Houston, We Have A New Problem (Dollar)


Bernanke managed to create a confirmatory signal yesterday in the dollar, which isn’t exactly what I’d call “good news”

It would be nice if these clowns would pay attention to the consequences of their acts.  That, of course, would require that they cared, and I’m quite convinced they do not.

The target on this, assuming it’s valid, is ~72ish, a roughly 10% devaluation.

Now here’s the problem with that, and I hope Bernanke (and Obama) are paying attention: with the bond market having rates at record lows, especially in the 2yr and shorter duration, anyone now buying these instruments as a foreign interest is now doing so only if they believe in the stability of the currency.

If that turns out to not be the case those foreign buyers are going to get fisted on the FX devaluation.

The worse news is that Treasury has been shortening duration of the US Debt in an attempt to control interest expense.  This is the sort of insanity that only a drug addict could love – taking actions that provide more of a “boost” to whatever you’re doing irrespective of the potential risks – in this case, rollover risk.

We are in fact running a gigantic Asian stimulus policy here in the United States.  It is not working in the United States and can’t because we destroyed our manufacturing base here and we have destroyed the incentives for capital formation through ZIRP and now explicit statements from The Fed that it will ignore the law governing its operations and redefine its mandate in violation of said law.

Specifically, from the Statement yesterday:

Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.

The Federal Reserve doesn’t have that discretion.  The actual Federal Reserve Act says price stability, not “price inflation.”

An “in your face” statement that The Federal Reserve will attempt to create inflation – intentionally – is tantamount to a declaration of willful and intentional violation of the law.

The market reacted to this, as you would expect it to – it looked beyond the black letter of the statement to the implications, and reminded itself that the last time The Fed went “rogue” was in the 1970s, and the result was double-digit price inflation.

The reaction in the dollar and gold was immediate and violent – and with good reason, given history.

Industry will react to this too – by avoiding it.  As a consequence we will find that not only has capital formation been destroyed by ZIRP but in addition avoidance of devaluation risk will continue to drive investment and capital overseas, further eviscerating labor (and wages) here in The United States.

Don’t expect Obama or Congress to show up with a sack sufficient to step on Bernanke’s neck for this crap, and as a consequence, do expect that absent some sort of very violent reaction in the equity markets to drive people into dollars (as the “safe haven”) that downside target is not only like to be met, it is likely to be exceeded.

The game is afoot.

Discussion (registration required to post)