Thursday, February 21, 2008


Yesterday, I mentioned that the weak dollar is used as "the excuse" for all that ails. The reality is that the very low price of the dollar is cause for great optimism. Do you want to buy a dollar when it is over priced or when it is cheap?

Today, a flood of dollar buying is in evidence. US exports of manufactured goods just went up more than 13% over last year. Both foreign and domestic businesses must consider locating plants in America right now because it is cheaper to build a plant with US dollars than with Euro Dollars.

Investors in US stocks will get a double bang for their buck over the next several years. In 1996, when the dollar was almost as cheap as it is now, was at the start of the second half of the 90's business cycle. As the business cycle progressed, US stocks soared in value in dollar terms. In terms of other currencies, US stocks rocketed off the charts. History does not repeat but it certainly rhymes. Over the next several years, the odds are good that the dollar will bounce off this major low and as it does, the incentive for foreign investors to buy US assets will be great.


The flip side of the US dollar price is the corn price. At or near the end of each commodity cycle surge, the price of corn gets out of whack. In 1974 the price of corn traded at $4 per bushel, a year later the price was down to $2.50 and within three years corn traded at $1.80 per bushel. By the end of the 1970's, oil had once again soared in price and corn traded for $3.95. By 1982, the price had fallen back to $2.15 and by 1986 the price had fallen to $1.45. In 1996, at the mid cycle turn, corn traded at $5.50 per bushel and it fell to $1.90 per bushel by 1998. As recently as November of 2005 corn traded at $2 per bushel but in January it was trading around $5.40.

Tons of corn syrup go into tons and tons of food products. Coke and Pepsi use very large quantities in drinks and Pepsi sells corn chips to match. The volatility of the price of corn is the main reason that the government issues two sets of inflation figures. The core rate of inflation does not include food or energy. The price of food and energy goes down in real terms over time but they each spike up in 4 and a half and 9 year patterns.

The bond market is forecasting inflation of about 2%. The most recent CPI headline numbers show 4.3% inflation. The long term average is 4.1% but we live in a time of "disinflation" forces. The USA is set up to see very low inflation for the next several years, partly because as our dollar strengthens the price of foreign goods will fall.


In case you are not aware, the dollar has not fallen in relative value for the past 6 months. Once the FOMC started cutting rates, the dollar stopped falling. The prospects for economic growth increase as US interest rates are cut and this makes the dollar more attractive to own. Pundits consistently state the relationship between interest rate cuts and the dollar strength upside down. They focus on the real short term effect of lower US rates causing money market investors to seek higher yields in other currencies.

When a few economic numbers were weak last week, the dollar bears come out of hiding, gold soared, oil soared and the pundits whined that the FOMC is between a rock and a hard place. They constant fear is that the economy is getting in worse shape so the FOMC needs to cut rates but the FOMC cannot afford to cut rates because that would cause a decline in the dollar.

One can look at a chart of Fed Funds Rates and the dollar and determine in about 5 seconds that the relationship is the other way around. The dollar fell and fell some more as the FOMC raised interest rates in the mid 90's cycle and in the mid 2000's cycle. Then, when the FOMC cut rates in 1996 and late in 2007, the dollar started to turn. By 2,000, the dollar had retraced its steps all the way back to the prior peak.

Are governments concerned about inflation? Sure they are! As the dollar climbs back up the mountain, the price of US corn (we only grew 100 million acres last year) will rise in price for the rest of the world. The price is ready to tumble in dollar terms.

Falling corn and oil prices in dollar terms will mean US interest rates can remain relatively low. Low interest rates means the value of assets are discounted at lower rates. The price of US assets is ready to soar!