VALUE OF A DOLLAR IS SHRINKING

VALUE OF A 1913 DOLLAR
Year Amount it took to
equal $1 in 1913
1913 $1.00
1920 2.02
1925 1.77
1930 1.69
1935 1.38
1940 1.41
1945 $1.82
1950 2.43
1955 2.71
1960 2.99
1965 3.18
1970 3.92
1975 $5.43
1980 8.32
1985 10.87
1990 13.20
1995 15.39
2000 17.39
2001 $17.89
2002 18.17
2003 18.59
2004 19.08
2005 19.73
2006 20.18

Understanding What a Dollar Really Is
One of the many lessons traders learn is to greatly limit their information flow, which is especially tough in today's environment of information overload. Ironically, those who are just starting out in trading often do better than seasoned pros precisely because they don't take in lots of information that leads to fear and uncertainty, which leads to making exactly the wrong trades. But there are a few exceptions, and one of them for me is David Nichols and his daily Fractal Market Report.

Here's a discussion of inflation and the dollar from yesterday's report that I think is pretty much on the money. The bottom line is that regardless of what you believe about the propriety of the matter, the dollar is a financial instrument that fluctuates in value relative to other assets and financial instruments. Understanding that is essential for making the correct long term moves.

Here's the article, reprinted with permission...

My discussion of inflation vs. deflation sparked some questions, so I want to continue on this topic. The reason this is so important is the fluctuation in the dollar is almost never factored into most people's thinking about financial markets.

I'm just going to ramble on a bit on these ideas, as I want to get this down quickly. I'm not going to document each point I make, or show charts on everything, as that would be a big job, and I'm just writing this after the close today. I'd rather just quickly make a few points, and let this be the starting point for your own independent rumination and study. You definitely do not have to take my word on any of this.

In a deflationary environment, the dollar becomes strong, as demand for dollars grows as assets come down in value. People want to get their hands on cash, as cash buyers are a scarce commodity, and those with cash are just as likely to wait on a purchase, as the asset they're considering is losing value with each passing day in this deflationary environment. In a deflation, dollars goes up in value as just about everything else sinks.

The Fed is scared of deflation, as they have limited policy tools to combat it. This is also why the Fed targets an inflation rate of 2% to 3% per year -- so there's always room to take interest rates below the level of inflation to stimulate spending and not saving (In deflation people become savers of cash, as it's going up in value in relative terms with each passing day). If inflation is in the Fed's target zone, they have the power to take interest rates into negative territory in real terms, in an attempt to spur spending and speed up the velocity of money moving through the economy.

One thing we know for sure is the Fed -- and Chairman Bernanke -- are avowed deflation-phobes. Inflation is their stated policy objective. They want it to continue.

But the problem is this: systematic inflation also systematically destroys the purchasing power of the dollar.

Let's look again at the monthly chart of the dollar.



It's no coincidence that during the Fed's most recent "reflation" campaign the dollar has lost almost 30% of its value -- and that is just relative to other currencies, which are also being systematically devalued by their central banks.

During this reflationary period -- starting in 2001, during the bear market -- gold has gone from $250 an ounce to a current $624. This also means that gold is doing much, much better relative to the declining dollar than other currencies, as it's gone up 136%, and other currencies -- most notably the Euro -- have only appreciated 50% against the dollar (A 30% decline in the dollar is equivalent to a 50% rise in the other currency).

But gold has gone up 136%, so it's apparent that gold has a lot of "gearing" to a declining dollar. Because of its scarcity, increased demand for gold causes big price moves, as lots of dollars chase relatively small amounts of gold.

Okay then..... let's get down to what the Fed's inflationary policies mean for you and me. I think it's fair to assume the Fed will keep on systematically destroying the value of a dollar. Already the dollar has lost 92% of its purchasing power since the Fed started in 1913. Remarkably, until the Fed came along, the value of a dollar had pretty much stayed the same throughout the 1800s. The inherent inflation we all assume is "part of the system" didn't exist at all until the Fed was created in 1913.

So we have to assume that the Fed's actual policy objective is to create inflation, and to systematically lower the value of the dollar over time. It's hard to argue with their track record.

We also know that debt levels in the US are now at record highs. We're swimming in consumer and government debt, not to mention the untold trillions in unfunded pension and healthcare liabilities that we've accrued and continue to accrue.

There is absolutely no way we can pay back any of this debt in today's dollars. It's simply not going to happen. Even if we all gave 90% of our income to pay down the national debt, we couldn't do it, because we spend so much. The only way to deal with this debt is to make tomorrow's dollars -- the ones we'll theoretically use to pay back today's debts -- worth a lot less.

This is also why personally I'm not too concerned about a "housing bubble", even though there is no end to the hand-wringing these days. That's because owning a house -- even with a big mortgage on it -- will always be the single best way to hedge against the systematic devaluation of the dollar.

It's actually a very simple concept to understand. Real estate goes up in value as the dollar goes down. Obviously there are other factors, most notably speculation and demographic trends, but the main reason real estate has ramped up so quickly since 2002 has been the plunging dollar.

Let's use the San Diego housing market to take a closer look at this.



In August 2001 -- right as the dollar was topping -- the San Diego Home Price Index was at 127. Right now it's at 247, so it's gone up 94% over the last 5+ years. But just to stay even with the decline in the dollar over this period -- and this is against other declining currencies, mind you -- explains about half of this gain. I think the scarcity value of real estate vs. currencies explains the rest of the gains, and this is why real estate is such a great hedge against the Fed's policies.

It's also worth noting that since the dollar index bottomed out at $81 in December 2004, housing markets have mostly gone sideways. To me all of this does not seem like such a big deal. Only in a true deflationary environment will housing markets be in serious trouble.

If the dollar starts going down again -- and I think it will, because that's what the Fed wants -- then real estate will start going right back up. But again this price appreciation will mostly be an illusion. Housing values will again go up in some proportion to how much the dollar goes down. Owning a house is always going to be the best way to maintain relative purchasing power in the US economy.

This is why I also purposely took out a big loan back in 2003, when I bought in San Diego County. I also did a much-maligned interest-only loan to boot. I just can't see the point of spending even one dollar of today's currency to pay down dollars that are due in 30 years. It doesn't make any sense.

Maybe I learned from my mom and dad's experience with our family house in La Jolla California. In 1967 they paid $54,000 for 3/4 of an acre in the "Old Muirlands," one of the most desirable neighborhoods in San Diego. 30 years later the land alone was worth well over $1 million, and now it's probably worth $2.5 million or more. It was completely insignificant to their overall financial situation in 1997 whether they owed $45,000 on the house, or owned it free and clear.

I think the amount that comes due on my house in 30 years will be a laughably small amount in 2033 dollars. (I took the mortgage in 2003). If anything, inflationary trends like this tend to accelerate. Most of the damage to the dollar has occurred since 1987, when Alan Greenspan took over. I think the next 27 years will see this trend accelerate, beyond anything we can dream of today.

I read lots of commentary from perma-bears about how the US economy is about to be destroyed by all of the refinancing and home equity loans taken out over the last 5 years. But I don’t get their logic. In an inflationary environment such behavior is rational. It makes sense to borrow today's dollars and pay back tomorrow's dollars.

If the dollar continues to go down, then everything else is going to go up. That includes equity markets too. It's a very real possibility that the Dow could hit 25,000 and actually be trading at a lower P/E ratio than it is today, and be worth less in real terms than it is now at 12,250. It's all relative.

This is also how gold and other commodities can skyrocket in value over the next 5, 10, or even 15 years. To gain any sort of relative wealth in an inflationary environment --where the dollar is losing vast amounts of purchasing power -- you have to hedge your dollar-denominated assets with something much scarcer than dollars. Gold and silver are natural choices.

Alright, I'm running out of steam, and it's time to send this out. I'm sure this is going to be controversial. But I think it's still early days on all of this, and having a strategy to deal with inflation and the dollar is pretty darn important. Hopefully this will stimulate some thought, at the very least.
http://www.uncsense.com/root/2006/11/understanding_w.html
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The Fed's New Conundrum: Slowing Housing
in Federal Reserve | Inflation | Investing | Markets | Real Estate
Yesterday' 1/4 point rate hike was no surprise . . . but the thought processes behind it may be. Consider the conundrum left to Ben Bernanke by his predecessor, Alan Greenspan.

Post market crash, recession, 9/11, and Iraq War, this was a flatlined economy. Anytime a major market takes a 78% whackage, huge swaths of capital gets destroyed. The Fed's response to this was to slash interest rates to half century lows.

The initial results of this were somewhat predictable: the Housing sector accelerated and the global economy reflated. Back in December 2002 I mentioned that investors might want to watch gold due to the inflationary potential of these ultra-low rates. (Not quite the table pounding of last year, but quite timely).


At the same time, China began building out its infrastructure in anticipation of its Olympic hosting duties. Concurrent to this was the enromosu boom in direct China investment by Western companies, all seeking to dramatically