How do you explain these charts?
Posted on 08/24/2007 3:56:39 PM PDT by Toddsterpatriot
Rate increases have rarely constituted “tightening” when it comes to restoring the greenback’s value.
The Federal Reserve’s change in bias last week toward cutting the federal funds rate, along with its half-point cut in the discount rate, offers an opportunity to test the widely held belief that rate cuts weaken the dollar while exacerbating existing inflationary pressures. In truth, the opposite is typically the case, since dollar-demand shifts when the Fed acts.
Last week, the market response to the Fed’s new course was profound: Gold began a new short-term downtrend. The dollar adjusted for gold started a short-term uptrend compared with the euro adjusted for gold. The 30-year Treasury yield began a short-term downtrend. And the Russell 2000 Index — comprising small-cap companies and arguably the most sensitive equity index to monetary policy error — ended its recent short-term downtrend.
Overall, lower gold prices, a stronger dollar against the euro, lower long-term bond yields, and rising equity valuations are indisputable hallmarks of a disinflationary environment — not a resurgence of inflation.
The 2004-06 rate-hike experience, compared with last week’s Fed easing scenario, is only a small episode in the longer-term dollar response to interest rates, dating back to the beginning of the post-Bretton Woods era of the early 1970s. The dollar lost 67 percent versus gold between 1972 and 1975, despite the fact that the Fed hiked rates from 3.5 percent to 13 percent in that period. When the Fed reversed course in 1975, lowering its rate target from 13 to 4.75 percent, gold actually fell 23 percent. When the Fed raised the funds rate all the way to 14 percent in 1980, rather than strengthen, the dollar fell, driving the price of gold from $150 an ounce to an all-time-high of $892.
Just as tax increases don’t always yield commensurate revenue increases due to a downward shift in economic activity, interest-rate hikes frequently fail to enhance dollar demand. In historical terms, rate increases have rarely constituted “tightening” when it comes to restoring the greenback’s value.
A case in point came at the tail end of Alan Greenspan’s tenure as Fed chairman. Greenspan is frequently blamed for keeping the fed funds rate too low for too long, in such a way that the dollar lost value. But the dollar price of an ounce of gold tells an entirely different story. Gold hovered in the high $300s while Greenspan held the fed funds rate at 1 percent between July of 2003 and June of 2004. Gold only began to rise once the Fed began raising rates that June. After 425 basis points of rate increases, gold has risen nearly 70 percent.
The significant rally in gold during the past three years understandably caused many to call for even more significant rate increases in order to quickly defuse budding inflationary pressures. But the systematic freezing of credit during the last month has forced the Fed to ease, causing financial markets to respond to the real prospect of a lower interest-rate environment.
Targeting higher interest rates to combat inflation is very much a Keynesian concept whereby central banks seek to reduce economic activity as well as prices. Contrary to current Fed objectives, the surest way to decrease dollar demand and ultimately cause a net excess of dollar liquidity that would spark new inflationary pressures would be to target the economy for slower growth with higher interest rates.
Looking ahead to September’s Fed meeting, if the FOMC lowers the funds target, media accounts will suggest a looser stance on the part of policymakers, while an increase will be described as a monetary tightening. In truth, a Fed ease will point to dollar strength and a budding disinflation.
— John Tamny is editor of RealClearMarkets, and can be reached at jtamny@realclearmarkets.com. Paul Hoffmeister is chief economist at Bretton Woods Research, and can be reached at phoffmeister@brettonwoodsresearch.com.
Do you understand how reducing deficit spending would increase the strength of the dollar?
Explain it to me.
Yes. But I also realize that I assumed that you were talking about the sub-prime “crisis” when you may not have been.
Because deficit spending can and often does lead to inflation.
Only if the shortfall is printed rather than borrowed. We don't do that here. Try again?
You don't belong to the Clinton/Rubin school, do you? Do you believe a lower deficit will reduce interest rates?
No, I wasn’t talking about that.
Deflation causes and is caused by a collapse of credit, which leads almost immediately to a shrinking of the money supply, typically at some point after credit has expanded too quickly for too long -- the original vicious circle.
However, you can do better, far better, because Mr. Friedman had it right. ''Inflation is everywhere and always a monetary phenomenon''.
Guess what? So is deflation. Sharp contractions in credit by definition cause contractions in the available money supply.
Gold has sod-all to do with this process, as the world once ''learned'' to its regret...and, kept repeating this error via Bretton Woods, which was just an attempt to postpone the next evil day of reckoning.
The net of it all is: both inflation and deflation are ONLY ever the result of various gov't policies. Right now, there's an enormous gov't bias against deflation and for inflation, because politicians will LOSE their jobs during a severe deflation, but might be able to keep them (viz, the Regress during 1974-1980) during a severe inflation.
Right.
I'm not sure how you can argue that extended deficit spending is not going to lead to inflation.
I'm still waiting for you to show that it does.
Because you are diluting the supply of money with spending that isn’t backed by revenue.
I knew this would happen if your ever tried to have a serious discussion about economics.
That is one of the dumbest things I've ever heard.
Hey Todd! Everything okey-dokey?
If you're not printing money to cover the deficit, and we're not, deficit spending has no impact on the money supply.
No, you’re still doomed.
Dang!
Deficit spending should be used in times of a serious recession to stimulate economic activity. Not in a time of full employment and extended growth.
I don’t like deficit spending either. I’m still waiting for you to show how it causes inflation.
It also contributes to inflation by stimulating consumer demand.
How do you explain these charts?
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