Intended or not, the Federal Reserve's policy of quantitative easing has crushed the U.S. dollar. (The second round announced Nov. 3 is called "QE2" because it's the second round of easing since the financial crisis of late 2008.)
Intended or not, the Fed's destruction of the dollar's value has pushed prices of commodities that Americans need -- such as instance food, cotton and oil -- higher.
Whether the Fed's QE2 policy will actually spark renewed growth in the economy is not yet known, but what is known is that the producer costs for essential commodities such as grain and cotton are skyrocketing, and those increased costs will soon appear on store shelves.
Just as pernicious for the stock market, higher commodity prices mean manufacturers' profit margins will contract as companies seek to limit the cost increases passed on to recession-battered consumers.
It may be the ultimate -- and ultimately tragic -- irony: While the Fed's policy is supposed to help the economy by encouraging more borrowing, the actual effect is to raise prices for companies and consumers alike, and to squeeze the very corporate profits that have been driving stocks higher.
These charts of the dollar, the S&P 500 (reflecting U.S. stocks) and three commodity ETFs (exchange traded funds) show the dramatic effect of the weakening dollar. While stocks have risen as overseas earnings for U.S. global corporations are boosted by the weaker dollar, commodities that end up in consumer goods have exploded higher.
The pass-through of higher input costs to consumers isn't theoretical -- it's real. For example UPS just raised its shipping prices by 4.9%. Since shipping-box dimension charges are also being changed, the effective rate increase for lighter, larger boxes could be as high as 16%. This is significant in an economy that's officially currently experiencing near-zero inflation. (Officially, the annualized inflation rates is 1.1%, according to the Bureau of Labor Statistics.)
According to the BLS, the cost of finished goods is rising at an annualized rate of about 4.8%. Since some low-demand commodities such as lumber (demand fell along with housing construction) and electronics (prices of TVs have been dropping) are declining, the price increases for essential goods may well be masked by a lower rate calculated for all finished goods.
For instance, wheat has jumped from $158 per ton in June, when the dollar began falling in response to the Fed's QE2 chatter, to $271 per ton in September. That's a 71% increase. You may not need a load of 2x4s or another flat-screen TV soon, but you certainly will be consuming wheat in bread, pasta and other foods.
Creating "Hot Money"
Many economists and market watchers think QE2 is bad policy: It's unlikely to work as intended and could further damage the economy. How? By funneling a new flood of cheap credit into speculative bets in emerging markets and commodities while the Main Street economy withers under the onslaught of higher prices unleashed by the same Fed-powered speculative binge.
As I reported last month, the Fed's "trickle down" policy of creating wealth for the top 10% who own most of the nation's financial assets has been a failure. The rise in emerging markets like Brazil and in commodities like wheat suggest that speculative "hot money" is the result when the Fed opens the floodgates of liquidity. Brazil's stock market, the Bovespa, has more than doubled since early 2009.
The semi-official reasoning behind weakening the dollar is that a lower greenback will boost exports. But since exports are a mere 7% of the U.S. economy ($1 trillion, compared to a GDP of $14.14 trillion), it's difficult to see how a modest improvement in exports could offset the dramatic price increases that are occurring across the board in the rest of the economy.
Maybe all the financial speculation enabled by the Fed's easy money, zero-interest rate policy (ZIRP) easing will enrich a few trading desks and hedge funds, but the price increases triggered by the Fed's policy will certainly reduce the net income of every American household as prices for essentials climb.
If you have any doubts about that, just take another look at those charts of cotton, sugar and grain.