As Fed Policy Sinks the Dollar, Prices of Essentials Soar By CHARLES HUGH SMITH
| November 4, 2010
Intended or not, the Federal
Reserve's policy of quantitative easing has crushed the
U.S. dollar. (The second round announced Nov. 3 is called
"QE2" because it's the second round of easing
since the financial crisis of late 2008.)
Intended or not, the Fed's
destruction of the dollar's value has pushed prices of commodities
that Americans need -- such as instance food, cotton and
oil -- higher.
Whether the Fed's QE2 policy
will actually spark renewed growth in the economy is not
yet known, but what is known is that the producer costs
for essential commodities such as grain and cotton are skyrocketing,
and those increased costs will soon appear on store shelves.
Tragic Irony
Just as pernicious for the
stock market, higher commodity prices mean manufacturers'
profit margins will contract as companies seek to limit
the cost increases passed on to recession-battered consumers.
It may be the ultimate -- and
ultimately tragic -- irony: While the Fed's policy is supposed
to help the economy by encouraging more borrowing, the actual
effect is to raise prices for companies and consumers alike,
and to squeeze the very corporate profits that have been
driving stocks higher.
These charts of the dollar,
the S&P 500 (reflecting U.S. stocks) and three commodity
ETFs (exchange traded funds) show the dramatic effect of
the weakening dollar. While stocks have risen as overseas
earnings for U.S. global corporations are boosted by the
weaker dollar, commodities that end up in consumer goods
have exploded higher.
The pass-through of higher input costs to
consumers isn't theoretical -- it's real. For example UPS
just raised its shipping prices by 4.9%. Since shipping-box
dimension charges are also being changed, the effective
rate increase for lighter, larger boxes could be as high
as 16%. This is significant in an economy that's officially
currently experiencing near-zero inflation. (Officially,
the annualized inflation rates is 1.1%, according to the
Bureau of Labor Statistics.)
According to the BLS, the cost of finished
goods is rising at an annualized rate of about 4.8%. Since
some low-demand commodities such as lumber (demand fell
along with housing construction) and electronics (prices
of TVs have been dropping) are declining, the price increases
for essential goods may well be masked by a lower rate calculated
for all finished goods.
For instance, wheat has jumped from $158
per ton in June, when the dollar began falling in response
to the Fed's QE2 chatter, to $271 per ton in September.
That's a 71% increase. You may not need a load of 2x4s or
another flat-screen TV soon, but you certainly will be consuming
wheat in bread, pasta and other foods.
Creating "Hot Money"
Many economists and market watchers think
QE2 is bad policy: It's unlikely to work as intended and
could further damage the economy. How? By funneling a new
flood of cheap credit into speculative bets in emerging
markets and commodities while the Main Street economy withers
under the onslaught of higher prices unleashed by the same
Fed-powered speculative binge.
As I reported last month, the Fed's "trickle
down" policy of creating wealth for the top 10% who
own most of the nation's financial assets has been a failure.
The rise in emerging markets like Brazil and in commodities
like wheat suggest that speculative "hot money"
is the result when the Fed opens the floodgates of liquidity.
Brazil's stock market, the Bovespa, has more than doubled
since early 2009.
The semi-official reasoning behind weakening
the dollar is that a lower greenback will boost exports.
But since exports are a mere 7% of the U.S. economy ($1
trillion, compared to a GDP of $14.14 trillion), it's difficult
to see how a modest improvement in exports could offset
the dramatic price increases that are occurring across the
board in the rest of the economy.
Maybe all the financial speculation enabled
by the Fed's easy money, zero-interest rate policy (ZIRP)
easing will enrich a few trading desks and hedge funds,
but the price increases triggered by the Fed's policy will
certainly reduce the net income of every American household
as prices for essentials climb.
If you have any doubts about that, just
take another look at those charts of cotton, sugar and grain.