Inflation fears drive dollar dip
Oil prices surge as investors worry about deficit, Fed strategy

By Steven Mufson
Washington Post Staff Writer
Thursday, October 22, 2009

Fears of inflation and large U.S. budget deficits drove the dollar on Wednesday to its weakest level since August 2008 and helped push oil prices to their highest in more than a year.

The euro rose above $1.50, while crude oil prices climbed over $81 a barrel in trading on the New York Mercantile Exchange.

Analysts said that investors and traders are worried that the Federal Reserve, fearing another dip in the economy, will hold interest rates low for too long and fuel a bout of inflation. And investors also fear that the Obama administration will be unable to rein in trillions of dollars of deficit spending used to revive the economy.

The dollar is "weakening for obvious reasons, such as the collapse of any fiscal discipline in Washington, D.C.," said Ed Yardeni, president and chief investment strategist at Yardeni Research. Combined with Fed action, he said, "It's pretty simple. There are too many dollars out there."

Oil rose primarily for financial reasons, analysts said, not supply issues. Indeed, because oil is priced in dollars, Europe has seen little to no increase in oil prices in euros. There are signs of stronger demand in China and of a modest increase in U.S. gasoline consumption, but U.S. petroleum inventories remain higher than the top of the average range, and there is a substantial amount of excess production capacity around the world.

Adam Robinson, vice president of RBS Sempra Commodities, said that investors were looking at oil and other commodities as a way to buy something that would retain value even if the dollar doesn't.

"You're either bullish [about oil] because you believe in an economic recovery" and stronger demand, he said, "or because you hate the economy and think the dollar is going to zero and that deficits are going to get even bigger and therefore you buy commodities as a store of value." Either way, he added, "You can't lose unless the Fed starts to tighten and deflation comes back."

But Fed officials have said that it's too early to raise interest rates and that they plan to continue their extraordinary measures, such as zero percent short-term interest rates, to prop up the economy and limit the damage from the financial crisis. They have said they would tighten monetary policy in time to prevent a surge in inflation.

Most analysts say that could be difficult.

"At every turn of this crisis, from the run-up to the aftermath, altogether too many experts have declared that the U.S. is different and special," said Kenneth Rogoff, Harvard economics professor and former chief economist of the International Monetary Fund. "The recent dollar rout is one more nail in the coffin of the latest 'this time is different' syndrome."

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