Analysts name the weak dollar as one of the reasons for the hot money that has flooded commodities this year. Since raw materials are basically traded in the U.S. currency, any weakening of the currency is usually followed by an upward adjustment in prices.
Economists have said that if the dollar were to strengthen, and the ailing U.S. stock market to rebound as well, some of the money in commodities could return to currency and equity markets. So far there's been little evidence of that happening, even with Tuesday's Federal Reserve plan to provide $200 billion to cash-starved credit markets.
One of the drawbacks of having the dollar be the currency in which most commodities are priced is the dollar's value has a strong correlation to the price of commodities. When the dollar drops in value, commodities become less valuable; they need to increase in price to simply tread water value wise.
This is one of the reasons why the Fed's rate cuts are so incredibly dangerous. As the Fed cuts rates, the dollar become less attractive. One of the reasons people invest in a country is the rate of return they can get on the assets they park in bank accounts. So right now traders are looking to the rate cuts and saying, "rates are higher somewhere else." Add to that the overall condition of the US economy, and you have a place people don't want to invest right now. Therefore, dollar demand drops as does the dollar's price.
Bernanke has obviously decided he can live with a higher inflation rate. But the big problem is how far out of control can you let inflation go before you have to play catch-up?
6 comments:
does that mean we get the recession we would have had, but now with extra inflation? or was the inflation always in the cards because of the economy?
There will be no recession permitted until 20 Jan 2009.
You can learn quite a bit about complex systems when they're under stress - especially if those systems were designed by Larry, Moe, and Curly. Who knew that when you turned on the stove, the lightbulbs would fill with water? Hilarious.
Bonddad- How bad does inflation have to get before the Fed changes its policy? I am not an economics whiz, just an average consumer and I simply can't believe the prices on things like flour and dairy. At some point, people are going to start screaming, right?
If basics become exorbitantly expensive, we are going to see vulnerable people starving to death right here in the US. I don't think that's an exaggeration. The elderly, the isolated poor- people are going to turn up dead.
I guess my question is how many more rate cuts will be allowed?
Irate Lady in ATL
Hey Bonddad,
Could you do an article on wealth preservation? I've been saving for a house for years and now inflation and the markets are killing my nest egg. It doesn't help at all that the fed seems intent on interest rates being under inflation...
Thanks,
Mike
Recession really has a big impact on stocks, commodities and currency. Commodity boom is one of the result of recession. It weaken dollar rate also. The government must do something about it.
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