Hello, Inflation is not good
for the Dollar
April 7, 2005
The fact that signs of growing
inflation have coincided with a strengthening dollar has led
many to the erroneous conclusion that higher inflation is somehow
good for the dollar. However, a proper understanding of inflation
reveals this to be impossible.
The operative word in "inflation" is "inflate."
To inflate means to expand. Properly defined, "inflation"
is an expansion of the supply of money and credit. Deflation,
the opposite of "inflation," is therefore a contraction
of same. So when the Fed expands (inflates) the money supply,
or expands (inflates) credit, it creates inflation. One of the
results of inflation is that prices rise, be they asset prices
or consumer prices. When it is the former no one seems to care,
but when it is the latter, suddenly some people begin to mind.
Note that prices do not expand and contract, they rise and fall.
So rising prices are not inflation, they merely result from inflation.
The reason that inflation causes prices to rise is quite simple;
in fact, it is basic supply and demand. As the supply of money
increases in aggregate, the value of each unit of money decreases
by the same percentage. All else being equal, prices will have
to rise to reflect the reduced value of currency. Of course,
rarely does all else remain equal. In free market economies,
productivity generally increases the supply of consumer goods
as well, making the impact of inflation, as judged by its effects
on consumer prices, harder to detect. In some cases, inflation
actually prevents consumer prices from falling. But in all cases,
inflation results in consumer prices being higher then otherwise
would have been the case in its absence.
So if inflation implies a reduction in the value of the dollar,
why do currency traders react to stronger indications of inflation
by buying dollars? On the surface it appears as if this is yet
another conundrum. The actual explanation however is quite simple.
It is not that currency traders believe that inflation is good
for the dollar, on the contrary, they understand just how bad
it is. As a result, they are confident that the Fed will take
decisive action to contain it. It is in anticipation of those
actions that traders buy dollars, in effect betting that the
Fed will take aggressive action, in the form of interest rates
increase, to assure that "nascent" inflationary pressures
However, this misplaced confidence in the Fed, besides being
complexly undeserved, ignores just how far behind the inflation
curve the fed already is. After years of denying the threat,
reluctantly admitting the obvious hardly constitutes decisive
action. Currency speculators, convinced that the Fed is prepared
to nip an incipient inflation threat in the bud, have neglected
to notice that inflation's seeds have already matured into a
full grown tree. The time to "nip it in the bud" has
long since past, and this "mighty oak" will not fall
with 1/4 point rate hikes. As a result of its own incompetence,
the Fed now needs a much bigger ax, and will have to swing it
However, as I have repeatedly written in the past, the Fed can
not bring down the inflation tree, without simultaneously bringing
down the entire U.S. economy, which at present is comfortably
resting in its extended branches. As a result, the Fed's inflation
bark (no pun intended), will always be worse than its inflation
bite. Once currency traders figure this out, bad news on inflation
will once again be reacted to as being bad news for the dollar.
April 6, 2005
not wait for pull backs that may never come. Buy gold at current
prices and do not look back. I still believe the best way for
average investors to participate is though the Perth Mint in Australia.
For more information on their unique, safe, private, low-cost
program visit www.goldyoucanfold.com.
In addition, as the dollar's
value is likely to sink far faster than those of other fiat currencies,
investors can learn strategies to protect wealth and preserve
purchasing power by downloading my free research report on the
coming collapse of the U.S. dollar at www.researchreportone.com
and subscribing to my free, on-line investment newsletter at http://www.europac.net/newsletter/newsletter.asp.
C.E.O. and Chief Global Strategist
Euro Pacific Capital, Inc.
Mr. Schiff is one of
the few non-biased investment advisors (not committed solely to
the short side of the market) to have correctly called the current
bear market before it began and to have positioned his clients
accordingly. As a result of his accurate forecasts on the U.S.
stock market, commodities, gold and the dollar, he is becoming
increasingly more renowned. He has been quoted in many of the
nation's leading newspapers, including The Wall Street Journal,
Barron's, Investor's Business Daily, The Financial Times, The
New York Times, The Los Angeles Times, The Washington Post, The
Chicago Tribune, The Dallas Morning News, The Miami Herald, The
San Francisco Chronicle, The Atlanta Journal-Constitution, The
Arizona Republic, The Philadelphia Inquirer, and the Christian
Science Monitor, and has appeared on CNBC, CNNfn., and Bloomberg.
In addition, his views are frequently quoted locally in the Orange
Mr. Schiff began his investment career as a financial consultant
with Shearson Lehman Brothers, after having earned a degree in
finance and accounting from U.C. Berkley in 1987. A financial
professional for seventeen years he joined Euro Pacific
in 1996 and has served as its President since January 2000. An
expert on money, economic theory, and international investing,
he is a highly recommended broker by many of the nation's financial
newsletters and advisory services.
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