Money Pumpers Facing Crunch Time!

While nearly all eyes on Wall Street were riveted to the Dow’s 315-point decline yesterday, the action in the U.S. dollar was even more dramatic, plunging to new all-time record lows!

But I still don’t believe we’ve reached panic time just yet. In other words, you should be open to the dollar going even lower.

I say that because of the price action across the board, and the fact that investors are rushing into commodities. Let me explain …

U.S. Policymakers Continue Trashing
The Greenback with Reckless Abandon

The dollar has been on an ugly path for seven years now. And you know what? The guys in Washington are okay with that. It has allowed them to spread dollars all over the globe.

Effectively, they’ve been juicing global asset markets. Because the dollar is (or should I say “still is?”) the world’s reserve currency, it is the legal tender of global trade and international payments. The more dollars sloshing around the globe; the more the wheels get greased.

But, there is ALWAYS a limit to the policy of never-ending credit expansion.

And history has told us that when this limit is reached, it always ends badly. I think this view is beginning to take hold in the minds of investors.

After reading thousands of financial books over the years, I can say that I have found no one who summarizes the inherent danger of credit expansion — which is now the full-time job of central banks and governments in the West — better than the late, great student of Austrian economics, Ludwig von Mises:

Ludwig von Mises

“Sooner or later, credit expansion, through the creation of additional fiduciary, must come to a standstill. Even if the banks wanted to, they could not carry on this policy indefinitely, not even if they were being forced to do so by the strongest pressure from outside. The continuing increase in the quantity of fiduciary media leads to continual price increases.

“Inflation can continue only so long as the opinion persists that it will stop in the foreseeable future. However, once the conviction gains a foothold that the inflation will not come to a halt, then a panic breaks out. In evaluating money and commodities, the public takes anticipated price increases into account in advance.

“As a consequence, prices race erratically upward out of all bounds. People turn away from using money which is comprised by the increase in fiduciary media. They ‘flee’ to foreign money, metal bars, ‘real values,’ barter. In short, the currency breaks down.”

I think this past week gave us a real taste of exactly what von Mises refers to in the end of the above passage.

So we may not have been in a dollar panic, but one thing was clear …

Rising Inflation is Sparking
A Mass Exodus Out of Dollars
And into Hard Assets

You’ve got to marvel at the power of money pumped out by central banks and governments; both in its ability to stoke the flames of investment and prices.

Milton Friedman, another of my economic heroes, nailed it when he said, “Inflation is always and everywhere a monetary phenomenon.”

With the fed funds rate making a beeline toward the basement, and the Federal government tripping over itself to get “our” money back to us, cash is pouring into the system.

These money pumpers know full well that leaving the spigots wide open leads to inflation. They just act surprised when prices actually do float higher. But it’s the implicit tradeoff that they hope will save the U.S. economy: Sacrificing inflation at the altar of growth.

This week we saw that on display during Fed Chairman Ben Bernanke’s two-day testimony on Capitol Hill. He reiterated the Federal Reserve’s focus on economic weakness even though a nasty report showed wholesale prices in the U.S. rose at the fastest year-over-year pace since 1981.

The whole thing has left investors with a nasty taste in their mouths. They know that wholesale price increases will soon seep into consumer prices. And that’s no fun!

And yet expectations are calling for FURTHER interest rate cuts!

Look, purposely debasing the currency at a time like this is akin to juggling champagne flutes on a rollercoaster. There’s a high risk of damage, especially when there are two structural concerns looming:

Structural Concern #1: Dollars for Oil

Crude oil is priced in dollars. So as the cost for black gold rises, more and more dollars are sent to the world’s oil producers. At this point, the largest suppliers are swimming in pools of green cash.

And even though they keep filling up the pool, the value of their cash is being sucked down the drain.

The consequence: Oil-rich nations will start to unload their dollars.

And no matter what they trade into — euros, gold, or even granny smith apples — you can bet the dollar’s slide will intensify.

Structural Concern #2: China Importing U.S. Inflation

China plays an awfully large role in U.S. trade. Large enough that it’s important to monitor the changing dynamics between the two countries.

Right now, China’s currency is creeping higher against the dollar, as it is still pegged to the buck. That means China can buy less with its yuan.

And the timing couldn’t be worse: China is dealing with inflation of its own, especially in food prices. Every time the dollar falls, China’s food and energy costs go even higher.

So it’s in China’s best interest to let its currency rise at a faster rate. That would send inflation back where it came from — the U.S.

All of this could pressure the dollar even more!

The promise that money will continue to be pumped into the system has refreshed confidence in global growth and appears to have sparked new demand for hard assets.

Result: Commodity prices are moving higher while the dollar is moving lower.

The fear of irrepressible inflation is driving everything!

The following chart tells the story quite clearly:

Hey, freeing up money for the American consumer and rescuing the credit market may seem like the right course of action to the Fed.

But they better stop ignoring the dollar’s status as the world’s reserve currency. If they continue down the path they’re on, there could be severe implications that are hard to undo.

Bottom line: Inflation has crept back up on us, and the money pumpers are facing crunch time!

Best wishes,

Jack

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