Bernanke Mentions the Dollar

Fed Chairman Ben Bernanke spoke before the International Monetary Conference on Tuesday in Barcelona. In his talk, he discussed several aspects of the U.S. economy, including the value of the dollar.

On the housing front, Bernanke channeled his predecessor Alan Greenspan in suggesting that a “substantial increase in the net supply of saving in emerging market economies contributed to both the U.S. housing boom and the broader credit boom.” Bernanke’s reasoning there is that a “savings glut” freed up enormous amounts of capital that fed housing’s rise.

The problem there is that savings gluts are very much a misnomer. Owing to the basic truth that we live in a world of infinite wants with entrepreneurs ever eager to fill those needs, it seems more than a reach that entrepreneurs and businesses ran out of ideas in this decade.

More realistically, just as all roads used to lead to Rome, so does much of modern economic history lead to the dollar. When the latter began to weaken in 2001, commodities began their long rise upward. While it’s not a perfect inflation hedge, housing has historically risen with commodities, and with the greenback once again weak, capital rushed to the real; housing one of many “real” beneficiaries.

Bernanke suggested that the “housing boom came to an end because rising prices made housing unaffordable,” but it’s more truthful to say that inflation is always and everywhere an economic retardant. The falling dollar led to an investment slowdown that was going to inevitably impact both mortgage holders and those hoping to achieve home ownership with a mortgage.

That is so because in a world of limited capital, inflationary periods re-direct capital away from businesses and job-creating innovators. This explains why inflation correlates so well with recession and broad economic uncertainty, and in view of the falling dollar in recent years, helps to explain the malaise in the electorate. Inflation cuts in myriad ways, but most notably it reduces the value of our pay while at the same time reducing the amount of investment necessary to boost our income in order to keep up with inflation.

And when commodities are considered, Bernanke made plain that at least in his public model, the commodity boom is not related to the dollar. So while it would be folly to suggest that simple demand hasn’t played some role in the rise of commodities such as oil over the years, the fact remains that oil is up 344 percent in dollars since 2001 versus 130 percent in euros.

Rather than acknowledge the obvious; as in the miscreant role of the U.S. Treasury and Fed in the commodity spike, Bernanke persisted in his view that the commodity boom is a growth concept, suggesting that “commodity prices will level out, a forecast consistent with our expectation of some overall slowing in the global economy and thus in demand for raw materials.” Some reporter or politician in a utopian world might ask Bernanke in light of his analysis why the world economy and stocks boomed in the ‘80s and ‘90s alongside the collapsing price of oil and all other commodities.

And if there remains any uncertainty about what Bernanke believes, he added that, “the prices of a number of commodities, most notably oil, have continued upward recently” even though the foreign exchange value of the dollar has “remained generally stable in the past few months.” What Bernanke ignores is that the interplay between paper currencies reveals very little, particularly if they’re all weakening at the same time. Indeed, it’s perhaps due to Bernanke’s wanting commodity analysis that commodities only fell a slight amount in response to his dollar comments.

Regarding his dollar remarks, after suggesting that future rate cutting is on hold for now, Bernanke said the “challenges that our economy has faced over the past year or so have generated some downward pressures on the foreign exchange value of the dollar, which have contributed to the unwelcome rise in import prices and consumer price inflation.” He might have added that the economic challenges he referenced were conceived through past dollar weakness.

But when we consider that the U.S. Treasury remains the chief mouthpiece for the dollar, Bernanke’s comments were notable, and commodities as mentioned trickled down slightly as a result. Whatever the longer-term outcome, investors should welcome any statements from monetary authorities suggesting there’s at least some concern about the impressively debased greenback.

Still, the various U.S. equity indices fell in response to the speech. Conventional wisdom would suggest that this has to do with Bernanke’s allusion to a rate-cutting pause, but that analysis seems wanting.

Explicit in the above reasoning is the broadly held view among commentators that Wall Street desires cheap money. As evidenced by the historically negative correlation between inflation and stock returns, nothing could be further from the truth.

More realistically, the great voting booth that is the stock market is not pleased with the way in which Bernanke might seek to achieve a strong dollar. Lest we forget, the dollar weakness that we’re presently experiencing did not just begin last August. Instead, the dollar weakened on and after 9/11, fell further amidst tariff impositions and Sarbanes-Oxley, and actually fell the most against gold and oil when the Fed engineered 425 basis points of rate increases from 2004-2006. While history says rate increases are a dollar negative, at the very least it should be said that the greenback’s problems began long ago.

Going forward, what will cheer investors is not talk of rate increases that have very little to do with liquidity, and that will serve to invert the yield curve. Instead, it should be remembered that money defined in gold terms is low interest-rate money, and when money has the stability offered by the gold definition, oil is stable and cheap.

In short, what investors really want is for the Treasury to announce in concert with the Fed a stronger and more credible market-based dollar definition. If this comes to pass, markets will rally for our monetary authorities removing a weak and unstable variable – the dollar - from ours and world economy. It can’t be said enough that the dollar is the most important price in the world.