News of the Dollar's Demise Continues to Create Headlines: Federal Reserve Money Policy is Failing

Two new stories today about the weakening dollar. Thanks to the Federal Reserves massive printing operations justified by this pseudo belief its needed to save Obama's economy, the dollar is worth 8% less than it was a year ago. The news gets worse. This from Euro Pacific Capital:

The U.S. trade deficit increased by 5.9% to $40.6 billion during the month of December, which was up $38.3 billion from the prior month. For the year 2010, the trade gap surged 43%, which was the biggest jump in a decade, as our government’s efforts to reignite consumer borrowing and spending led to a record number of imported consumer goods. For all of 2010, the trade gap climbed to $497.8 billion, up from $374.9 billion in 2009. The Commerce Department reported that consumer spending rose at an annual rate of 4.4% in the fourth quarter of 2009. That increase—which was the biggest in four years—was led by a surge in imports and helped send the trade gap back onto its unsustainable trajectory.

Despite the fact that the U.S. dollar has fallen 8% since June of last year, the trade deficit has continued to widen. That’s because the inflation caused by a falling dollar has made it more expensive for foreigners to importer U.S. made goods—thus offsetting the increased purchasing power of their currencies. And, of course, the cost of U.S. imports has increased because there is no immediate domestically produced alternative to foreign made goods. Therefore, the U.S. trade imbalance continues to climb higher.

That economic truth ushers in the fear over how much wider the trade gap will grow once the dollar actually crashes, as it inevitable must. Why must it crash you ask? Simply because the U.S. is incapable of paying its debts without a massive dilution to the currency. Once the greenback loses its place as the world’s reserve currency, prices will skyrocket for our imported goods, thus sending many more dollars into foreign control. And send the red ink associated with our trade imbalance beyond the limits of what most economists could ever conceive to be possible. And before anybody tells you that a trade deficit isn't something to be concerned about, ask them if they don't mind selling a great proportion of the assets and the sovereignty of the nation to another country.


Then this from Peter Schiff:

Based on his recent public comments, Fed Chairman Bernanke seems determined to give the U.S. dollar the reputation of Egypt’s Hosni Mubarak: an unwanted relic of the past that everyone agrees must go, but stubbornly clings to a privileged position. The dollar is currently the world’s ruling currency, but, as with Mubarak, I believe that growing public discontent will spur regime change quicker than most pundits expect.

Clearly, the most significant problem facing central bankers around the world is the recent eruption of inflation, which is sparking unrest in Asia and the Middle East. With respect to this issue, Bernanke is alternating his responses through two different personas.

Sometimes he chooses to act like Baghdad Bob, the Iraqi Information Minister who, in the opening days of the 2003 invasion of Iraq, continued to deny the presence of American troops even as U.S. tanks rumbled behind him. The parallel to Bernanke's testimony to Congress today is striking.

Speaking to the House Budget Committee, Baghdad Ben not only claimed that there is no evidence of overall inflation in the U.S., but that even food and energy prices are rising less than 1% annually. This is simply not true. He then claimed that the Fed’s massive QE purchases of U.S. Treasuries do not distort the yield curve, despite the fact that he has stated repeatedly that the program was specifically designed to lower long-term rates.

The reason behind these lies should be evident. Acknowledging inflationary threats would force him to raise rates. But Baghdad Ben knows that the current economic “expansion” is a lie built on a weak foundation of ultra-low interest rates. He knows that even marginally higher rates will trigger a savage return to recession. In his view, the only choice is to sell us an elaborate fiction – even when it obviously conflicts with the facts.

At other times, Chairman Bernanke assumes the persona of Marie Antoinette by professing regal indifference to how his own actions negatively impact the great unwashed. In a rare Fed press conference last week, Bennie Antoinette showcased this “let them eat cake” attitude by declaring that U.S. monetary policy is solely designed to benefit the U.S., and that any adverse consequences in other countries are not his problem. As a result, he broadly absolved the Fed of any blame for global inflation, putting it instead on foreign governments for not allowing their currencies to appreciate and for keeping their interest rates too low.

It is this type of attitude from our top monetary policy maker – to either deny inflation or to lay blame elsewhere – that will accelerate the day of reckoning for the dollar.

Amazingly, for all its flaws, the buck remains the world’s reserve currency. So, for now, the U.S. continues to enjoy all the rights and privileges that come from that status, including lower consumer prices and lower interest rates. But along with those benefits comes the great responsibility of not conducting monetary policy in a vacuum. Since the dollar is the benchmark currency, when it is debased, other currencies must follow suit. Because of the massive printing effort underway for some time now, the dollar has gone from an instrument of stability to an instrument of inflation.

A reserve currency must not go on in perpetual decline. Since abandoning the dollar as a reserve implies radical change with unknown consequences, governments have been very reluctant to take the chance. So, they are acting to preserve the status quo. But, in so doing, they're creating inflation in their own countries. Unfortunately, this strategy may prove more risky in the end.

Other factors are also influencing foreign central bankers to stick with the devil they know. For one, as emerging markets compete to export to the United States, no one wants to surrender what it perceives to be its competitive advantage. None of these governments yet understand that if the dollar were to collapse, new customers would be instantly created in those countries whose currencies appreciate against the dollar.

Emerging markets also feel obligated to protect the value of the trillions of dollars that they already hold in reserve. Like traders throwing good money after bad, their instinct is to average down their cost of their position. The reality is that the more dollars they buy, the more they will ultimately lose. Once they realize that the rise in their own currency will more than offset their dollar losses, they will cut their losses and run.

When emerging-market governments decide they do not want to eat Bennie's cake, but rather keep their own bread prices from rising, they will have to pursue the tighter monetary policies. When that happens, the dollar will lose its reserve status.

When the rest of the world no longer links their currencies to ours, the Fed will truly not have to worry about fueling global inflation. Instead, all of its inflation will burn through our banks accounts right here at home. And that blaze, so concentrated, will burn a lot hotter than the fires we see abroad.

The bottom line here is this continued belief the central bank known as the Federal Reserve printing money is going to fail. The dollar continues to drop in value, and yet Bernanke continues to print. Eventually you have all this paper floating around that has now value, which we are starting to see as the articles note inflation is starting.