“Greater Fools” Driving USD Higher

The U.S. has the highest inflation in 40 years, and yet it also has the strongest dollar in 20 years. How can that be? How can the dollar be so weak and yet be so strong at the exact same time? [This article] tries to make sense of this tale of two dollars.

This version of the original article by Peter Schiff (schiffgold.com) has been edited ([ ]), abridged (…) and reformatted for the sake of clarity and brevity to provide the reader with a faster and easier read.

The dollar has been on a tear in recent months…hitting parity with the euro last week [after 20-years)…and a 24-year high against the Japanese yen…and yet we have a massive devaluing of the dollar domestically…You can see the impact of dollar strength on import-export prices….

• [On one hand,] export prices rose 0.7 on the month and are up 18.2% on the year – double the consumer price index..[and] that is a real number, unlike the CPI that is a completely contrived, made-up number where you have a formula that’s reverse-engineered to come out with a lower number.
• On the flip side, import prices are much lower thanks to the power of the dollar. Nevertheless, even with dollar strength, import prices are still up 10.7% year-on-year….If the dollar wasn’t so strong, import prices would have gone up a lot more than that and that would have spilled over into the CPI so, but for the strong dollar, we would have much higher inflation numbers than the ones we’re dealing with.

THE DYNAMICS

When you boil it all down, inflation is the loss of a currency’s purchasing power. If our currency buys less, that means the currency is weakening. It is losing value. We need more and more dollars to buy the same quantity of goods and services…The limiting factor isn’t money, though. The government can print money at will. The limiting factor is the availability of goods and services and that’s what’s happening in the U.S.. It’s not so much that prices are going up. The value of the dollar is going down. There are trillions more dollars in the economy than there were a few years ago and therefore the value of each dollar is falling.

[That being said, however,] while the dollar is losing value, it’s not been this strong in decades. It’s gaining value relative to other currencies – and that is the dichotomy. It’s a tale of two dollars. You have the domestic dollar that is weak and losing value and then you’ve got this international dollar that is strong and is gaining value. The strength of the international dollar is helping Americans somewhat, but the weakness domestically is outstripping that international strength.

The question remains — why is the dollar so strong internationally when it’s so weak domestically?…If you look at everything from a fundamental perspective, today’s inflation should be exacting an even larger toll on the value of the dollar relative to other currencies than it was back in the 70s but the opposite is happening. Inflation is actually turning into a boon for the dollar. The weaker the dollar is in America, the stronger it becomes overseas. Why is that? Where is all the demand for dollars coming from? Foreigners don’t need dollars to buy U.S. products. The U.S. is running a massive trade deficit. The demand is coming from speculators.

Right now, the dollar is acting as an inflation hedge for everybody outside of the United States. It’s not an inflation hedge inside the United States. You can’t buy the dollar to hedge inflation if you’re an American living in the U.S. because there’s no hedge. The dollar is losing value. That’s not the dynamic that Europeans are looking at, or the Japanese. From the perspective of Europeans, and the Japanese, yields in the U.S. are very positive because they’re looking at the appreciation of the U.S. dollar…

There is also a self-perpetuating dynamic in play. As foreigners buy the dollar to hedge their currency’s inflation, the dollar goes up, reinforcing the idea that it’s an inflation hedge and that suckers in more buying…Fundamentally, though that does not makes sense. [In reality,] the dollar is rising on the greater fool theory. People are buying dollars not because they need them to buy American products…[but] because they think some greater fool is going to pay a higher price for their dollars in the future. That can go on for only so long until, ultimately, the bubble pops and that is what is going to happen to this dollar bubble because that’s what it is. It’s a massive reinforcing bubble where people are buying the dollar because it’s going up and, because it’s going up, people buy it.

Right now, the dollar looks like a much better alternative to gold but, at some point, people will start selling dollars to get their own currencies back then there is going to be a rush into gold. As I’ve been saying, gold will be the last safe haven standing because it’s the only true safe haven.