Falling currency and inflation

September 1st, 2008

Share |

Back in February this year, while the US dollar was still in a downward trend, Jimmy Rogers made a scathing remark about Ben Bernanke here:

We know now he doesn?t even know about economics. I mean, he?s got a PhD in economics and he was a professor of economics, but he doesn?t have a clue about economics.

I will quote you – I hate to quote you, but one more time – I was watching him testify before congress and I almost fell out of my chair. He said under oath, so we presume he wasn?t lying, that he was just a fool, he said if an American only buys American products, it does not matter to him if the value of the U.S. dollar goes down. He will not be affected. I was looking at the man to see if he was lying, giving government propaganda, but then I could see he didn?t even really understand.

He didn?t understand if, you know, even if say I?m an American, Lindsay, and I only buy American tires. Well if the price of foreign tires goes up, obviously the price of American tires are going to go up too. Plus, if the dollar goes down, the price of rubber?s going to go higher, etcetera, etcetera, etcetera.

So the man doesn?t even understand economics. He?s going to print money. He?s going to throw money out the window. The dollar?s going to go down further and further and further. Inflation?s going to get worse and worse and worse throughout the world – the world, not just America – and we?re going to have a worse recession in the end.

What happened was that Ben Bernanke swore under oath that a falling US dollar would not hurt Americans as long as they buy only American products. But as we explained before in Is the falling dollar good for the economy?, a falling domestic currency will result in a

… divergence between the internal and external value of the dollar. Since in the short term, the domestic economy cannot increase its production, effect (1) will be the result.

Since the American economy is very much dependent on imports, a fall in the US dollar will result in an increase in demand for American-produced goods. Without increased capacity in the short-term, this will almost certainly result in price inflation.

Now, we will look at the context of Australia, which is another import-dependent country. A rapid depreciation of the Aussie dollar will result in rising price inflation for the same reasons stated above. To make matters worse, the Australian economy is already at full productive capacity, due to reasons that include full (or almost full) employment, inadequate infrastructure, skills shortage and so on. Therefore, in order to take advantage of the increased demands for Australia’s commodities in the longer term, there will be a need for a restructuring of the Australian economy. As we explained in Is the falling dollar good for the economy?,

This means a restructuring of the economy whereby some industries will have to decline in order for the export industry to expand. This is effect (2).

The restructuring process is where the pain lies. It is a time where certain industries decline, unemployment rises and people returning to university and TAFE to retool and retrain on other skills and professions. The problem with Australia is that with far too many people and businesses filled with too much debt, such restructuring process can be too painful to be contemplated.

Tags: , , , , , ,