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Higher Interest Rates Won't Help the Dollar

Peter Schiff
May 26, 2006

As U.S. inflation is beginning to be taken a bit more seriously, the dollar has found some temporary support as traders anticipate higher interest rates from a more aggressive Fed. Ironically, foreign investors attracted to the higher yields will be stung by the declining value of the dollar which must result from higher inflation. (See my commentary of April 6th 2005 Hello, Inflation is not Good for the Dollar). Therefore, even if in the short term higher rates may buy the dollar some time, in the long run the dollar will buy much less. However, even if we were to ignore inflation's impact on foreign exchange, the investment logic itself is flawed as it does not factor in the U.S. economy's vulnerability to higher interest rates.

To be viewed as bullish for the dollar, inflation is operative only when one believes that the Fed is firmly committed to fighting it. Lost in translation is the fact that the Fed's anti-inflationary rhetoric may be just that - rhetorical. While bad news for savers and investors, higher inflation is actually the government's best friend and is the most politically expedient way to resolve America's economic imbalances and reduce the real burden of repaying its own debts.

When higher interest rates really start to take their toll on consumer spending and home prices, the Fed will either do an about face and start cutting rates in a desperate attempt to revive the economy, or it will continue to raise them, deliberately pushing the economy deeper into recession. Both scenarios are bearish for the dollar, and it is only a matter of time before the market figures this out.

It is also ironic that Stephen Roach, who recently capitulated his long-held bearish position on the global economy, just added his voice to the chorus calling the rise in commodity prices a bubble. His principal reason for doing so was his observation that given that there is no inflation, commodity price increases of the magnitude recently experienced were unwarranted, and should therefore be reversed. That is like expecting an obese individual to lose weight simply because he claims to be dieting, while ignoring his third trip to the buffet table.

The fact that Wall Street's brightest stars accept the current environment as non-inflationary, while they stare at commodity prices that skyrocket on a daily basis, demonstrates how successful the government has been in its disinformation campaign. With the bill of goods firmly grasped, they expect prices to fall rather than question the inherent irrationality of the government's claims. Just as Roach's declaration that America's economic imbalances were no longer problematic likely means that they will soon weigh heavier than ever, his pronouncement of inflation's absence likely means it is finally about to spiral out of control.

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Peter Schiff
C.E.O. and Chief Global Strategist
Euro Pacific Capital, Inc.
1 800-727-7922


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 County Register.

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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