On October 6, 2010, Treasury Secretary Timothy Geithner, during a question/answer period at The Brookings Institution, said, “It is not good for the world for the burden of solving [the exchange-rate problem] to rest on the shoulders of the United States... It’s better for it to happen through the collective force of [the IMF and the G-20].”
Though the Federal Reserve is already in ‘pedal-to-the-metal’ mode in an effort to revive the U.S. economy by holding the Fed-funds rate down at an ultra-low zero-to-0.25% and by purchasing hundreds of billions in U.S. Treasuries, they have now flipped open the protective cover to the red ‘turbo-drive’ button and are prepared to punch it by buying hundreds of billions more in Treasuries in Round Two of Fed quantitative easing, “QE2”. It, therefore, seems insincere of Secretary Geithner, with his left hand, to gesture for a multilateral approach to solving the exchange-rate issue, and through his right-hand man, Fed Chairman Bernanke, outprint every nation on earth and then insist the markets be allowed to drive currency prices when it’s the Chairman who’s doing the driving – inciting foreign central banks to likewise print in defense of respective exporter competitiveness.
The Treasury and the Fed’s intent for QE2 is to provide the liquidity that will encourage companies to spend and invest. However, what QE2 will primarily do is accelerate the disturbing polarity between lower standard-of-living lows and higher stock-market highs.
Lower Standard of Living: Higher Debt, Higher Prices, Reduced Purchasing Power
As of the latest data, the Federal Reserve maintains its position as the third-largest holder of U.S. Treasury securities at $821.2 billion. China is the largest holder at $868.4 billion, followed by Japan at $836.6 billion. QE2 may well be the game changer.
By inundating the markets with billions of newly-created dollars via Treasury securities, engaged commodity suppliers will demand more dollars for the same amount of goods to compensate for dollar dilution. Consider QE’s current effect on fast food and gasoline:
Corn, which is also used for livestock feed, has risen in value over 30% since April 2010. Beef, pork and chicken prices, as a result, are climbing. Fast-food retailers feeling the profit squeeze include McDonald's, Burger King, Wendy’s, Arby’s, KFC, Chick-fil-A, Boston Market, Bojangle’s and El Pollo Loco. In response, McDonald’s is expanding its range of non-burger products. Higher costs for other ingredients such as coffee, milk and cocoa are affecting coffee retailers Starbuck’s, Green Mountain Coffee Roasters, Peet’s Coffee & Tea, and Caribou Coffee. QE2 will compound upward pressure on prices.
As for gasoline, according to AAA as of October 18, 2010, the average price of a gallon of regular was $2.832; marginally lower than the previous day’s $2.834; up from $2.807 the week before; up from $2.735 the month before; and up from $2.547 the year before, as oil hovered near $82 a barrel and poised to rise on dollar deflation which will also affect heating oil, kerosene, tires, jet fuel, etc. – further deepening ongoing economic miseries:
- Rising unemployment: The U.S. lost 95,000 jobs in September; and down 70,000 manufacturing jobs for the year. Taxpayers supported over 20 million unemployed workers with $76.8 billion in unemployment benefits in 2009, up significantly from 9.5 million unemployed with $43.7 billion in 2008, which is quite higher still from the 7.6 million unemployed with $29.4 billion in 2007. The desired objective of QE2 will unfortunately be offset by the current housing-title crisis besetting banks. Many small businesses will continue to be denied the credit needed to carry on – let alone, hire workers;
- Millions receiving food assistance: As of the latest June figure, 41.2 million people were receiving monthly assistance in the federal food-stamp program, which averaged $133.36 a person. Also, over 9.3 million people are participating in the WIC Nutrition Program with a total monthly cost of about $70.27 per person. The total spot-annual cost of both programs comes to about $73.7 billion – and rising with unemployment;
- Continued cost-of-living pinch: Even though the cost of food and energy is rising, 58 million social security recipients will not receive a cost-of-living increase next year since the inflation rate is below 2008 levels (thanks to the price of oil having reached $147 per barrel), which will intensify calls for lower prices.
Rising Markets: The Dow, “Buy China”, and the Strategic Use of a Roth IRA
On the rising markets, history has shown that the Dow-Jones-Industrial-Average basket is a profitable investment for long-term capital appreciation. Those who determine the Dow 30’s make-up and formula do whatever it takes to ensure the index is comprised of high-powered, high-profit companies with significant international exposure; and that its formula is configured for success. So, as a Dow investor, I needn’t worry about picking the right stocks or deducing the right allocation – the Wall Street pros take care of that. If there had been a Dow Jones Industrial Average (DJIA) ETF in 1929, its value today would be sky high in spite of the turbulence the index has experienced over the years.
Moreover, repatriated earnings into a weak-dollar environment make profits appear quite attractive; and the excess liquidity created by central banks – pouring into quality assets such as the companies represented in the Dow – will push the index to historic highs.
For U.S. investors seeking capital appreciation, there is the DJIA ETF, symbol: DIA; and for those relying on dividend income, there is the Dow 30 Enhanced Premium & Income Fund ETF, symbol: DPO. In this environment, international investors should consider whether the upside gains of DIA, or the dividend income from DPO, outperform possible exchange-rate losses when converting U.S.-dollar gains/income into local currency.
Many say, “Buy China”, however, China has yet to understand how the global economic game is played. The ruling party seems to think it can pour new wine (capitalism) into old wineskins (socialism) with no regard for the fact that without appropriate modifications, the old wineskins will burst. China must realize compromise is key to capitalism. And until China categorically embraces private ownership, I would not advise investing in its state-owned companies, but in the commodities China requires for continued 9%+ economic growth: oil (ERF, PGH), copper (JJC), and coal (NRP, PVR). Gold (GLD, CEF) will also do well.
Capping off, I would hold such investments in a Roth IRA with a discount broker like E*TRADE Financial. Deposit after-tax dollars into the Roth IRA, choose your desired investment vehicles, and at the age of 59½ you have penalty-free access to the tax-free growth-and-income gains in that account. For at some point, federal taxes and interest rates will rise, reducing purchasing power by increasing our tax burden and debt-service costs. Consult with a tax advisor for personal guidance.
As unfair as material polarization may be, it is the result of ‘debt gone wild’. Whether you consider yourself in the ‘haves’ camp or in the ‘have-nots’, we all have this in common: Times of testing are upon us. Therefore, let’s work together toward equitable economic solutions.
