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Race to the Bottom

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If you follow the dollar, this has been a very interesting week of news. One very interesting article I came across in The Wall Street Journal, entitled "Fed Officials Mull Inflation as a Fix", related how the Fed is considering reversing three decades worth of monetary policy to adjust their informal inflation target.

The reason they're considering this is because the economy is so fragile and the recovery is not happening like they want it to. They hope that by raising their inflation rate target that it will put downward pressure on "real" interest rates—nominal interest rates minus inflation—"encouraging consumer and businesses to save less and to spend or invest more."

Savers are losers

I've been saying for a long time that savers are losers. Here is further proof of that. It's financial insanity to think that you can save dollars and win financially when the Fed is willing to reverse three decades worth of monetary policy in order to get people to spend more and save less.

The fact that the Fed is willing to even consider inflation as a fix for our financial woes shows that they have given up on the dollar and are willing to sacrifice it on the altar of economic growth.

And the world is taking note.

Dollar Days Are Gone

Just last week, the dollar dropped to a 15-year low against the yen. The Wall Street Journal reported that pro-yen bets against the dollar skyrocketed by 72 percent.

The reason for these bets? "Speculation swirled that the Federal Reserve may soon act to stimulate a sagging economy." Translation: Investors believe the Fed will sacrifice the dollar for growth, and they're betting against it.

You may be wondering why the Fed would want to weaken the dollar and how a weak dollar would fuel growth. One answer is that by weakening the dollar, our exports become cheaper, leading to export-lead growth. The problem is that every nation is looking to have export-lead growth, and they're also willing to weaken their currencies to achieve it. Most notably, China is notoriously keeping the yuan artificially depressed in an effort to stay ahead in the export wars. As a result, the US is pressing China harder to let their currency appreciate and trying to rally international support through the International Monetary Fund (IMF). The result is a currency race to the bottom.

What's the Point?

You may be wondering, what's the point of all this dire news about the dollar? The point is that the dollar is very dangerous. Everywhere I turn, it seems people are talking about savings. Saving money is touted as a prudent economic move. The financial talking heads are cheering about the fact that people are being "smart with their money again."

But I'm here to tell you that saving dollars is not being smart. It's financially ignorant. It ignores the fact that the Fed will do everything in their power to make the dollar weaker, to raise inflation to stimulate growth, and to push you and me into debt.

Good Debt, Bad Debt

As I've written before, debt is the new reality of money. Our money is debt. The only way our economy grows is if you and me spend and spend some more. It's the interest on our loans that the ultra-rich are after.

And as I've written before, there is good debt and bad debt. The dividing line between winners and losers in the new economy will not be savings. It will be understanding the difference between good debt and bad debt.

Very simply, good debt is debt that puts money in your pocket. Bad debt is money that takes money out.

So, going into debt to purchase a rental property that provides cash flow that covers the debt payment and the operating expenses is good debt. Your tenant pays the debt down, you get the asset, you get cash flowing into your pocket each month, and you get all the appreciation (if there is any)—all while putting up only 70 to 80 percent of the asset's purchase price thanks to leverage.

Bad debt would be taking out a home equity loan to fund a vacation for your family or to purchase a car. Those are liabilities because they provide no cash flow. They only take money out of your pocket—and they do so for a long time in the form of interest payments.

Today, there is much opportunity. While depreciation is happening, you have the opportunity to acquire great assets as rock bottom pricing. This will not last forever. The Fed will find a way to create inflation, and when that inflation hits, savers will lose and debtors will win.

I encourage you to continue your financial education and to learn about the difference between good debt and bad debt. Then, put that knowledge in action before it's too late.

Original publish date: October 12, 2010

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