Forum for Science, Industry and Business

Sponsored by:     3M 
Search our Site:

 

Inflation and Dollar Depreciation

04.06.2009
Both the dollar depreciation and the increase in longer-term interest rates are attributable to fears of significant long-term inflation resulting from massive government borrowing and anticipated ongoing deficit spending. Expecting inflation, investors worldwide tend to move their money from dollars to what they believe will be more stable currencies. This results in depreciation of the dollar.

Recently, two major economic changes have taken place. First, the value of the dollar has fallen appreciably. From early March to June 1, the dollar index fell nearly 11 percent.

Second, interest rates on longer-term Treasury securities (those with maturities ranging from 10 to 30 years) have increased dramatically. This took place even though the Federal Reserve Bank purchased nearly $600 billion of Treasuries and mortgage-backed securities. Interest rates on 30-year fixed rate mortgages are tied to 10-year Treasury Note rates. Late in May, rates on both increased. The increase in mortgage interest rates has long-term negative implications for an already-depressed housing market.

Furthermore, increases in longer-term Treasury rates result in increases in corporate bond interest rates. Such increases dampen corporate plans to make capital expenditures, thereby prolonging the recession.

Both the dollar depreciation and the increase in longer-term interest rates are attributable to fears of significant long-term inflation resulting from massive government borrowing and anticipated ongoing deficit spending. Expecting inflation, investors worldwide tend to move their money from dollars to what they believe will be more stable currencies. This results in depreciation of the dollar.

The decreasing value of the dollar has resulted in China calling for another currency to replace the dollar as the major reserve currency. (A reserve currency is a stable currency that is used for a significant portion of international trade.) Although this is unlikely to take place, countries could well decide to replace the dollar with a basket of currencies. Such a move would reduce the demand for the dollar, resulting in its further depreciation.

The actual increases in longer-term interest rates result primarily from the fact that bond purchasers – who take a long-term view of the economy – want to obtain a real (inflation-adjusted) return on their investments. Consequently, whenever they expect inflation to increase, they require higher interest rates to compensate them for the anticipated losses in purchasing power that will result from the impending inflation. This fear of inflation drives longer-term interest rates upward.

Similarly, anticipated inflation has a negative impact on stock prices. When stock market investors foresee inflation, they too want higher total returns. This results in dampening of stock prices. This dampening is harmful for two primary reasons.

First, people spend less when they have less wealth. Lower stock prices (as well as low real estate prices) result in decreased consumer spending and prolong the recession. Higher stock prices stimulate spending and economic growth.

Second, at present, many retirees and would-be retirees have seen 40-percent decreases in their 401(k) plans. Many retirees have been forced to return to work; many would-be’s have been forced to postpone retirement. This has led to personal hardship for many, contributed to the increased unemployment, will lead to higher long-term unemployment and will postpone economic recovery. Baby Boomers, especially, are frightened about their futures; many are reluctant to spend.

The depreciating value of the dollar is already having significant negative effects on the economy. For example, worldwide contracts for many commodities and all contracts for oil are denominated in dollars. Thus, when the value of the dollar depreciates relative to other currencies, the price of oil increases. Mid-summer 2008, crude oil futures spiked at about $150 per barrel. When the worldwide financial meltdown threw most of the world into recession, oil dropped to a low of about $33 a barrel (end of 2008 – February 2009). Since then, oil has increased to about $67 a barrel.

Similarly, gasoline prices have already hit $2.51 a gallon following a December 2008 low of $1.61 (as reported by AAA). For a person purchasing 15 gallons per week, this increase equates to a “gas tax” of $700 a year. From a macroeconomic viewpoint, the U.S. consumes about 378 million gallons of gasoline a day. On an annualized basis, the recent $.90 per gallon price increase translates into an additional $124 billion per year. Higher gasoline prices act like regressive taxes, decreasing discretionary expenditures and prolonging the recession.

Continued high levels of government deficit spending will impede economic recovery as well as result in prolonged high rates of unemployment and inflation. In 1980, the last year of the Carter presidency, inflation was 13.58 percent and unemployment 7.18 percent: the “misery index” totaled 20.76 percent. Currently, unemployment is 8.9 percent (and expected to increase to 10+ percent); inflation is negligible. Once inflation rears its ugly head, we could experience a rapid return to a 20 percent misery index. Fiscal policy must be addressed now to avoid this scenario.

NOTE: Pritchard is the senior member of the Rohrer College of Business faculty. Pritchard has authored/co-authored nine books in the fields of finance, small business management and marketing and has written more than 250 trade journal articles. He has consulted and provided financial training for many businesses and trade associations throughout the United States. Pritchard's research interests include real estate, personal financial management, retirement planning and Social Security. He may be contacted by e-mail: Pritchard@rowan.edu.

Dr. Robert E. Pritchard | Newswise Science News
Further information:
http://www.rowan.edu

More articles from Business and Finance:

nachricht Is there a bubble in the art market?
07.01.2016 | Universität Luxemburg - Université du Luxembourg

nachricht Finance: Belief in higher returns from private equity may be misplaced
13.10.2015 | Universität Luxemburg - Université du Luxembourg

All articles from Business and Finance >>>

The most recent press releases about innovation >>>

Die letzten 5 Focus-News des innovations-reports im Überblick:

Im Focus: Production of an AIDS vaccine in algae

Today, plants and microorganisms are heavily used for the production of medicinal products. The production of biopharmaceuticals in plants, also referred to as “Molecular Pharming”, represents a continuously growing field of plant biotechnology. Preferred host organisms include yeast and crop plants, such as maize and potato – plants with high demands. With the help of a special algal strain, the research team of Prof. Ralph Bock at the Max Planck Institute of Molecular Plant Physiology in Potsdam strives to develop a more efficient and resource-saving system for the production of medicines and vaccines. They tested its practicality by synthesizing a component of a potential AIDS vaccine.

The use of plants and microorganisms to produce pharmaceuticals is nothing new. In 1982, bacteria were genetically modified to produce human insulin, a drug...

Im Focus: The most accurate optical single-ion clock worldwide

Atomic clock experts from the Physikalisch-Technische Bundesanstalt (PTB) are the first research group in the world to have built an optical single-ion clock which attains an accuracy which had only been predicted theoretically so far. Their optical ytterbium clock achieved a relative systematic measurement uncertainty of 3 E-18. The results have been published in the current issue of the scientific journal "Physical Review Letters".

Atomic clock experts from the Physikalisch-Technische Bundesanstalt (PTB) are the first research group in the world to have built an optical single-ion clock...

Im Focus: Goodbye ground control: autonomous nanosatellites

The University of Würzburg has two new space projects in the pipeline which are concerned with the observation of planets and autonomous fault correction aboard satellites. The German Federal Ministry of Economic Affairs and Energy funds the projects with around 1.6 million euros.

Detecting tornadoes that sweep across Mars. Discovering meteors that fall to Earth. Investigating strange lightning that flashes from Earth's atmosphere into...

Im Focus: Flow phenomena on solid surfaces: Physicists highlight key role played by boundary layer velocity

Physicists from Saarland University and the ESPCI in Paris have shown how liquids on solid surfaces can be made to slide over the surface a bit like a bobsleigh on ice. The key is to apply a coating at the boundary between the liquid and the surface that induces the liquid to slip. This results in an increase in the average flow velocity of the liquid and its throughput. This was demonstrated by studying the behaviour of droplets on surfaces with different coatings as they evolved into the equilibrium state. The results could prove useful in optimizing industrial processes, such as the extrusion of plastics.

The study has been published in the respected academic journal PNAS (Proceedings of the National Academy of Sciences of the United States of America).

Im Focus: New study: How stable is the West Antarctic Ice Sheet?

Exceeding critical temperature limits in the Southern Ocean may cause the collapse of ice sheets and a sharp rise in sea levels

A future warming of the Southern Ocean caused by rising greenhouse gas concentrations in the atmosphere may severely disrupt the stability of the West...

All Focus news of the innovation-report >>>

Anzeige

Anzeige

Event News

Symposium on Climate Change Adaptation in Africa 2016

12.02.2016 | Event News

Travel grants available: Meet the world’s most proficient mathematicians and computer scientists

09.02.2016 | Event News

AKL’16: Experience Laser Technology Live in Europe´s Largest Laser Application Center!

02.02.2016 | Event News

 
Latest News

LIGO confirms RIT's breakthrough prediction of gravitational waves

12.02.2016 | Physics and Astronomy

Gene switch may repair DNA and prevent cancer

12.02.2016 | Life Sciences

Using 'Pacemakers' in spinal cord injuries

12.02.2016 | Medical Engineering

VideoLinks
B2B-VideoLinks
More VideoLinks >>>