More trouble for the U.S. Dollar?

Recently, the FED has substantially cut rates in response to the growing recession fears that have spread into the minds of more academics and economists. Although the possibility of a recession is no small matter, the FED has seemingly ignored another major problem facing our economy and financial well-being.

Our US Dollar has resumed its downfall against other major world currencies, most importantly the Yen and Euro. After a mid-December rally, the USD has plunged to new lows again compared against both currencies. Despite a global credit crunch and recession worries in Asia and Europe, the FED typically acts most rapidly and decisively when problems arise. On this positive note, we can expect the other central banks to begin cutting rates sometime later in the year as a more reactionary measure instead of a combination between reaction and precaution. Asian growth is still expected to maintain, but interest rates have risen to unhealthy levels. Meanwhile, Europe seems a few months behind the US economy in the GDP cycle, so slower growth may not be realized until the late 3rd or early 4th quarter of this year.





One solution to the falling value of the Dollar the FED has yet to utilize is the mop up of excess money floating around throughout the economy. Unfortunately for the US central banking arm, excess liquidity has been necessary in a marketplace stricken with tightening credit standards and loan requirements. As the financial sector continues to right itself (with the help of much needed investment from the private sector and abroad), the FED may begin to start diminishing some of this exorbitant amount of dollars. Hence, less supply will help drive the USD's value back in the right direction.

Protectionism is a double-edged sword

Sen. Hilary Clinton continues to lead the protectionist rampage on the political front, she has yet to provide any hints as to her solutions to the various problems that are certain to arise should she win and enact her regulations. Protectionism has both positive and negative effects, the later of which Clinton ignores.

I doubt anyone questions the concern over the amount of outsourcing that has taken place since the early 1990s. Something needs to be done to revitalize the US economy, that isn't debatable. The methods for achieving the end means is where politicians and economists seem to differ.

Clinton tends to suggest that Protectionism will help keep jobs inside of US borders, lower the trade deficit and ultimately act beneficial to the overall economic well-being. She doesn't seem to realize that the trade deficit has no net affect on the United States. Entities and people trade, not countries. She should be more focused on U.S. GDP Growth rates because various factors influence trade, including tariffs, tax rates in respective countries and currency conversion rates.

If you look at Hilary's plan, implementing policies to force companies and Americans to buy home-grown products will certainly result in significant spikes in inflation. She doesn't seem to have any grasp of this concept. If strong tariffs or other protective measures are enacted, those goods that will be then produced by workers in America will most definitely be higher in price due to the wage and benefits difference.

Another key consequence on protectionism is a stronger US Dollar. Although some argue that would be beneficial for the United States and her citizens, this would only hold true when trading or converting currency or wealth with other countries. An inflated currency has proven to be part of the problem with outsourcing because a higher USD makes foreign imports cost less and become more attractive. This is a central factor in the massive import problem the US faces. Should the USD fall relative to the Asian currencies, which it still has yet to do, demand for US exports will rise dramatically.

The double edge sword comes into affect if the US Dollar were to fall too quickly, lowering the value of personal wealth and ultimately creating inflation simultaneously. By any means, the situation is complex and fragile, something Sen. Clinton needs to realize soon.

China learning well from U.S. Economists

As one of the fastest growing economies in the world and one of the largest, China could easily be arrogant, unresponsive and even disrepectful to the U.S., a former Cold War nemesis. That does not seem to be the case however, considering the trend of decisions made by the Chinese version of the FED, with counsel from U.S. bankers and economists.

The Wall Street Journal reported today that China lifted bank reserves in an attempt to help control growth. Although growth in double digits seems very appealing to most investors, the Chinese Central Bank and U.S. economists realize it may actually pose a huge recession threat down the road. With a lesson learned from the U.S. housing bubble, created by Alan Greenspan's flawed monetary policy, China is attempting to prepare itself and provide a soft-landing to the world's second largest economy (GDP using PPP).

Though the graph suggests no recession problems, you can be sure that growth will be tough to sustain at such a high rate. If China can curb its growth now at 8-9%, it will be able to sustain it for a much longer period of time with less volatility, such as the graph suggests. However, if they continue growing by double digits, the threat of a bubble burst is likely, one that could ultimately ruin the economy or set Chinese progress back severeal years.

Economic Worries for the U.S. Economy

Despite weak GDP performance in the first quarter of 2008, the equity markets continued their climb today with the Dow closing at yet another record high. All of this came amidst talk of a potential recession, a weak Dollar, and declining markets abroad. With this seemingly unstoppable run continuing, there are still several factors that worry me about the current economy.

First off, let me make it crystal clear that I am still Bullish on the stock market and economy in the long run. However, there are too many factors signaling a struggle ahead. Lets begin with the inflationary pressure on the economy. The CPI and PCE both rose to suggest higher prices across the broad economy. Although prices in commodities continue to increase, I do not see these increases in the CPI and PCE repeating themselves for more then a few months. Commodity prices are being driven by international demand and growth, not domestic. Therefore, rising commodity costs are not being translated into actual inflation for most ordinary Americans except in the form of gasoline.

Another concern I have relates to the Fed's competence and the inverted yield curve it created. Greenspan is out, so I will wait to see how Bernake handles a fragile situation. Many bears argue we have never seen an inverted yield curve without a recession following. This fact is entirely accurate, yet may not be in this unique situation. The Fed mishandled rates in 2002-3 by sending them too low, creating the massive housing boom. Without properly limiting growth and speculation in the housing sector, the expected happened in when the bubble burst. Sub-prime spillover and sharp declines in housing prices and sales are not what worries me though. The drastic lowering of interest rates was overdone compared to inflation numbers. Additionally, it hurt the USD, which dropped steeply between 2002-4.



In an attempt to try and generate a perception of normal inflation, the Fed has increased the amount of money it prints to provide a short-term wealth. This will only worsen inflation in the long run as prices of goods and service remain constant the value of the dollar drops even more. To help control inflation, the Fed keeps focusing on raising the short-term FF rate instead of both the short and long or just the long. This has created the inverted yield curve, which undervalues long-term lending. Why would anyone borrow for the long term when they can get short-term returns at higher rates? Not to mention, it makes the U.S. pay back larger debts sooner rather then later.

Lastly, corporate profit records of late have been derived from operations abroad, not domestically. These profits are good since the companies making them are many of those headquartered in America. But, the income and revenues being attained globablly does not help our economy in terms of GDP, employment, and other factors. When you consider most of the returns on the investments made internationally stay outside the U.S. boarders, it really has no net affect on our country except for aiding to drive the equity markets higher. Also, if you consider the gains of the Euro and Pound against the USD, it makes sense that these companies continue to report record earnings. It must be near impossible for Wall Street to predict income and revenues generate across the world, let alone exchange rates to translate those earnings and sales.

These are just some things to consider in the short-term. Once GDP growth heads back towards 3-4% in the 4th Quarter, you can be assured that a new big rally will begin. Unless, of course, the current rally just never dies. As Larry Kudlow says, "It's the greatest story never told" and I expect many Americans to continue to reap benefits of investing in stocks, mutual funds and ETFs.

Could Protectionism Actually Hurt the Dollar?

Although some Democrats claim to be in favor of protectionism to help bolster the U.S. Dollar and curb outsourcing and the trade deficit, John Rutledge, former Reagan Economic Advisor and current President of Rutledge Capital, says it may actually cause an inverse affect. Over the past year, the U.S. Dollar Index has declined sharply while falling substantially against the Euro, Pound and Chinese Yuan. The important aspect to note in these declines against other notable currencies is that only the Yen and Yuan have a significant impact on the U.S. economy because China and Japan are two of our prime exporters and trade partners. Europe and England fail to pose nearly the threat that Japan and China do should the U.S. Dollar really free-fall against those currencies, which essentially would drive up inflation.

Democrats believe protectionism will help maintain the value of the U.S. Dollar, when in fact, the opposite needs to happen to help control outsourcing and decrease the number of imports into the U.S. If the Dollar falls significantly against the Yuan and Yen, manufacturing and production in the United States will ultimately become cheaper and in theory, our manufacturing sector will actually begin to expand again to adequately supply the public with their needed goods and services. However, the only possible scenario for the USD to decline drastically enough against the Yen and Yuan is free market forces, not government regulation or policy-making.

Additionally, Rutledge went on to explain that the USD should stabilize vs. the Yuan and maintain its success with the Yen. His theory for the slowing of the USD decline against the Chinese currency was based on increased speculation on the Yuan and the theory that recent run-ups by the monetary unit have created a bubble that will likely burst at some point in the next couple years. Keeping the USD strong against the Yuan will be key for controlling inflationary pressure in the economy, but likely will continue to contribute to outsourcing and a lack of trade balance with China.

The solution to this dilemma is simple; let the Yuan run its course and lower corporate tax rates in the U.S. to make business investment and production more attractive.