Stagflation and Falling Dollar

[powayseller]

Peter Schiff:

As the U.S. economy contracts, the Federal budget deficit will grow and the perceived appeal of U.S. financial assets will be lost.

As a result, foreign capital will flee at precisely the time it is needed the most.

This will put additional upward pressure on interest rates, further increasing mortgage rates, suppressing real estate prices and consumer spending. More importantly, it will also cause the dollar to fall, making imports more expensive and pushing up raw material prices, thereby increasing production costs for domestic manufactures as well.

As the dollar loses value relative to other currencies, foreigners will be able to outbid Americans for scarce consumer goods. As a result fewer products will be imported into the U.S. and more of America’s domestic production will be exported. Therefore, despite the fact that financially strapped Americans will be consuming much less, they will be paying much higher prices for the privilege of doing so.

[PerryChase]

I remember on the plane meeting an elderly British lady on holiday. She was telling me about the “good old days” of the early Thatcher years with sky-high interest rates. Remember 18% mortgages? That scenario is great for elderly retirees who own their houses free and clear. They can simply leave their savings in the bank and go on holidays.

[North County Jim]

PS,

There are some pretty sharp people out there taking the other side of that trade.

The PIMCO crew, just to name one, is very bullish on treasuries.

…foreigners will be able to outbid Americans for scarce consumer goods.

What consumer goods are, or will be, in short supply? You can make a case for a scarcity of commodities but it seems to me the world is awash in consumer goods.

[powayseller]

PIMCO has been wrong for a year now. I don’t follow him any more, since he’s been wrong too many times. What I do like about McCulley is that he admits he’s been wrong. Maybe his business sways his outlook.

[sdduuuude]

Sounds like a good theory – but I think this is a necessary path, not necessarily a bad thing. Painful, but not bad.

[qcomer]

I don’t understand how Schiffer is implying that rising interest rates will cause the dollar to fall. Currency traders are most sensitive to interest rates. The dollar fell 40% vs Euro in 3 years before the Fed started raising rates and since then it has stayed its ground vs Euro in almost 2 years. The budget deficit in the mean time has grown and grown but hasn’t been able to hurt dollar while rates have been rising. Also, if the dollar falls, then after a transitory period, US exports will grow reducing the trade deficit. This will help dollar as well as economy. Moreover, falling dollar will boost real assets like housing keeping the prices up though value may go down. There are just too many confusions for me in this post.

Also, traders and hedge fund managers have been betting on a dollar decline for nearly 4 years now. Consider that as there is huge amount of money shorting dollar. Any short squeeze can result in unexpectedly boosting the dollar. Same happened to Yen in 1996-1998 when everyone was short on Yen.

US economy, dollar, housing, bond and stock markets are all very delicately poised. Things are definitel going to get ugly but by how much, is difficult to say. Whether we hit stagnant economy and rampant inflation is potential possibility but not a sure bet.

[equalizer]

The dollar crash crowd has been wrong for so long that I doubt it will crash. The Chinese cant afford for the dollar to crash and cause their stores(walmart) to lose customers. The Chinese and Japanese will protect the dollar.

[rankandfile]

It is assumed (at least in a market system) that producers produce enough product to be purchased within a reasonable amount of time. The costs to carry excess inventory, in most cases, outweighs the benefits. Or so this is the thinking. In other words, producers produce just enough goods that will be purchased by willing buyers, hence they are scarce and will go to the highest bidder. Then again, I am not an economist.

[Anonymous]

Chris Johnston

Jim,

I discussed this in my blog yesterday, that is the rally that is taking place in the 30 yr bonds. On a short-term basis for now, Gross has been right on the money. The 30 yr has rallied right from the day he made the comments. Maybe he moved this mkt some himself?

I pointed out that if we get above 10814 the downtrend in price (uptrend in rates), will be broken. It is what it is. The theories may say rates should be rising, but they are dropping at the moment on the long end.

[powayseller]

I don’t understand how Schiffer is implying that rising interest rates will cause the dollar to fall.
That’s NOT what he said. He said that the falling dollar will put upward pressue on interest rates. Whenever the Fed is done, we get a stock market rally and the dollar falls, because investors in the dollar think they can get a better return elsewhere.

equalizer, the Chinese and Russian economists have been quoted all year about their concerns of the falling dollar and their need to diversify out of the US dollar. Japan propped up the dollar a few years ago with the yen carry trade, which injected $300 billion into US Treasuries. Global central banks are tightening now, so a liquidity injection to buy dollars would go counter to their current monetary moves, and I think they cannot do it. How do you think those countries could save the dollar?

[Daniel]

For now, the bond market seems to believe that inflation is not likely to be a significant problem in the future. However, it is telling us pretty clearly that a recession is around the corner.

[qcomer]

This is what the post reads:
“As the U.S. economy contracts, the Federal budget deficit will grow and the perceived appeal of U.S. financial assets will be lost. As a result, foreign capital will flee at precisely the time it is needed the most. This will put additional upward pressure on interest rates, further increasing mortgage rates, suppressing real estate prices and consumer spending. More importantly, it will also cause the dollar to fall”

It seems like he is implying that as foreign capital runs away from the US markets it will cause 1)higher rates 2)weak dollar. Sorry but I don’t believe both can happen at the same time right now. BTW, what will happen to housing prices when dollar falls to dear lows? Also, bearish housing sentiment and stagflation expectations are kind of contradictory as housing assets will beneft from falling dollar.

People looking backward at the 70s stagflation generalize too easily. If you let inflation go out of hand then you can have stagflation where you have to raise rates despite economy already reeling from high prices stripping consumers. So the key is not to let inflation run rampant and I believe as long as Fed REALLY prioritizes controlling inflation as top priority then we probably won’t hit stagflation. As I said before, there is more downside risk but there are no sure bets.

[powayseller]

qcomer, the dollar falling only affects the exchange rate, I think. It will increase our exports and make imports more expensive, but it shouldn’t change housing prices, unless interest rates are dramatically affected by the Fed changing them to keep FCBs buying Treasuries again. So I don’t see how a falling dollar affects housing.

I think we can have higher rates and a weaker dollar. As soon as the Fed stops raising, FCBs could stop buying Treasuries. They will instead buy assets in countries with stronger economies (less debt, more exports). We could have 7% Fed funds rate and a falling dollar. It’s certainly possible. The other countries are getting nervous about having so many US$, and want to diversify. This can cause them to sell dollars, and that makes the dollar weaker.

I think the Fed will keep raising rates as long as commodity prices are rising and feeding through to producer and consumer prices. They have to avoid letting inflation take hold. I am surprised that inflation signs are still showing up. Do you think they will stop in August?

[Author]

Posts