The Race for Countries to Devalue Their Currencies Against Each Other Is On

Thanks to record government debt and the fattening balance sheet of the Federal Reserve, the U.S. dollar has decreased significantly in value against other world currencies. All this borrowing and money printing has economists like me worried about rapidly rising inflation ahead.

The Wall Street Journal Dollar Index, which measures the value of the U.S. dollar against other major currencies, has fallen 18% since 2010. The index has fallen 20% against the Brazilian real and 18% against Korean won in the same period. (Source Wall Street Journal, September 20, 2012.) The reason for this significant fall is very simple—the Federal Reserve’s quantitative easing (QE) is creating more dollars. Economics 101 says the more there is of something in circulation, the less it is worth.

The decline in the value of the U.S. dollar not only affects the U.S economy, but also the global economy, as the U.S. dollar is the foreign reserve currency of most world central banks.

Now, with another generous round of quantitative easing just announced, known as QE3, central banks around the world could be rethinking the value of their own currencies.

If the U.S. dollar goes down in value against other world currencies, the values of those foreign currencies appreciate—which is troublesome, because then exports to America ultimately become more expensive for Americans—something the U.S. wants (so people buy “made in America” products again) and foreign manufacturers do not want…an imbalance foreign central banks will be pressured to fix.

What do other central banks do to stay competitive? Well, of course they want their own currency to fall in value against the greenback, so those foreign countries can export more and grow their own economies.

This creates a tremendous problem, because the only way for these foreign countries to devalue their own currencies is by printing more of their fiat money. There are not too many options. World central banks will buy U.S. dollars by simply printing more of their currency. And that’s the last thing we need: more fiat currency in the system. (I should mention that Germany has been the only major industrialized country against money printing.)

Brazil’s central bank is already taking action against the devaluing U.S dollar. It has announced it will go ahead with “reverse dollar swaps” to make sure the Brazilian real doesn’t appreciate against the U.S. dollar.

Central banks in Peru and Turkey have also taken measures to fight against the declining U.S dollar.

Similarly, central banks in South Korea, Thailand, Singapore, and the Philippines are on standby mode and are watching the U.S. dollar closely. Any further strength in their respective currencies will force them to take action, too.

Where does this all lead? It leads to countries and central banks falling over each other to lower the value of their currencies. For investors, it leads to higher inflation (something we cannot do much about) and higher gold prices (something we can profit from).

Where the Market Stands; Where it’s Headed:

In one of the most anticipated actions of the Federal Reserve in recent memory, the Fed announced QE3 two weeks ago. And, as expected, the stock market rallied on the news. The stock market got a kicker from the Fed in the fact the Fed did not place a fixed dollar amount on QE3. The Fed basically said it would spend $40.0 billion a month to buy mortgage-backed securities with an open-ended time frame.

Hence, we have what I’ve been writing about for months now: a stock market that’s rising on the Fed’s actions. The stock market isn’t rising because corporate earnings or revenues are increasing (see my lead story today). And the stock market certainly isn’t rising because the economy is getting better. In fact, we are facing a worldwide decline in economic growth.

A sustainable and real stock market rally does not happen on money printing. It now looks like all the excitement over QE3 has dissipated. I see corporate insiders selling stock, I see stock market advisors turning increasingly bullish on stocks (a bearish indicator), and I see the S&P 500 earnings growth actually contracting this quarter.

The building blocks for a stock market top, for an end to the bear market rally that started in March of 2009, are being cemented.

What He Said:

“A Stock Market’s Obituary: It is with great sadness that we announce the passing of the Dow Jones Industrial Average. After a strong and courageous battle, the Dow Jones fell victim to a credit crisis and finally succumbed on Friday, October 3, 2008, when it fell decisively below the midpoint between its 2002 low and its 2007 high.” Michael Lombardi in Profit Confidential, October 6, 2008. From October 6, 2008 to November 27, 2008, the Dow Jones Industrial Average experienced one of its biggest two-month losses in history.