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but the 10% nominal rate is not only compensating for inflation, it may be needed to compensate for the extra currency risk that foreign investors require to invest in US assets. I believe the domestic inflation probably won't go above 10%, but adjusted for currency risk?
My understanding is, inflation has two components: stuff that we produce locally, stuff that we import. For stuff we produce locally, e.g. food, houses, etc. we are seeing some kind of inflation, let's say, 10% a year for simplicity's sake. For stuff we are importing, e.g. energy, cars, etc., shouldn't those foreigners force us to pay more for their goods because they are afraid that our money may not be worth as much as it does today, apart from compensating for their inflationary expectations?
If the Eurozone is having 2% interest rate, and we are having 10% interest rate, won't part of the differential be what I portray as the "currency risk"? After all, commodities like metals, gas, energy, food are "globalized" so whatever inflation we are facing should be faced there as well. The only difference in inflationary force between the dollar zone and euro zone should be stuff that cannot be outsourced or imported, like education, housing, medical service, etc. So after the housing bubble bursts here in the US, unless education and medical service suddenly decide to become the next bubble (I don't know how), why should there be much difference in inflation between europe and us in such a globalized economy where goods flow freely?
In the short term, interest rate differential will have a bigger impact than trade balance or national debt in affecting the currency strength. I am just not sure if this is sustainable in the long term. And if our interest rate shoots up, I believe part of it is already factored in as a compensation for "currency risk".
So, that is why I believe our interest rate will be higher than 10% if we need to account for the devaluation of the dollar.
If the Eurozone is having 2% interest rate, and we are having 10% interest rate, won’t part of the differential be what I portray as the “currency risk�
There isn't that much of a currency risk component to the USD. H.Z. is dead on, as I understand it. Interest rates are governed by covered-interest-rate-parity (CIRP), which pretty much holds over the long term. But real goods exchange rates will change purchase-power-parity (PPP) over the shorter term.
Also, keep in mind that the US is the country *least* sensitive to interest rates in the rest of the world (ROW). Most other countries cannot change their nominal rate without an automatic adjustment in the real rate and inflation, because they are real-rate takers, not setters. The EU does have some nominal rate power, but nothing near the power the US has. Simply, we can buffer inflation by encouraging or discouraging capital inflows via nominal rates.
I mean, most of our jets and military systems are made in China or Singapore, and who knows what weird stuff is put into our weapons.
Not even remotely true. The US manufactures one thing very very well, weapons.
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Inflation coverage in the financial press is growing daily. The headline (total) official inflation numbers for the US are the highest in 30 years, but the core inflation numbers (which excludes energy and food), is barely noticable. The stock market has been reacting to inflation data, selling off globally (despite the laughable dow 40000 stories). Precious metals are hitting records. But the bond market is slow to react, only now inching into bearish territory. There are arguments that inflation helps RE (real estate is a good store of value during general inflation); there are arguments that it hurts RE (reduced purchasing power and rising debt burdens depress affordability). I’d like to hear everyone’s take.
By Randy H
#housing