The Dollar and America's Lost Decade

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As government officials implement plans H, I, J and K in their effort to salvage America's financial system, an ominous refrain heard oft and again is: "Japan's 'lost decade' - can it happen here?" Better questions might be: Has it already happened here and if so, what happens next?

The Japanese' financial and real estate juggernaut peaked in 1989 about the time they were purchasing American trophy properties like Rockefeller Center and Pebble Beach. And for Japan's markets it has been mostly downhill ever since. Economic historians have taken to calling the era, "Japan's lost decade."

It was notorious for falling asset values, stagnant growth, massive government infrastructure spending and "zombie" banks. The banks were termed zombie because the government propped up failing institutions and kept them afloat despite mountains of non-performing loans.

Sadly, these banks with impaired capital were of little help in providing the type of credit needed for a vibrant, grass-roots economy. The net result was zombie-like performance for Japan's domestic economy. Japan's one dynamic sector was its export industries - autos and electronics.

Investors, here and abroad, can't be blamed for feeling they are now trapped in an American remake of a bad Japanese horror movie - Godzilla and the Zombie Banks Trash Manhattan - bigger budget, grander scale, worse ending.

The sad reality is that major U.S. stock indexes have already endured a lost decade of their own, with the Dow Jones Industrials and the Standard &Poor's 500 now trading at the lowest levels since May 1997.

In assessing what happens next, it is important to understand the origin of economic downturns. They almost always result from macro policy errors in one or more of four key areas - fiscal (taxes), monetary, regulatory and trade.

Policy errors in multiple areas can compound the trauma and, in a worst case, turn a recession into a depression.

In this case, policy errors in the monetary and regulatory arenas bear the blame but it is monetary policy that has whip-sawed the economy and caused the most mayhem.

A reliable metric for judging the effectiveness of monetary policy is the price action of gold. Why gold? Gold is history's oldest form of money and recognized around the world as a storehouse of value. In fact, gold served as currency thousands of years before any of the modern currencies we take for granted were developed. And lastly, America has spent most of history on the gold standard. It has only been since 1971 that the global economy has operated in a floating rate currency regime.

As a report card on monetary policy and its economic impact, consider the accompanying graphs.

On the top is a 25-year chart of the dollar priced in gold ounces while the bottom chart is the S&P 500 stock index over the same time period. The charts are divided into two 11-year periods.

The first period enjoyed a relatively stable unit of account as shown by the dollar trading at the same level in December 1985 as it did 11 years later in August 1997 - the 5-year moving average fluctuates some but is relatively smooth, indicating a stable unit of account.

Classical economists give monetary policy an A-plus for that period and it is no coincidence that the stock market gained over 400 percent during the same span.

There is good reason for business to flourish during such conditions. Business growth and expansion requires long term plans and commitments and just about every contract, whether for sales, inventory or plant and equipment, is priced in dollars.

A stable dollar greatly increases the probability that those obligations will be successfully met and business plans will work out as projected.

The second period from 1997 to the present has seen wide swings in the value of the dollar. Those swings were instrumental in spawning a decade plus of booms, bubbles and busts. Some might call it a Charles Dickens economy, "It was the best of times, it was the worst of times ..."

The period 1997 through 2000 is best remembered as the high-tech boom but those were tough years for the input side of the economy. Gold fell versus a super strong dollar as did other commodities.

Three notable Mississippi businesses that succumbed to the double whammy of falling prices for production while having to pay interest and debt with ever more valuable dollars were, Mississippi Chemical, Friede Goldman Halter and Birmingham Steel's Flowood mini-mill.

As the chart indicates, the dollar's value changed course dramatically in 2001, and what were once tail winds for some sectors became head winds and vice versa.

In hindsight, the falling dollar was setting the trajectory for the next set of booms and busts - residential real estate and credit.

Instructive on how fortunes can change with a monetary tailwind at your back has been the turn around in the agriculture sector. Grain prices after trading at decade lows in 2000 rebounded to all-time highs by 2008 and even with higher fuel and fertilizer costs U.S. Department of Agriculture estimates that farm income for the year just ended will be a record $89 billion on crop production of $182 billion - the best year ever for the American farmer.

As the first quarter of 2009 draws to a close there are modest signs of economic stability but still precious little evidence that the dollar is stabilizing in value.

It is still near its historic low and monetary authorities remain focused on saving the banking system while stabilizing the dollar is a secondary priority.

Where is the next bubble? Could it be Treasury securities, which are priced historically rich and perceived as the one safe, sure thing?

Perhaps China is the canary in the Treasury coal mine - China's Premier Wen Jiabao recently said he was "worried" about the impact of massive federal spending on China's $740 billion in U.S. Treasury notes and bonds.

Perhaps he has read the rest of Dickens' quote, "... it was the age of wisdom, it was the age of foolishness; it was the epoch of belief, it was the epoch of incredulity; it was the season of Light, it was the season of Darkness ... ."

Could it be Mr. Wen fears the season of inflation?

Ashby M. Foote III is president of Vector Money Management in Jackson, MS. Contact him at

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