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Cue the Helicopters – Dollar Devaluation is Here

“Cue the Helicopters – Dollar Devaluation is Here” March 24, 2009

The world’s financial powers seem to understand that the U.S. needs to print its way out of this mess.

In my column on Dec. 9, 2008, “Dollar Devaluation To Fix The Great Recession,” I suggested that the government consider an overnight devaluation of the dollar as a fix to sagging asset prices. The response was about equally weighted by those who wanted to know more about how it might work or be accomplished, those who thought it was brilliant and the “I am 100% cash” group, who suggested I might be the most ignorant, if not stupidest, person on earth. At this time, I’d like to offer a little more in the way of explanation, or perhaps aggravation.

I still contend that we are headed for a massive dollar devaluation, regardless of the means–whether it is planned and accomplished by central banks, or by the markets reacting to huge government money printing that force the devaluation. Unlike during the Great Depression, we are no longer on the gold standard. Currencies are free to float and can be manipulated by central banks or politicians and moved by markets. In fact, I believe that one or both has already begun

In early December, Treasury Secretary Henry Paulson traveled to Beijing to encourage the Chinese to strengthen their currency (devalue the dollar versus the Chinese renminbi). Our Federal Reserve chairman, Ben Bernanke, then surprised most everyone by effectively moving the Fed funds rate to 0%, another move to devalue the dollar. Coming next, a new Bretton Woods?

The G-20 met in November, scheduled another meeting for April and in the weeks following the November meeting, physical gold all but disappeared. Are central banks buying gold in preparation?

In normal times, you might expect a global financial meltdown to cause a tidal wave of foreign currency exchanged for dollars. But this time, the dollar has rallied less than 20% against the highs of the euro and has actually lost more than 20% against the yen while staying flat against the Chinese renminbi. If that is the best the dollar can do at the height of panic, I expect that you will see it gradually lose its luster until either the central bankers, or the markets, push it off the cliff.

Perhaps you’ve already given me the benefit of doubt that the markets might react this way, but are you wondering why central bankers would want the dollar to devalue? Wouldn’t that be bad for export countries like China or Japan? In a way it would. Certainly it makes their products more expensive for U.S. consumers (so you might want to stay away from foreign exporter stocks).

On the other hand, if you want to sell some of your exports, it might be reasonable to keep your best customers alive, even if it means selling to them at somewhat thinner margins. China is still building its domestic market, but it is growing quickly, so they can take a small lump or two on exports. A stronger renminbi will allow China to buy oil and other necessary commodities at a relatively cheaper price, offsetting some of the price reduction. And with another billion people to incorporate, they will still be the cheapest manufacturer of many products for many years to come.

If that were not enough, consider China’s good fortune. For years, China has invested heavily in U.S. Treasury bonds while its currency and global inflation have grown at a much higher pace than the interest rate they received. It was simply a cost of doing business while growing an economy. In the last couple of months, that “cost of doing business” has turned into a huge profit opportunity, at the handiest of times. As worldwide panic set in, the money that flowed into the dollar was concentrated in Treasuries. By mid-November, the 30-year was priced at more than 40% over par value–a $1,000 bond was selling for over $1,400! If you wanted some money for your own stimulus plan, and you wanted to keep your customer on life support by devaluing the dollar, you simply could not ask for a more fortunate event.

I am constantly amazed that so few reporters ask the question, “Where is the money to bailout banks, Fannie Mae (nyse: FNM – news – people ), Freddie Mac (nyse: FRE – news – people ), homeowners, the auto industry, not to mention for a pork-filled stimulus bill going to come from?” The answer, of course, is simple. The government has a printing press, and the result will be that our currency must and will decline.

With the devaluation of the dollar, asset prices will re-inflate. Real estate will again be worth more than the underlying mortgages. Everything from your parents’ Oldsmobile to gold and stocks will rise in value relative to the dollar, but debt remains the same. If the dollar devalues by 30%, it takes $1.43 of those (70 cent) dollars to buy the same amount of any asset. Take my December example of a homeowner with a $250,000 mortgage on a home that is only worth $200,000. After the dollar drops by 30% and the resulting 43% inflation of asset prices, the same home will sell for $286,000 but still have a $250,000 mortgage. Now, that homeowner has a new incentive to make payments and keep the home, or sell it for a profit.

The weaker dollar will make U.S. manufacturers more competitive overseas, bringing more (nominal) money to more American families. At the same time, it means stronger consumers for foreign goods. Interest rates will rise, giving fixed-income investors a better return.

You just cannot be 100% cash in this environment. It is not a safe investment, and it is not diversified. Don’t e-mail me your complaints about the impact it will have. I did not create this situation. In fact, I’ve been warning it was coming since early 2006. It is here. If you avoided some of the market carnage by going to cash, you are to be congratulated. Just don’t think you’re done now.

The chances of an aggressive money-printing program may be greater than you want to believe. The Nobel Prize-winning economist, Dr. Milton Friedman, wrote of exactly this solution for the type of problems we are encountering. Fed Chairman Ben Bernanke has also referenced this option on how the Fed and Treasury could print our way out of a deflationary economy.

The world wants inflation, and I think we are about to get it. When we get it, you will see gold, stocks, real estate and other assets re-inflate. I’ll end again with my favorite old Saturday Night Live skit that says, “Think of inflation as your friend. Wouldn’t you like to wear $1,000 suits and smoke $100 cigars? I know I would.”


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