The Fed and the Dollar
Do we need a more responsible Fed?
Analysts who recognise that the Fed was instrumental in creating the enormous US credit bubble often make the mistake of calling for a more responsible Fed. If only, they say, the Fed could be completely independent of the government and the banking system and act purely in the long-term interests of the Nation. However, although a prudent and responsible Fed would be a huge improvement on the status quo, all intervention in the economy is mischievous regardless of whether or not the intervention occurs with the noblest of intentions.
There is an insurmountable problem faced by all government agencies in their attempts to 'improve' on the free market. The problem is that no person, or group of people, can ever possibly account for the myriad variables and inter-relationships that guide the interactions of millions of individuals. As such there is no way that any person, or group of people, can ever know what the 'correct' intervention should be in order to achieve a desired outcome.
No system is perfect, and even a free market results in imbalances and inequalities. It was, in fact, a recognition of the 'inadequacies' in the free market system that originally led well-meaning (we'll give them the benefit of the doubt by calling them "well-meaning") people to advocate government intervention. However, when these interventions had unforeseen consequences, as all interventions in the free market necessarily do, the negative consequences were put down to further market deficiencies and prompted calls for additional intervention. Step by step, over more than 100 years, each intervention created more problems than it solved and brought calls for still more intervention. We now live in a world where the government not only tries to regulate and/or monitor most economic transactions, but a world where the vast majority of people do not even question the need for such an intrusive government.
The reason that government intervention in the economy always creates more problems than it solves is that it distorts the means by which information is transmitted throughout the economy - price. When prices stop reflecting the natural supply and demand fundamentals, bad decisions necessarily result. This is also why inflation, while initially appearing to be innocuous, has such a pernicious effect on the economy - an excessive increase in the supply of money distorts prices and leads to mal-investment and the misallocation of resources. For a blatant example of what can happen when a government intervenes in the economy, in this case by regulating retail electricity prices and restricting the way the utility companies contract for energy, just look at the present debacle in California. There is now a significant chance that the huge Californian economy will be crippled due to an energy shortage.
We do not need a more responsible central bank, we need the elimination of the central bank and the system that allows money to be created at the whim of banks.
The Dollar's Long Term Trend
Whether you see a market as a bull or a bear market, or the trend as being up or down, often depends on your time frame. For example, the S&P500 has been in a downtrend for the past 12 months, but if we look at a chart covering the past 20 years we can see that it is still in a long-term up-trend (refer to the chart in the Mar-26 WMU). It is a similar story with the Dollar. Looking at a 5-year chart of the Dollar we can clearly see a powerful up-trend, but taking a much longer-term view we could argue that the Dollar is in a major downtrend and has just completed a 5-year bear market rally.
Our interpretation of the Dollar's long-term trend is shown on the following chart (the chart shows the Major Currencies Index - a trade-weighted index of the foreign exchange values of major currencies against the US$). Our view is that the major trend is down, but very occasionally (once per decade?) something happens that prompts a multi-year surge of capital into the US thus causing the US$ to diverge from its major trend. The divergence is subsequently resolved by the Dollar 'snapping back' onto the major trend.
King Dollar
Many analysts have argued that US technological superiority, combined with the reserve status of the Dollar, will ensure that the Dollar remains strong for a long time to come. We think, however, that they are missing an important point - valuation. For example, Cisco may have been the world's best business in March 2000 and it may still be the world's best business today, but that didn't stop the Cisco stock price from dropping by more than 80% over the past 12 months. As far as we can tell there is very little difference between those who argued, in March 2000, that Cisco's growth profile meant that no P/E ratio was too high, and those who argue today that US technological superiority means that no current account deficit is too high.
Steve Saville
Hong Kong
12 April 2001
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