Inflating the Index with Worthless Dollars

By Dr. Duru written for One-Twenty

June 1, 2007

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After seven years and change of agony and thrills, the S&P 500 has now managed to get back to even with the all-time closing high from March, 2000. In that same time, the dollar has declined in value by 21% (using the "Dollar Index" from TC2000). The dollar made a triple-top over the next two years after the S&P 500 peaked, rising another 12%, and hasn't looked up since. Interesting. So, we have dropped interest rates, printed a lot more dollars, borrowed many hundreds of billions from China, took liberal advantage of the "carry-trade" with cheap Japanese currency, and it still took us seven years just to get our major index back to even. I suppose on a dollar-adjusted basis, we are still down 21%. Ugh.

So, we can understand the fleeting hopes of the many for more rate cuts (cheaper dollars). How else can we continue to support the levitating markets? Inflate and stuff them with more worthless dollars course. Keep the liquidity flowing for the guys with the big guns to continue taking shares out of the public markets (don't worry - these same shares will be back on sale over the coming years, albeit at much higher prices). The drumbeat for rate cuts continue to be heard even though the economic data continues to suggest that the economy is holding its ground. Imagine - if the economy truly did hit the tank enough to encourage more rate cuts, then all these private equity deals, corporate share buybacks, and bigtime mergers and acquisitions will essentially have happened near or at the top of this current bullish economic cycle. Given how much praise has been heaped on all this activity, this smart money could not possibly end up being the dumb money, right? Right? Right.

Bush holds up a dollar bill
Bush tries to defend the dollar? (pic from "solongjohn")

It is also interesting to note that even as interest rates have been creeping back up recently - and have even had an upward bias since hitting rock bottom in 2003 - the long-term trend remains DOWN.

It must seem strange to worry about how much our dollars are worth from a global perspective. After all, if we just buy domestic products and not travel outside our own borders, then these cheap dollars don't matter. But as we all know, we Americans have a voracious appetitie for foreign-made goods, and who wants to stay at home year-after-year? As we continue to drive down the value of our dollar, these imports get more and more expensive. Read: inflation. The main thing that has saved us so far is that the Chinese have been very willing to deflate their currency right alongside ours, just as we keep sending over more orders for manufactured goods. The American government is now trying to transform the Chinese consumer into a much more American one. President Bush confirmed this desire in talks with President Hu Jintao of the People's Republic of China in Vietnam last year:

"I strongly support...your country [becoming] a nation of consumers and not savers, which will inure to the benefit of our manufacturers, both large and small, and our farmers, as well."

Now that's what the export of American values is all about! The world needs more consumers, not savers. You cannot take your savings with you when you're gone, right? Right.

I hope we can find someone else to lend us money when the Chinese are buying more goods...from Europe, Japan, and SE Asia no less!

Be careful out there!

DR. DURU®, 2007