What is the Dollar Worth?

The answer to the question in the title is "not much!" But then again, it depends on one's time horizon. However, if we go back to 1913, which by the way was the year that the Federal Reserve System was established, a dollar in 1913 would be worth only a "five cents" today. This is very interesting, because one of the Fed's main objectives is to maintain a stable currency as the protector of our economy's stability. Then again, in this day and age, who wants to be accountable for one's action.

Since the Fed cut the Fed Funds rate, it seems every currency, inclusive of Third World currencies, in the world has rallied against the dollar. The Euro is at an all time high, recently the dollar was trading at $1.412 to the Euro. Even the Canadian dollar (loonie) is now at par against the dollar, which is the first time in three decades. However, take solace, the dollar did hold its own against the Zimbabwean dollar where inflation in that country is only running at 15,000% a year.

In addition to the dollar's weakness against currencies in general, the price of oil exceeded $84 a barrel; and with the prospects of reflation, the price of gold went to $740.

Don't worry. The Fed has everything under control. Just look at how well they have protected the value of the dollar.

August Wholesale Prices Fall Sharply (What about core inflation?)

"The 1.4 percent decrease, the biggest since October 2006, followed a 0.6 percent increase in July, the Labor Department said today in Washington. So-called core prices, which exclude fuel and food costs, rose 0.2 percent after a 0.1 percent gain the month before."

The reason that I posted this information is to inform you that the market will do anything to justify a rate cut by the Fed. The whole emphasis in today's financial press is on the decline of wholesale prices, which in effect is saying that inflation at the wholesale level is in check. Therefore, the Fed can go ahead and cut interest rates. However, what is completely ignored is the fact that just a month ago the emphasis by the financial media was on "core inflation." And, if you noticed the last sentence in the first paragraph, you read that core inflation rose .2%, which on an annual basis is 2.4%. This was double from the previous month. The Fed generally would like the core inflation to be between 1% and 2%.

Will the Fed cut the Fed Funds rate? You bet! Will the equity markets be satisfied? Probably not. That is why the old Wall Street adage will probably be true, which is "Buy the rumor and sell the news."

Root Causes of Financial Bubbles

All financial bubbles, subprime included, start when the banking system is awash with liquidity (money). Then, the question one must ask is who or what provides the liquidity to the economy in the first place? From your course in Macroeconomics, you learned the answer to that question as being the Federal Reserve System. Therefore, the Fed initiates any financial bubble through increasing reserves (money) to the banking system, which in effect will lower interest rates. Then, banks, which now find themselves with additional reserves, will do what they are in business to do; and, of course, that is to make loans, i.e., mortgages. Because of low interest rates, which is caused by the increase supply of reserves, individuals are more than happy to borrow money, in this case, for that new home or refinance their current home and draw down any home equity that is available.

Another question to ask is why and when did the Federal Reserve increase reserves to the banks? The Fed started its current monetary expansion program after the last recession, 2002. The Fed realized that since the consumer is such an important component of GDP, something like 71%, it needed a catalyst to stimulate the economy. The consumer was that catalyst. By providing and injecting reserves to the banking system, the Fed knew that the desired outcome of GDP growth would occur through the assistance of the banking system and individual borrowers. However, this contrived real estate bubble has finally burst, as all bubbles do, and the consequences are going to be felt for many years to come. The Fed's solution will be to simply reinflate the economy and create another bubble.

What I find interesting about this current subprime mess is that no one or a very small fraction of the financial world is looking at the Fed as the real culprit or villain. However, I do hear that the subprime mess is the fault of mortgage banks, credit agencies, and hedge funds. But I firmly believe that these entities are not the "root" cause of the problem. For that, simply look at the Federal Reserve and its expansionary monetary policies.

By the way, the chart from my post of September 3, which was entitled, “Picture is Worth a Thousand Words,” is that of the Money Supply. The chart can be accessed at the following URL: http://research.stlouisfed.org/fred2/series/MZMNS.

The Next Subprime Mess

Get ready for another financial debacle. This time it is going to be those nasty SIVs. No, I don't mean SUVs, which I guess the "Green Movement" would consider to be nasty. SIVs stand for "Structured Investment Vehicles. Trust me, SIVs will become as well known as those SUVs we drive.

These investment vehicles are entities that banks use to issue commercial paper, which is a money market instrument. With the proceeds, banks purchase corporate receivables, auto loans, credit card debt, and, yes, mortgages. Why is this so alarming? Take Citigroup, for example. Citigroup owns about 25% of the market for SIVs, which is approximately $100 billion according to the "Wall Street Journal" in its September 5, 2007 edition. Yet, in its 2006 filing with the SEC, there is no mention of it. What? How can this be? Well, accounting rules don't require banks to separately record these type of off-balance sheet investment vehicle on their main financial statements. One would have thought that the accounting profession would have learned something from Enron, World Com, and Global Crossing. The demise of each of these companies was directly tied to off-balance sheet vehicles.

The Federal Reserve System has a major challenge ahead of itself in trying to bring stability and trust back to the financial markets. In my opinion, these challenges are a direct result of their own polices instituted during the past five years. The banks and financial markets did not create this subprime mess or pending SIV mess. The Fed did that all by themselves. The banks and financial markets were just reacting to what the Fed was doing. That is, when the Fed reinflated the banking system with reserves (money), banks made loans. Because interest rates were low, which was caused by the Fed reinflating the banking system, individuals were more than happy to refinance their homes and draw down their home equity. This resulted in real GDP growth. However, the consequence of all this liquidity has been the inflation of all financial assets. Like all bubbles, they do burst; and we have already seen the subprime bubble burst. The next one just could be those nasty SIVs.

Picture is Worth a Thousand Words

A picture is worth a thousand words is a proverb that refers to the idea that complex stories can be told with just a single still image.

What is the name the above chart?