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« US Dollar Rally Falters: Good For Gold Prices | Main | Barrick Gold Corp Shows Heavyweight Gold Stocks Can Move »

The Other Side of the Coin: Strong Dollar

We like to present our readers with balanced arguements to aid them in making sound investment choices, so at times it helps to hear from a different point of view.

The following is an article by one of our readers, Rob de Graaf, and is not the view of however we are publishing it in order to add balance to the arguement and show a different viewpoint:

Why the Dollar Will Remain Relatively Strong and Hyper-Inflation is Not an Issue in 2009 By Rob de Graaf

Europe’s Stance
On the 30th Day of the Investor held in the Netherlands, there was no reason to fear for inflation in the forthcoming two years, according to Han de Jong, Head-economist of ABN-Amro. Along with the collaborating Central Bank efforts in Europe, Asia and the United States, the current crisis is not expected to evolve in a Great Depression that we saw in the early 1930’s.

Seen from perspective, probabilities are indeed low and the differences are clear;
• Policy makers are collaborating instead of embracing protectionism policies
• No significant currency devaluations expected…
• Major banks are not allowed to go bankrupt
• Government stimulus packages are injected to boost domestic economies

The populace accepted consensus is that the current economic stimulus measures are hyper-inflationary. Indeed this would be the case when money is simply ‘printed’ into the real economy. However, it should be clear by now that a significant deflationary force is present in the private sector and ultimately this is withholding inflation from running wild. Budget deficits of the individual nations are controlled to some responsible portion of their respective Gross Domestic Product (GDP). The European Central Bank (ECB) has its target inflation rate set at 3 percent of GDP and is moderate in implying sanctions towards its EU member countries that cross the threshold. As expected, chairman Trichet is unwilling to let inflation run wild. Overnight rate stands at 2.5 percent, as I write.

US policy
The Federal Reserve (FED) is continuing to maintain aggressive policy by artificially tax their (creditworthy) citizens by expanding the FED balance sheet almost 200 percent to $1.6+ trillion since September in relation to the $850 billion at the beginning of 2008. Not all of that capital has yet been flowing into the ‘real economy’ as you can see by selecting the hyperlink below. The light-blue base of the chart shows the actual currency in circulation.

FED liabilities chart
FED liabilities chart
(click to enlarge)

The amount of dollar currency in circulation increased by approx. 10 percent. The rest of the money ‘printed’ is hold by the FED in an attempt to avoid immediate hyperinflation. Until now, the deflationary outflow of capital from the private markets is considerably larger than the inflow of consumer credit, hence the continuous lowering of the target interest rate to 1 percent (from 5,25% on Sep. 2007) to stimulate corporate and consumer lending. So far, prices in T-bond market are soaring, with yields at zero and negative percentages for near-maturing bonds. Given the fact that investors are willing to park their money in treasuries at zero/negative bond yields, is currently predicting monetary deflation. Together with the ‘official’ CPI number, investors are actually losing real money in short-term bonds. Not even considering the extremely low yields for 30-year bonds from Treasury. Thanks to the FED, we have a new bond-bubble to collapse soon.

In my humble view, the FED is very anxious about monetary deflation and sequesters dollars to put in use when the overnight rates approach zero percent to counter the contracting money supply. The FED controls this inflationary weapon effectively for as long as needed until normal credit lines to consumers are restructured once again. There are balancing forces on each side of the equation. As long as the monetary velocity (basically, the speed of exchanging money in the financial system) remains low, there is no inflation to be seen anywhere. Not for as long the economy is contracting and consumers refuse to invest, borrow and spend.

You can't just look at the current money supply and pin down the prospects of future rampant inflation without considering that the Fed can pull back liquidity from the banking system before money velocity picks up again.

Creditors and debtors
From a debtor’s standpoint, inflation isn’t all that negative. As the money supply grows, each nominal dollar value declines in terms of the goods or services it can buy. The debtor can count on inflation to erode purchasing power over the life of a loan or mortgage and have the ultimate effect of decreasing their debt load in real terms. Debtors love this effect of inflation. Unfortunately, with Americans generally becoming a nation of inherent debtors, it is not surprising that politicians are almost all pro-inflation since debtors make up most of their constituency, government included. Creditors, on the other hand, count inflation as true evil. Over the life of a loan that a creditor grants to a debtor, inflation weakens the dollar and causes the creditor to be repaid in dollars worth less than the initial nominal value of the loan. Therefore, inflation robs real wealth from creditors. In the current environment this affects US foreign creditors in particular.

Manipulation of dollar and Gold
The Fed, as a private institution, has no obligation to report to Congress. In that way they can do whatever they want they think is right. Ben Bernanke knows all about printing dollars, and he shows how good he is at that. But you’ll have to give him more credit, because Bernanke does more than simply levering the printing press.

The Fed intends to feed money into the system, but at the minimum rate needed to possibly prevent the DOW index from staying under 8,000 for any significant period of time, therefore not triggering US banking laws that force banks to start selling and become insolvent. The FED consumes all those newly printed dollars ($1.2 trillion and rising), until the US Treasury has finished the major part of its funding activities at the lowest rates possible combined with a (temporary) strong dollar face value. Lowering the rates is done by buying back maturing short-term Treasury bonds and bills. This lowers the short term interest rate (in addition to the FED overnight lending rate) and indirectly lowers the middle to long term (mortgage) rates at the same time.

To learn more about all the government intervention techniques, I urge you to read this great article from James Conrad at Seeking Alpha. There Mr. Conrad has written a terrific piece, with the upmost correct vision about the intervening policies around the dollar and gold in which I strongly believe is unfolding today.

I would like to conclude with some food for thought;
After this massive deleveraging cycle, whether we avoid monetary deflation or hyperinflation, chances are we’re going to see a new type of financial system. Banking will become boring again. New regulations will allow banks to limit their leverage in the future. When you think about the effects of deleveraging, you must also think about stock valuations. Think about it. Stocks aren’t as cheap anymore as they appear to be. Stocks seem to be cheap at the moment, but are they really? Stocks are cheap when valued within the context of a financed economy once dominated by leverage, low interest rates and low corporate taxes. Those traditional days are over.

If you have any comments about the above article, please post them below!

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Reader Comments (11)

If my eyes don't deceive me, it appears that the dollar index has just completed a bearish head and shoulders pattern and looks to be headed down.

December 14, 2008 | Unregistered CommenterSidj

It certainly does Sidj.
It went down, it came back up, comes down again and continues to go down in the long run. Short term however, the dollar is in relatively strong demand caused by deleveraging. People need dollars to pay off their debt. For foreign investors, there is nothing more 'secure' than the dollar at this time, when around you all other currencies (some of them pegged) are losing ground also. Global recession.
Dollar is king of the hill until things get better again, or when people (creditors) lose faith in it.


December 14, 2008 | Unregistered Commenterde Graaf

Excellent piece! How long do you think this global recession will last and for how long will the dollar remain as King? Your comments will be appreciated.

December 14, 2008 | Unregistered CommenterLuchillo

Nice write up ... being a novice I just don't understand it.
It seems to me if the US dollar was allowed to weaken it would inspire their exports and it would strengthen some of these commodities that have been hammered down and this should spur the stock markets a bit.
I'm one of these guys that believes the economy is driven by a good stock market not the other way around. I also believe these big money managers screw the markets down which drives the economy down and of course they are making bundles whether it is going up or down ... I think the credit swaps kind of got them out of control this time but it still started by some of them deciding we needed to take things down and it snowballed.
Let's get that US buck back down and get the market moving up.

December 14, 2008 | Unregistered CommenterBill V

Luchillo, Bill, thanks for the kudo's.
I'm not really into predictions etcetera, because I'm not Peter Schiff who's got a tremendous analyzing ability in seeing this crisis ahead of time.
So therefore I'm just reflecting the things that I see (and analyze) happening around us. And try to communicate it towards you guys, so we can all profit from decent quality gold investments in the future. Keepin' it real.

Bill, do you see those three dots, after the line of text in my column where I wrote:
No significant currency devaluations expected...

Those three dots are placed there by me with a reason behind it. Because I think (for now), the only way for the US of A to come out of their debt liabilities (~$50+ trillion incl. Medicare), is to eventually devalue the dollar like every other currency-in-trouble had to do, that was loaded with debt in the past (Argentina, Ecuador, Russia, etc.)


ps; by the way, weakening the currency at this point (apart from investors fleeing out of the dollar etc) doesn't really help the US. There is a huge service industry, but 'nothing' being manufactured. They can't even build competitive cars at the moment... and with the world on its butt in recession, no-one will consume whatever there's left for export from the States.

December 14, 2008 | Unregistered Commenterde Graaf

looking at my scottrade site and typing in symbol udn which represents the powershares DB us dollar index DOWN - it shows last 5 business days this fund has been moving up meaning dollar has been moving down-- using screener that shows 6 month chart you can see in between november and december fund bottomed meaning dollar srength had topped out and is heading lower as is shown in the chart moving upwards [upwards movement in chart represents dollar moving downwards } ALSO typing in symbol uup which represents powershares DB US dollar index up { fund showing strength in the dollar } last 5 business days have shown downward movement -- representing downward movement in the strength of the us dollar - ALSO chart topped out in between nov and december and chart shows now is moving downwards ........for those looking for another way to make money in the decline of the dollar besides buying gold and gold shares you can also buy powershares db us dollar index down fund and profit from this downwards strength in the dollar caused mostly by the HUGE DEBT THE USA HAS and know that the bailouts resulting in the huge infusion of cash into the world economies will and has weakened the value of the dollar.......wil

December 14, 2008 | Unregistered Commenterwil

degraaf stocks stocks ARE cheap at the moment ...SEE the mass upwards movement in the market???? many are below or slightly above their 52 week low...duh... someone as smart as buffett said it was time to buy again and he said the market is close to a bottom on october 18 of this year.....stocks are cheap when people start buying them again in huge numbers like they are doing now! NOT because they are valued within the context of a financed economy once dominated by leverage,low interest rates and low corporate taxes BLAH BLAH BLAH ... get real degraaf you really are full of yourself,you make it sound so complicated when really whats going on is so simple ........

December 14, 2008 | Unregistered Commenterwil

If things were all that simple as Wil says it is, then we obviously did not have all these kind of financial problems we see today. We wouldn't need high ranking economists like Bernanke and Paulson if what you say is true.

When thinking about stock valuations. Don't just think about commodities, because they are definately cheap.
I mean financials stocks, retail, REIT's, ETF's etc, in short; Nasdaq and Dow.
The type of investment bank like Goldman Sachs and JP Morgan etc. are disappearing in their current form. They are trying to buy themselves FDIC depository guarantees (read; commercial banks) and are attracting deposits to become an ordinary commercial bank holding or internet banks. This will limit their leverage potential from 35:1 back to 10:1 (regulations). This means there is going to be less money available, or it simply needs to be inflated with phoney money from the FED, but then the true face value will become worth-less.

Read this, to see how much money their is needed to catch-up with the losses due to deleveraging caused by investment banks;

December 14, 2008 | Unregistered Commenterde Graaf

Interviewed Monday last week on the "Trading Day" program of Business News Network in Canada, former Federal Reserve Governor Lyle Gramley hinted that a big upward revaluation of gold may figure heavily in the Fed's attempt to rescue the U.S. economy.

You can view this at:

The video runs 23.50 minutes, but for the people with less time available who do want to hear some 'hot items' I suggest to view just around:

8:00 minutes
12:00 minutes
15:30 minutes
22:00 minutes

But I recommend to view it in whole. A very revealing video in my opinion.

December 15, 2008 | Unregistered Commenterde Graaf

I forgot to post part II of above video. I added it below.
It presents us a more appropriate vision from professionals in regard to my views on the dollar related to gold.

This offcourse does not mean, that gold won't rally big. But the effect of the dollar on gold is not fundamental in my opinion for the 2009 rally in gold prices. Don't forget, I'm very bullish for gold on the long term. Short term however faces some pressures by FED and Central bank policy efforts.

Continue this video: at 15:40 min. where the gold forecast is being discussed. (ends at 19:00 min.)

This is exactly my stance on the dollar relation to gold.
Again, fundamentals for gold are not just driven by a weakening dollar in the current deflationary circumstances. Its just not that simple people.

Invest wisely,

December 15, 2008 | Unregistered Commenterde Graaf

degraaf the real MAIN REASON why we had financial problems and are still experiencing the repercussions of them is BECAUSE THE BANKS WERE NOT REGULATED- THE FED - BERNANKE AND PAULSON THE HIGH RANKING GOVT OFFICIALS WERE NOT DOING THEIR JOB ! REGULATING THE BANKS DUH! not enough regulation funds that were rated triple aaa contained within them junk bonds! duh! deriaviatives were not being regulated ! and yes the spending of money they didnt have - the mass printing over excessive printing of money i might add to fix all that ailed the economy--- big mistake when their was no REAL PLAN TO FIX THE ECONOMY JUST THE PRINTING OF MORE MONEY TO FIX IT ALL ! THATS JUST A PART OF IT DEGRAAF--I NEVER SAID IT WAS SIMPLE just outling the main reasons why the economic catastrophie occurred... gold prices do you dispute this also? things that you yourself pointed out that was going to lead to the economic catastrophy a long time ago? ...............................WIL

January 2, 2009 | Unregistered Commenterwil

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