Topic
Since the financial meltdown in 2008, the public's attention has turned squarely to the major fiscal and economic issues that threaten its financial future, such as the widening budget deficits, the skyrocketing national debt, the depressed housing market, and rising oil and food prices. It's impossible to get through a day's news cycle without receiving a dose of news on any of these issues.
In watching it all unfold daily, investors are asking themselves what they should be doing to protect their investments and plan for their futures. The problem is that these issues and events are lagging indicators of what has already occurred and do little to indicate what may happen in the future.
What you don't see being reported every day, at least with the same level of attention, is the status of the value of the U.S. dollar (USD), which can be much more predictive of the direction of markets and the economy.
Whereas measures such as GDP, inflation, and unemployment reflect what has already happened, the changing value of the dollar acts more like a barometer of future economic conditions, not just here at home but all over the world. As the dollar changes value, it can trigger economic changes and market shifts that will impact investments.
Essentially, ever since the decoupling of the dollar from the gold standard in the 1970s, it has declined in value relative to the inflation-adjusted price of gold. Over the years, whenever the economy was strong and the need for debt financing government expenditures was low, the dollar strengthened against other currencies. When the economy weakens and subsequently forces the Federal Reserve Bank to loosen money to increase liquidity, it drives the value of the dollar lower. This is because the Fed has to print more money, for which there is no direct backing of assets. As with anything, when supply increases, the price declines, especially if it exceeds demand.
Following the 2008 financial crisis and again following the pandemic-induced economic meltdown, the Fed has engaged in what has been termed "quantitative easing" (QE), which is, in essence, the printing of billions of dollars to create market liquidity. It also capped the federal interest rate (the rate at which it loans money to financial institutions) at historically low rates.
The effect of lots of "cheap" money flowing into the market has resulted in the inflation of assets such as the stock market. Once the Fed's QE program stopped, the stock market began to decline.
While federal policymakers will probably deny it, the fact is that there has been a concerted effort to devalue the dollar. The theory is that when the dollar is cheaper than other currencies, it will make our products less expensive abroad, which will increase U.S. exports. The hope is that this will spark economic growth.
At the same time, it makes goods produced overseas more expensive to us. Also, because other governments have to inflate the value of their own currency to offset the loss in value of the U.S. dollar, food and fuel prices increase. And because the U.S. supports more goods than it exports, the prices of daily consumption goods will continue to rise.
While economists will debate whether there is an actual cause and effect between a lower dollar and higher oil prices, all you need to do is chart the dollar's value against oil prices, and you can see that it has a direct inverse relationship. No one can dispute the fact that, as the dollar has declined in value, oil prices have risen sharply. The other effect of a declining dollar is that investors, financial institutions, and the central banks of other countries seek to counter the loss in dollar reserve value by investing in gold. The rapid appreciation of the price of gold has occurred during a time when the value of the dollar has fallen.
Investors can look to current or stated Federal Reserve policies or the current economic conditions to predict the direction of the U.S. dollar with a fair amount of accuracy. A perceived weakening of the economy will result in a weakening dollar, likely leading to increasing commodity prices, lower rates on savings, and a more robust bond market. A stronger economy leads to a stronger dollar, likely leading to higher inflation, higher interest rates, and a more robust stock market.
For the best indication of how your investments might perform in the future, just keep your eye on the bouncing dollar.
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