The High Price of Fed Dollar Depreciation

On November 9, the Bureau of Labor Statistics released data for U.S. import prices showing a higher than expected increase of 0.5% for the month of October. While some of this increase was due to volatile fuel prices, I continue to see evidence that increases could potentially become a long-term trend. I believe this may spell trouble for U.S. consumers, as a depreciating dollar could drive up prices of imported goods, and therefore diminish purchasing power. 

This month, Richmond Federal Reserve Jeffrey Lacker became the latest to join the ranks when he said in an interview with Market News International that one of the objectives of Federal Open Market Committee’s (FOMC) latest round of quantitative easing was “designed in part to depreciate the dollar”. You may recall that at the end of September, within two days not one but two Federal Reserve Bank presidents discussed import price inflation and the exchange rate of the U.S. dollar, which signaled that the Fed was attempting to weaken the dollar to boost the economy and spur job creation at the expense of heightened inflationary risks. 

Lacker has been a vocal dissenter of the Fed’s quantitative easing actions for much of the year, so his cautionary words on inflation don’t exactly come as a surprise. However, he is the third Fed president in two months to allude to a dollar depreciation strategy. This is especially striking considering that the Fed normally refrains from making comments on currency—U.S. dollar policy is typically left to the U.S. Treasury.

I am not the only one concerned; a number of foreign ministers have criticized quantitative easing in the U.S. as a tool to devalue the U.S. dollar. Many have said that this strategy will disrupt international capital flows and cause the currencies of developing nations to appreciate considerably. The criticism grew such that at an October seminar sponsored by the Bank of Japan and the International Monetary Fund, Fed Chairman Ben Bernanke delivered a speech in which he explicitly defended the actions of the FOMC, citing that monetary accommodation was appropriate when one aspect of the Fed’s dual mandate (maximum employment) was too high and the other (price stability) was well contained by low inflation. In my mind, his speech practically admitted to a dollar weakening strategy.

Though Chairman Bernanke encouraged other nations to refrain from intervening in their currency markets, I believe that this will largely go unheeded. Instead, I believe that we will continue to see policy resistance to foreign exchange appreciation. As a result, I see this dollar depreciation scenario being a gradual one that happens against many currencies and in different phases for each rather than a sudden, sharp and generalized fall in the greenback. And I believe that increases in inflationary expectations and rising import prices for U.S. consumers could potentially follow. Given this, I continue to believe that now is a time for investors to consider ways of protecting their purchasing power.



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