The U.S. dollar has been on a rally since June/July of this summer. But, how can this be? The U.S. Federal Reserve has slashed interest rates like crazy, almost to 0%. When interest rates fall the dollar tends to fall with them. U.S. rates have come down way faster than foreign interest rates, so why is the dollar rallying in the face of falling rates? I think it is because the REAL U.S. interest rate is not falling. The Fed is trying to lower rates and stimulate lending/spending, however, banks are not lending and people are not spending. If lending is not taking place there is no real pressure on rates to actually fall. Why is lending not taking place? It is because of the liquidity trap that the U.S. is in. What is a liquidity trap? A liquidity trap is, "a situation in monetary economics in which a country's nominal interest rate has been lowered nearly or equal to zero to avoid a recession, but the liquidity in the market created by these low interest rates does not stimulate the economy. In these situations, borrowers prefer to keep assets in short-term cash bank accounts rather than making long-term investments. This makes a recession even more severe, and can contribute to deflation." So, we have 0% interest rates, but because of the liquidity trap our REAL interest rate doesn't fall. What does this mean? Well, in countries around the world, such as Germany, China, Canada, and Australia, where a liquidity trap does not exist, their interest rate cuts ARE working. This reduces the value of their currencies relative to ours, since our REAL interest rate isn't dropping. This is what is responsible for the dollar rising. The rising dollar is responsible for oil, natural gas, copper, and other commodities absolutely collapsing. This creates deflation. Also now contributing to deflation are the falling home equity prices. People see houses getting cheaper and cheaper every day. So what are they going to do? They are going to wait another day before they buy a house. Nobody wants to buy a house for $250,000 when they can get it one year from now for $150,000. This leads to the expectation of further deflation. People quit spending because they know they can get the same goods tomorrow for cheaper, and it snowballs. Less spending means more savings and the money supply actually ends up contracting no matter what the Fed trys to do. We are basically going through the same thing as Japan's "lost decade" of the 1990s except on a much larger scale.
I expect to see the dollar continue its rally. I expect to see asset prices keep falling. I expect to see other economies recovering much faster than us (because they don't have mounds of debt and huge liquidity traps). Then after years of deflation and debt destruction I expect the United States to emerge once again, however, much weaker and hardly the center of the earth it is today.
Here is a summary of the Kondratieff Autumn (think 1980-2000) and Kondratieff Winter (think 2000-present & beyond). If you want to read the whole article click here. http://www.kwaves.com/kond_overview.htm
AUTUMN - Deflationary Growth (Plateau Period)
The primary recession occurs out of an imbalance forced upon the economy by real limitations. The rapid rise in prices and changes in production correct this imbalance -- at least temporarily. The change in price structure, along with the mood of a population used to consumption accompanied by the vast accumulation of wealth from the past 30 years, causes the economy to enter a period of relatively flat growth and mild prosperity. Due to structural changes and the limits of the existing paradigm the economy becomes consumption oriented.
Excesses of an unpopular war, along with fiscal liberalism, cause popular reaction toward stability or normalcy. A mood of isolationism permeates . The plateau period generally lasts seven to ten years and is characterized by selective industry growth, development of new ideas ( both technological and social ) and a strong feelings of affluence, terminating in a feeling of euphoria. The inflated price structure from the primary recession, along with the desire for consumption, produces a rapid increase in debt. Eventually, wealth consumption expands beyond all practical limits, and economy slips into a severe and protracted depression.
WINTER - Depression
Excesses of the plateau period effect a collapse of the price structure. This exhaustion of accumulated wealth forces the economy into a period of sharp retrenchment. Generally, the secondary depression entails a three year collapse, followed by a 15 year deflationary work out period. The deflation can best be seen in interest rates and wages that have shown a historic alignment with the timing of the Long Wave - peaking with and bottoming at the extremes.
Kondratieff viewed depressions as cleansing periods that allowed the economy to readjust from the previous excesses and begin a base for future growth. The characteristic of fulfilling the the expectations of the previous period of growth is realized within the Secondary Depression or Down Grade. This is a period of incremental innovation where technologies of the past period of growth are refined, made cheaper and more widely distributed. Incremental innovation consolidates industries.
As increment innovation narrows profits and increases
The Down Grade sees one final period of recession before transitioning to a new period of growth. The final recession is mild with very low inflation and appears far more severe than it will be remembered for later in the Growth Cycle.
Within the Down Grade is a consolidation of social values or goals. Ideas and concepts introduced in the preceding period of growth while radical sounding at the time become integrated into the fabric of society. Often these social changes are supported by shifts in technology. The period of incremental innovation provides the framework for social integration.
It is important to realize the Long Wave as global. While global issues are of prime importance today with increased air travel and communication, the Long Wave defines a time table for geo political events. The Growth Period is one of political stability. Staring a the peak old alliances become challenged. Through the process of the Down Grade old alliances fail and new alliances are formed. The final stages of the Down Grade is a period of coalescing or "quickening" of the alliances that will govern the next period of growth.
Hope you enjoyed....Brant (here is the chart of the dollar showing its recent strength)
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