Airplanes and the Purchasing Power of the U.S. dollar

Rodney Johnson | Wednesday, November 28, 2012 >>


I started my working life on Wall Street, first in a management training program and then on a bond desk. When you get to a trading desk, the first thing you have to learn is the rhythm of whatever security you trade. In bonds, the rhythm wasn’t too hard.

Lesson #1: Don’t fight the Fed. They have more money than anyone else.

Lesson #2: Stand up and hold your arms out like an airplane. Pretend one “wing” is the price of the bond and the other “wing” is the yield. When one dips, the other rises and vice versa.

That’s it.

Now imagine a group of 20-something-year-old hot shots who think they are cool new traders standing around in designer suits pretending they are airplanes. You get the picture.

This lesson in prices/yields recently came to mind when I was asked for the eight-millionth time about the U.S. dollar. You know the story…

Given that the Federal Reserve has launched not one, not two, but THREE rounds of quantitative easing, where they create money from nothing – and by the way, the third round has no defined end – doesn’t the dollar have to go down!?

Clearly, when there are more dollars created then all the rest lose value, so the Fed’s efforts must, and I say MUST, lead to devaluation… right?

Wrong.

You’ve got the wrong airplane in mind.

To figure out what will happen to the U.S. dollar, you can use the same exercise that I was forced to use when determining the movement of prices versus yields on bonds. Stand up or, for those a bit more sedentary, simply stay in your chair, and put your arms out like an airplane.

One “wing” is the value or purchasing power of the U.S. dollar, and the other “wing” is NOT… I repeat, NOT… the number of dollars we print or are in circulation. Instead, the other “wing” is the value of foreign currencies.

Given that there are numerous foreign currencies, sitting might be better so you can put out a foot to represent another currency.

If you think about it, we don’t price dollars against other dollars. When we talk about more dollars being created leading to lower purchasing power, the unspoken qualifying statement is, “with all things being held constant.” Of course, this alludes to the purchasing power of all other currencies being held steady.

This is the myth of currencies and central banks. They are always in flux. The value of a currency is not a simple outcome of activities inside the country. It is a combination of all activities inside the country compared to the combination of all activities inside another country.

The actual exchange rate is simply the numerical representation of how people view the complex items on any given day. Our situation today is a great example.

Inside the U.S. we sort of suck. Coming off the worst economic downturn in a generation, we have wheezing economic growth at 2% or less, wages are falling, prices are rising and the fed is wildly printing new money (figuratively) while manipulating interest rates lower.

By any rational measure, the U.S. dollar should be in free fall.

HOWEVER…

Using the airplane analogy from above, if the U.S. dollar is in one hand and the euro in the other, which one should go up and which one should go down?

The euro must be on the downside. With Greece in bankruptcy and Spain not far behind, the very existence of the euro is in question. To hold it for a storehouse of value would be a fool’s game.

Now do the same with the yen. With a debt-to-GDP of 230%, a rapidly aging population that is literally dying off and a young set that doesn’t want to work or marry, who wants to hold the yen?

Once we change the measure of the U.S. dollar from “how many are out there?” to “what would you rather have instead?” it’s easy to see how the U.S. dollar could, and should, remain quite strong in the months and even years ahead.

This doesn’t mean the U.S. dollar is golden. We are still a very weak economy. If the euro zone countries or Japan radically improve their economies, we could see a huge swing in the value of the dollar. But I’m not willing to bet my savings on it. We’re still the best looking beast in an ugly dog contest.

Rodney

 

 

Ahead of the Curve with Adam O’Dell

Why We Continue to Root for the Value of Dollar

As Rodney explained well, the value of the U.S. dollar is completely relative. You can’t say what the dollar is actually worth. You can only say what the dollar is worth in relation to the value of some other currency.

 

 

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Categories: Economy

About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.