The big news this morning is about the decline of the dollar, but to understand why that is happening one needs to look at unemployment and today’s jobless report explains a lot.
The dollar is declining because our federal government is spending too much. Our almost $1.5 trillion deficit is going to be financed by the Fed which will print money to buy federal debt. They will also purchase additional large amount of Treasurys and other assets to create inflation. The currency markets have reacted strongly to this new move into quantitative easing (QE) and, in anticipation of a future devaluing dollar, they have discounted the dollar heavily, raising other currencies such as the Canadian and Australian dollars into parity with the US dollar.
The reason the Fed will engage in massive QE is to try to effect their mandate to maintain full employment. They believe price inflation will stimulate the economy and create employment. The markets fully understand what money printing is: a debasement of our fiat money currency. As the dollar loses value, other currencies who don’t debase their currencies as much as the dollar will appreciate.
The Fed in its September minutes said they would keep a close watch on unemployment as an indicator of whether or not “additional measures” were required. Thus, this morning’s news that jobless claims were up last week, after improving for the prior 5 weeks, will be a negative signal for the dollar because it insures that the Fed will “soon” engage in QE.
The jobless report noted something that should be disturbing to the Fed:
Continuing claims fell substantially in the October 2 week, down 112,000 to a recovery low 4.399 million. Yet improvement here reflects, to an uncertain but probably significant degree, the loss of benefits. Those on emergency and extended benefits both fell. The unemployment rate for insured workers is down one tenth to 3.5 percent.
In other words, jobless claims are decreasing because people are falling off of the radar not because they have found jobs, but because their benefits have run out. That means long-term unemployment is becoming a reality for many workers. This is a stinging indictment of the obvious failures of the Administration’s economic policies and the Fed’s policies. It puts heavy political pressure of the Fed to “do something.”
Another signal came in this morning and that is the Producer Price Index, a measure of price inflation at the producer level. On an overall basis, you would think that the Fed would be happy with a 4% YoY total price inflation, but they are not. The Fed pays more attention to ”core” inflation which excludes food and energy. As the Fed would look at it, “core” price inflation remained flat for the month and was up only 1.5% on an annual basis. The Fed looks more attentively to “chained” personal consumption expenditures (PCE) which measures consumer expenditures in 2000 dollars. The core chained PCE for August was up, in the Fed’s eyes, a measly 1.39% MoM.
To the Fed, low inflation is something that needs to be “cured” to produce employment and they do that by inflating (debasing) the money supply.
So, if you were a foreign central bank or a foreign bank holding US dollars, and you see that the two main indicators that the Fed uses to gauge the need for QE, you would expect inflation of the dollar and you would sell. It is no surprise. We can blame the Chinese, the “unfair” balance of trade, the speculators, other central banks, the “international banking cabal” but they are not the culprit. The only reason all those dollars are sloshing around outside the US is our government’s deficit spending. After all the Fed created all those dollars.
The short-term effect of a currency devaluation will be to transfer economic benefits away from consumers, who benefit from cheap imports, to US exporters who will benefit by selling goods which appear cheaper to foreign buyers.* Note that China pegs the yuan to the dollar, so expect no major prices increases of their goods unless they unpeg, which, despite all the pressure on them to do so, is unlikely.
*I will publish a longer article on the foreign exchange, foreign trade issue soon.