Why a Weak Dollar Isn't Good for America

This week, Bloomberg ran an item announcing that, "China's trade surplus almost doubled in the first quarter, adding friction as the U.S. takes complaints against its second-largest trading partner to the World Trade Organization."

In another item, Bloomberg said "The dollar's slide may be coming at the right time for U.S. Treasury Secretary Henry Paulson and European Central Bank (ECB) President Jean-Claude Trichet.

The item goes on to explain how American exports are helped by a cheap dollar. It then adds, in stark contrast, that the ECB are content to see a high euro (of $1.3442) because it will help the ECB to fight European inflation.

All these items are interlinked, but we believe the reasoning as to why a weak dollar suits both the U.S. and the European Union (EU) deserves examination.

It is well known that a weak currency initially makes a country's exports relatively cheap and more price competitive, boosting overseas sales.

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However, in the longer term, history shows that a weak currency allows internationally uncompetitive corporations to accept higher domestic costs and pass them off on relatively cheap exports. This export of domestic inflation is represented by the initial down-stroke of the letter "J".

[Editor's Note: Cash in on Dollar Slide. Make 25% to 50% in Six Months.]

A weak currency also makes the price of imports increasingly expensive in terms of the weakening domestic currency. This is represented by the up-stroke of the letter "J".

This so-called "J" curve shows that a weakened currency is advantageous in the short term, but is highly inflationary in the longer-term. From this we can see that the ECB are correct. A stronger euro will indeed prove anti-inflationary in the longer-term. It will also help to force public acceptance of corporate restructuring, which the EU so sorely needs.

The exports of corporations that fail to restructure become increasingly uncompetitive and they either become taken over by more competitive companies or face bankruptcy.

From our American point of view, a weaker dollar spells pain relief in the short term, as exports become more price-competitive, but agony in the longer term as the "J" curve becomes reality as inflation takes hold and U.S. interest rates are forced to rise.

As we have said repeatedly to our readers that "stealth inflation" (far higher that the politically "cooked" CPI figures) stalks our economy.

[Editor's Note: Lou Dobbs: Inflation Numbers Lie!]

We believe the Fed is aware, at least in part, of stealth inflation. That is why Fed Chairman Bernanke is so concerned about inflation, even in the face of a housing slump and economic recession.

As we have told our readers, inflation and recession at the same time, add up to the worst of economic woes, stagflation.

The sad thing is that, facing stagflation, our Treasury and Federal Reserve Board are allowing the dollar to continue an ever speeding slide.

This keeps much of corporate America happy as exports climb on the back of our floundering greenback.

Meanwhile, our domestic economy continues to ease towards recession.

We feel that it will not be long before inflation becomes so strong that it will become obvious, even in terms of the politically "cooked" CPI figures.

By then, stagflation will have taken a firm hold, heralding a long period of high interest rates.

Meanwhile, despite the falling dollar, our trade deficit with China continues to mushroom like a giant economic nuclear cloud.

It appears that, the lower our dollar falls, the higher our deficit with China climbs, from a shocking record of $177.5 billion last year.

[Editor's Note: What Happens When Easy Money Disappears? 12 Ways to Profit.]

How so?

Well, as Stephen Roach, the internationally acclaimed chief economist of Morgan Stanley, has long warned, "It's the relative savings rate, Stupid, not the currency."

We strongly agree with Roach, but our Congress and many in our mainstream media appear to give Roach little attention.

As Roach points out, the Chinese save most of their income, leaving little spare cash to spend upon luxury (non-domestic) imports.

On the other hand, we, in America, tend to spend all we earn and then some, as we raise massive debts on our inflated house prices. We have plenty to spare on buying masses of even cheap imports, especially form China. This phenomenon has served to keep our economy growing, with record corporate profits and "apparently" (by means of a politically "cooked" CPI) very low inflation, allowing for continued unrealistically borrowing rates and yet more consumer debt.

For electoral reasons, our Treasury (and possibly our Fed) appears willing to allow us to continue on this imprudent spending spree, even if it results in massive economic hardship for our children. Some might even be tempted to say that the European Union's present experiment with "Post Democracy" may have something to it!

So there you have it. A weaker dollar reflects an increasingly skeptical collective international view as regards the economic viability of current U.S. economic policy.

To do nothing to correct our economy, including our massive off-balance sheet social security obligations and a chronically low savings rate, will prove disastrous in the long term.

In the short term, a weakening dollar will dull the pain of reality and make us feel good, hopefully (probably our leaders think) until the next election!

[Editor's Note: 2007: Year of Financial Reckoning? Why the Dollar Could Crash and Gold Skyrocket This Year.]

In short, the ECB is correct, a strong euro is anti-inflationary. Our leaders, on the other hand are leading us on a path towards economic pain. They appear more willing to give us economic aspirin rather than face the electoral risk of telling us the truth.

Historically, a slowing American economy has exerted inflationary influence.

Even a short look at the U.S. Treasury market, appears to show that bond investors are now, at long last, beginning to see a real risk of inflation. This message may even force the Fed's hand, against the Treasury's wishes, in raising rates on May 9.

Such an increase in the Fed funds rate would help the U.S. dollar; be anti-inflationary; put us in a better position to fight stagflation; but hurt both the long-term bond markets and our stock markets, as reality is allowed to dawn.

In the meantime, we stand firm with our recommendations to our most conservative readers: This is a time for patience, not greed. Continue to give heavy asset allocation weightings to cash, high quality, high coupon, short-term bonds/CDs, and gold.

Editor's note:
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