Currency Wars: Our Short-term Gain Results in Long-term Pain

There’s a real competition among industrialized countries going on. And it’s not about who has the fastest growing country or who is exporting more. The game is called currency devaluation. Every major industrial country wants its currency lower so it can export more than it imports. It’s all about cheap currency, cheap money.There’s a real competition among industrialized countries going on. And it’s not about who has the fastest growing country or who is exporting more. The game is called currency devaluation. Every major industrial country wants its currency lower so it can export more than it imports. It’s all about cheap currency, cheap money.

And who’s winning the currency war? America, of course. Below, is a list of industrialized countries and their respective central bank rates:

Country Interest Rate
Australia 4.75%
New Zealand 3.00%
Euro Zone 1.00%
Canada 1.00%
United Kingdom 0.50%
United States 0.25%
Japan 0.10%

Next to Japan (a country that has been dealing with deflation for almost 20 years), the U.S. has the lowest central bank rate. Over the past few weeks in these pages, I have called it the “quiet devaluation” of the greenback.

Let’s say I’m a businessperson from any of the above countries except Japan. I want an apartment in New York. The further the U.S. dollar dives in value against the currency of my country, the cheaper that apartment gets for me. Same concept holds for stocks…the more the U.S. dollar falls in value, the more attractive those well-known American stocks look. And let’s not forget travel. A lower greenback brings tourists back to the U.S.

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For the U.S., luring investors in to buy real estate and stocks does what the Fed desperately needs. It pushes prices higher, alleviating deflation concerns. As Americans, we want our real estate moving up; we want our stocks rising in price. But the problem with all this? It is just temporary fix.

The U.S. has gone from a manufacturing economy to a service economy. Playing with our currency to make American goods, services, real estate, stocks and other investments look attractive to foreigners is a long-term mistake. What I call short-term gain for long-term pain. Do we really want a country that falls more and more into foreign ownership?

What I didn’t include in my list above was China. The one-year lending rate is 6.06% in China. A one-year deposit rate (similar to the American one-year CD or the Canadian GIC), pays three percent. Interest rates in China have been rising to cool the economy—the total opposite of what is happening in the United States. This illustrates where the strength is in economic power.

So what is the point of all this? Simple. The significance of the devaluation of the U.S. dollar in the “American Plan” is being underestimated. The cheaper our dollar goes, the higher the stock market rises. But it is a short-term fix. If our dollar goes too low—and it’s just on the cuff of breaking to a record low on the downside—the less our debt obligations become to the foreigners. Politicians need to stop taking the short-term attitude they are accustomed to defaulting to. But long-term attitudes do not buy votes.

Gold will obviously benefit from the devaluation of the greenback, and that’s why the metal has moved up from $300.00 to $1,400 U.S. an ounce and will continue to rise. The stock market loves a cheaper U.S. dollar, because that means foreign money continues to pour into stocks, not out of stocks. Hence, why I have been saying in the immediate term this bear market rally will continue to rise. That’s the best stock advice I can give.

Michael’s Personal Notes:

One of the most common questions I get e-mailed is, “How high do bond yields need to rise before the stock market is negatively affected?”

Well, we’ve all known for years that the bond market and the stock market have moved in the same direction. As interest rates fell over the past 30 years, so did bond yields, pushing the bond and stock markets higher. The bond market has been a terrible place for investors to be in since the fall of last year, as the 10-year U.S. Treasury yield rose from 2.4% in October of 2010 to about 3.4% today.

So, if the bond market is falling on rising interest rates, when do rising long-term rates start to affect the stock market? In my opinion, when long-term interest rates hit four percent, the stock market starts to suffer. If the bellwether 10-year U.S. Treasury went to a yield of six percent (which is what I believe we will see in the next couple of years), it would be a disaster for the stock market.

Bottom line: bond yields of four percent to six percent put real downward pressure on the stock market. Unfortunately, that’s where we are headed with this new interest rate cycle.

Where the Market Stands; Where it’s Headed:

The Dow Jones Industrial Average opens this last day of the week up 4.2% for 2011. I don’t see the Libya situation as something for the stock market to get terribly worried about. Getting Qaddafi out of Libya is the best thing that can happen for that country and the world. I see oil prices spiking because oil producers push crude prices up on any opportunity to make more money. But I do not see gold rallying on the Libya crisis, which tells me the situation is already a forgone conclusion.

I’m still worried about America’s serious domestic problems—rising long-term interest rates, out-of-control government spending, the quiet devaluation of the U.S. dollar. Hence, short- to long-term, I’m bearish. But in the immediate term, I believe the stock market rally that started two years ago next month has more life left in it.

What He Said:

“When I look around today, I see falling stock prices…I see falling house prices…and prices for retail goods stores declining. The media has it all wrong in blaming (worrying about) inflation. In my opinion, the single biggest threat to the U.S. economy and to the Fed in 2008 is deflation. You can bet the Fed will expand the money supply and drop interest rates aggressively, as deflation starts to rear its ugly head.” Michael Lombardi in PROFIT CONFIDENTIAL, December 17, 2007. Michael was one of the first to warn of deflation. By late 2008, world economies were embedded in their worst state of deflation since the Great Depression.