Your Pick, Ben, But One Goes Off the Cliff

04-22-2011 • OfTwoMinds.com/blog

It's one or the other, Ben: you either push the real economy over the edge or you push stocks and the risk trade off the cliff. Now that you've pushed the dollar down, Ben, it's your pick on what to push off the cliff: your beloved risk trade or the real economy. Here's a chart of the U.S. dollar and crude oil. Notice they're on a see-saw: when the dollar tanks, oil skyrockets. When the dollar recovers a bit, oil declines. Ben Bernanke and the Fed are replaying their 2008 game plan: drive the dollar down to goose the risk trade in stocks. But a funny thing happened on the way to blowing another equity bubble: oil bubbled up, too, and that killed the real economy. For the past three years, Ben has been trying to resuscitate the real economy via "the wealth effect": if your portfolio of stocks is rising, then you'll feel richer and your "animal spirits" of borrowing and spending will be aroused. The only proven way to goose stocks is to crush the dollar so overseas corporate earnings will be boosted by the currency depreciation (when transferred back into dollars, even flat profits look like they're rising), and U.S. exports will be cheaper to our trading partners. Flooding the U.S. market with liquidity and keeping interest rates at zero had another consequence, one adamantly denied by the Ministry of Truth: it sparked a carry trade in which cheap dollars could be borrowed for next to nothing and exported around the world to seek higher returns. Unsurprisingly, much of this free money flowed into commodities, which retained their value as the Fed pushed the dollar down. Also unsurprisingly, oil exporters raised the price of their oil in dollars as the dollar tanked. Ben and his motley crew at the Fed reckoned that the financialized U.S. economy would respond positively to the lower dollar and the goosing of the risk trade in stocks. But the guys and gals seem to have forgotten that the real economy is dependent on oil.