FEBRUARY 16, 2011
Note from Ben: The following post is courtesy of John in Ottawa
A couple of days ago, Jesse made the comment that China has been exporting deflation to Canada for years. That’s absolutely correct and life has been easier ever since we became able to buy a dozen tube socks for six dollars. But that’s not the current debate.
The current debate, and Jesse’s comment got me thinking about it, is the US exporting inflation to the rest of the world. We have heard that food price inflation is helping to inflame much of the Arab world.
I wondered just how much Canada is being affected by the US exporting inflation. By way of a little background, the US is fighting deflation. To save themselves from the ravages of deflation, the Fed is flooding the financial markets with liquidity. Their hope is that they can stabilize house prices and get businesses and consumers borrowing again.
Unfortunately for the Fed, and the US as a whole, consumers and businesses don’t want to borrow and banks don’t want to lend. However all that liquidity has to go somewhere and it seems to be headed into the commodity and foreign markets.
So, the Fed is “debasing” the US dollar by “printing” money; that is they are buying up bonds and flooding the market with cash. This should show up in exchange rates.
All of the charts I am going to show are taken from OECD statistics.
I’ve chosen to illustrate Australia, the Euro, and Canada. We’ve been following Australia somewhat and the Euro has been in the news quite a bit lately.
Clearly, all of these currencies have increased significantly against the US $ and for much longer than the current QE experiments. The US has stated that it is committed to a strong dollar, going all the way back to George W. Bush, but its statements and its actions are not correlating well.
Now let’s have a look at some selected consumer price indexes. Intuitively, one would think that a strong dollar relative to the US would translate into being able to buy all sorts of goodies on the cheap, especially as the Chinese Yuan is pretty much pegged to the US dollar.
Hmmm. That isn’t working out as expected. You can see the severe deflation occurring in the US and even Germany is fighting deflation. In spite of flooding the markets with liquidity deflation appears to be getting worse in the US.
Then look at Canada and Australia, two of the great commodity resource countries. Ouch. In spite of our strong dollar we are suffering from an increasing CPI. To add insult to injury, as commodities are priced in the world market in US dollars, as our dollar strengthens we receive less for the commodities we sell in the world. One begins to understand why China wants to hold its peg.
Just to help clarify the correlation that holds between our dollar and CPI, I have put them on the same graph, with CPI divided by 100 just so our dollar and CPI can be compared easily. CPI equals 100 in June, 2005.
*Added: This graph illustrates that there is a strong inverse correlation between the US dollar and our CPI. That is, as the US dollar weakens, our CPI increases.
John in Ottawa