with Paul Volcker and the dollar will most likely have a very sharp decline.

    Let's see how resilient Greenspan is. I think the Fed is in one tight spot. If it keeps up the rate increases, it wins on inflation but sinks the economy. If it stops raising rates, it loses all credibility with the market, long term yields spike and the dollar sinks. Hmmm...
  4. You all pretty much kick ass because you
    can share some economics knowledge
    with me.

  5. Plugger, don't hold your breath on thinking Greenie will lose credibility. The man has been a near-genius to the US economy and has gotten the US out of an infinite of tight spots many times before.

    We'll see what the new guy does, but Greenie - nah, homeboy's got game.
  6. plugger


    Ivanovich, I disagree with your assessment of Greenspan, but I do think he'll do the right thing by raising rates as he rides off into the sunset. I don't think he's the genius he's been portrayed as by the press. He's been 'lucky' through a good portion of his tenure in the respect that inflation has been low and every time a problem arose, he was able to throw money at it (without the fear of an inflationary spike). I think the man was at his best in the early 90's when he wasn't afraid to make and implement the tough decisions.

    Good points you make, but I just don't agree.
  7. Understood. I forget the exact quotation and who exactly said it, but some percent of genius is made up of luck.
  8. "Don't confuse genius with luck and a bull market", maybe? That would be John Bogle, the founder of Vanguard, who's been fond of saying that through the 1990s.

    But when it comes to Greenspan, I can't help but think of the song lyrics,

    Old age and treachery
    always overcomes
    youth and skill.
  9. The way I see it, there's been some huge uninformed buying of the dollar that is just waiting for some big funds to take their bet. That point may not be far away now.
  10. kowboy


    Short term, it is the statements from the Fed and their current policy of raising interest rates to counter inflation and the current housing bubble that is perceived by the market as bullish for the dollar.

    However, as John Templeton and Warren Buffet point out, the trade deficit and US govt deficit will eventually cause the dollar long term to devalue against foreign currencies. My understanding is that Buffet is short the dollar long term. For example, it is felt by some that the actual rate of inflation far exceeds that published by the Govt., with some estimates as high as 6 to 8%.

    Part of the equation is the exponential expansion of the money supply M3 and the need to exponentially expand US issued debt instruments in order to finance the deficit. The Fed has not been able to influence government to reign in the deficits. The role of the Fed has been a reactionary one of attempting to do the impossible task of inflating the money supply in order to finance the deficit but without giving the appearance of this causing undue inflationary pressures. But in fact, actually allowing and encouraging a degree of inflation to occur without saying so. One of the main functions of the Federal Reserve has been to devalue the dollar over time so that it's easier to pay back US debt instruments in the future with cheaper devalued dollars, while all the time giving lip service to controlling inflation. Also too much tightening of credit and higher interest rates all at once has the undesirable effect of slowing the US economy too quickly causing a possible slowdown. The Fed would rather have a robust economy at the expense of inflation.

    From 1980 to today, M3 has inflated five fold. Not being an economist I understand this in simplistict terms. In 1979 I purchased a new 1/2 ton 4x4 pickup for about $6500. The same pickup today I'm guessing is about $35,000. About a five fold increase in the cost for the same product. This would equate to a devaluation of the dollar in real purchasing power of only 1/5 of what the dollar would buy in 1979. This is equivalent to an average annual inflation rate of 6.4% throughout the entire 26 year period.

    So the question is: would your assests do best in dollar related instruments for the short term? Then when the Fed has overcorrected, as it inevitabley always does, with high interest rates causing the economy to slow down, and requiring the easing of credit, at which point you would be better off shorting the dollar or placing your assests in another currency such as the Swiss franc
    #10     Oct 5, 2005