VTI - The State Of The Economy: Listen To The Dollar

2023-04-26 15:43:14 ET

Summary

• Market discontent about United States economic policies has grown, as reflected in a declining value of the dollar and a rising price of gold since early in November.
• Money is moving out of the U.S. dollar and flowing into gold.
• Furthermore, the United States is moving into presidential election territory, and governmental policies, both fiscal and monetary, will be gathering more and more attention.
• If policies follow current pathways, the dollar will only decline more in value and the price of gold will rise, setting up a not-very-pretty narrative for the upcoming election.
• But, because of the things that have happened over the past three years or so, alternative pictures are not very pretty either, even though they may need to be pursued.

What should be the economic policy of the U.S. government right now?

The Federal Reserve is fighting inflation and has been doing so since March 2022. The federal government is pushing for economic growth and the federal deficits are large and are increasing.

But, just what should the government be doing?

The specific data I am drawing on comes from the Bank for International Settlements as presented by Niall Ferguson in an article in Bloomberg .

Mr. Ferguson has used the U.S. dollar real effective exchange rate produced by the Bank for International Settlements.

This is the chart used in the article.

Mr. Ferguson divides these data into six periods, beginning in July 1971, just before President Nixon froze wages and prices and removed the gold backing of the U.S. dollar. The U.S. dollar has floated in foreign exchange markets ever since.

Ferguson's six periods end in October 2022. The value of the U.S. dollar hit a near-term peak in that month and has declined since then.

The US Dollar Index (DXY), published daily by the Wall Street Journal, has fallen since the near-term peak it hit on November 3, 2023. Since that date, the value of the dollar has declined by 10.3 percent.

Note the title of the chart. Mr. Ferguson doesn't feel that this move is, at its present level, much of a currency crisis. At least, not nearly what Mr. Ferguson considers to be a currency crisis, drawing from the data since 1971.

In the three crises Mr. Ferguson identifies since August 1971, the average decline in the U.S. dollar amounted to just over 31 percent.

So, there is a long way to go here to qualify the drop we are in as a "currency crisis."

But, we are on the downside.

Current Economic Policy

There seem to be two problems troubling investors these days.

The first is inflation. Inflation has been the reason for the Fed's monetary tightness.

The second has to do with the worldwide sanctions the U.S. has ordered since Russia invaded Ukraine.

These two problems are cited as the reason for the falling price of the U.S. dollar.

But, these two problems also seem to be behind the rise in the price of gold. It seems that central bank gold purchases are at the highest level on record.

It is ironic that the value of the U.S. dollar and the price of gold hit turning points, both on November 3, 2023.

Gold Continuous Contract ((GCOO))

Note that an ounce of gold cost $1,633.40 at the market close on November 3, 2023, a near-term low.

Around noon on April 26, 2023, the price of gold was around $2,000.00, reflecting a 22.4 percent rise.

Also, consider the fact that the price of gold reached a near-term high of $2,054.40 on April 13, 2023, just a few dollars under the all-time historic high.

So, we have the U.S. dollar declining in value and we have the price of gold increasing quite rapidly reflecting world inflationary pressures and also reflecting world political tensions.

What should the U.S. government be doing?

The Most Important Price In The Economy

Paul Volcker, to me, puts everything into perspective in the book he wrote with former Japanese central bank leader, Toyoo Gyohten, "Changing Fortunes: The World's Money and the Threat to American Leadership," (published by Times Books in 1992, page 232).

"A nation's currency is the single most important price in the economy."

A world leader in central banking wants to see the price of its currency be strong, to see its economy strong, and to see its currency as the leading reserve currency in the world.

Of the six periods, Mr. Ferguson identifies in his article, the three periods in which the value of the U.S. dollar is rising, the U.S. economy is growing well, the inflation rate is low, and the price of gold is also low.

In all three periods, inflation had been brought under control, both fiscal and monetary policies were conservatively managed, and the economy was robust and United States corporations were very competitive in the world.

Mr. Volcker also writes in the book, the price of the nation's currency "will influence the entire range of individual prices, imports and exports, and even the level of economic activity."

This is what was achieved in the three periods of time identified by Mr. Volcker in which the value of the dollar rose in foreign exchange markets.

So, from where Mr. Volcker stood, not only was "a nation's currency" the most important price in the economy, a nation's currency needed to be strong in the marketplace and respected within the investment community.

Since November 2022, the value of the U.S. dollar has been getting weaker.

But, it has not gotten that much weaker.

Mr. Ferguson believes that we are "hardly in a currency crisis."

Yet, we cannot say that we have not entered into another decline in the value of the U.S. dollar that could carry us into territory that would threaten the position of the dollar in the world over the next several years.

And, Where Are We?

Perhaps the most important thing coming up is the 2024 presidential election in the United States.

An incumbent president needs an economy that is relatively healthy. Voters must feel that the president is doing a relatively good job in managing the economy.

Right now, polls seem to indicate that the current president is not rated that high for his management of the U.S. economy.

In this situation, how can he change opinions about economic performance? How can he prove himself over the next sixteen months or so that economic policy is where it should be?

What about the Federal Reserve? The Federal Reserve has been fighting inflation since the middle of March 2022.

Right now, there are a large number of financial market participants that believe Jerome Powell, the Fed chair, and the Federal Reserve will soon "pivot" on monetary policy and ease up to support the markets and the president.

Stock market participants are one such indicator of such an attitude.

But, the position of the president and the position of Mr. Powell and the Federal Reserve does not quite match the conclusions discussed in the earlier part of this post.

What Is Called For?

Given the framework presented by Mr. Volcker, discussed above, the U.S. economy needs the government to stick by a policy of monetary tightness combined with more fiscal constraint.

The value of the U.S. dollar has only fallen by about 10.0 percent since last November.

As Mr. Ferguson suggests, this is hardly a currency crisis.

Yet, the Federal Reserve cannot ease up on its "tight" monetary policy at this time because that would surely result in a further and faster decline in the value of the U.S. dollar.

And, it would result in many new historic highs for the price of gold.

The current fiscal policy will not be able to overcome a situation in which the value of the dollar ends up dropping by an average of 31 percent as discussed above.

The recession that has been looming over the U.S. economy for so long will not be able to be contained within this kind of environment.

A significant recession over the next year will not be a welcome addition to the presidential election that will be taking place at the time.

This, it seems to me, is not a situation that can be overcome by an optimism that is not really warranted by the facts.

The situation is not a good one. As I have been writing over and over during the past three years or so, the economy is in a mess. Disequilibrium exists everywhere and the future is subject to radical uncertainty.

To me, the situation must be accepted by the administration, and the approach to the future must always be on the side of honesty and full disclosure.

Inflation must be controlled, the value of the U.S. dollar must rise, and these will, over time, lead to a much stronger economy.

This is not a narrative that will be very popular with the voting public.

But, it will be as close to the truth as we can come at this time and with the information we have.

Other paths will just result in greater pain and greater disenchantment.

We don't need more of them.

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