Many conservative commentators have expressed concern over the recent sharp decline of the U.S. dollar on world currency markets. On the face, there is cause for alarm. When pit against a representative basket of foreign currencies, the dollar is down an average of 15 percent in just over seven months. If it falls about 5 percent more, the dollar will hit an all-time low.
In this light, it’s not surprising that various nations, especially China, say the dollar should be dethroned as the world’s reserve currency, and the currency in which much global trade and investment is denominated. These cries come just as the U.S. government needs foreign investors more than ever to help finance record deficits and accumulated debt.
Is the Obama Treasury Department oblivious to all this? Surely it should be doing something, or saying something. At the least, our national prestige on the global stage is at stake. At the worst, our ability to fund our debt is in jeopardy.
Well, I had the opportunity last week to discuss the weak dollar with several of the highest-level officials at the U.S. Treasury. I can’t report that they have a secret plan to save the U.S. currency. In fact, they’re going to be carrying out some policies that they know will make it even weaker. But I think conservatives can take comfort in the fact that their approach to the dollar is both realistic and sensible.
For starters, nobody at the Treasury Department insulted my intelligence by spouting hollow clichés about a “commitment to a strong dollar.” It’s obvious that they aren’t doing anything to bring such a thing about, so at least they’re being honest.
They’re appropriately humble, too. They believe, correctly in my view, that the responsibility for the dollar ultimately rests with Ben Bernanke and the Federal Reserve. No matter what the Treasury does or says, if the Fed runs an inflationary monetary policy, the dollar eventually is going to weaken. Inflation erodes purchasing power, and that’s the final long-term arbiter of any currency’s value.
Officials at the Treasury also are keeping an appropriately cool head about the dollar, even though this coolness can be mistaken for insouciance. They note that the recent dollar decline has taken place in a very special context — that of a historic global credit crisis. This year’s 15 percent dollar drop began on March 9, the very day the stock market found its bottom. Tick for tick, the dollar’s decline has tracked the stock market’s monster rally. In this sense, the weakening dollar is a sign of economic recovery and strength.
Bear in mind that prior to the weakening trend the dollar had soared 24 percent since mid-2008, which is right when the credit crisis began to unfold. That’s because investors and banks worldwide desperately needed dollar liquidity, and not because the U.S. was an especially safe haven during the financial storm. (Obviously, it wasn’t.) U.S. dollars — the standard currency of world trade — were needed to settle dollar-denominated investment and credit flows in markets that to a large extent had simply shut down.
This is the key to understanding why so many nations are talking about diversifying out of the dollar standard now that the crisis has ebbed. Surely, if we have learned anything from the crisis, it’s that it is too risky to have so much global trade denominated in any one nation’s currency. In a pinch, that currency will become dangerously scarce, and the mad dash to acquire it will induce costly distortions that will make matters worse.
Yes, if the dollar does lose its current status in world markets, serious issues will be raised about funding our deficits. Today, the need of other nations to hold large dollar reserves creates an automatic need for them to hold our government debt — happily for us. But if world nations have to hold fewer dollar reserves, they’ll want to hold less of our debt. Right?
This makes sense in theory. But the Treasury officials I spoke with observe, quite correctly, that for all the talk about going off the global dollar standard — and despite very low interest rates on Treasury bills and bonds, and notwithstanding the dollar’s 15 percent drop this year — foreign nations just keep buying more and more of our debt. U.S. debt ownership by foreigners is at an all-time record level. So at least for now, no harm and no foul.
I did, however, find less encouraging the Treasury’s attitude about the currency policies of other nations, especially giant exporters like China. Many people argue — some sincerely, some for mercantilist reasons — that China and other nations deliberately manage their currencies, keeping them artificially low to make their exports more competitive on world markets. The Obama Treasury is committed to using diplomacy to stop that currency management, which was the exact same approach used by the Bush Treasury.
This may sound good on the surface. But the expectation of Treasury officials is that if the management stops, currencies like the Chinese yuan will rise in value. But that means, as surely as night follows day, that the U.S. dollar will fall in value relative to the yuan. Hence, urging the Chinese to adopt a strong-yuan policy is akin to pursuing a weak-dollar policy.
It doesn’t take a genius to figure out the winners and losers on this score. If you buy cheap Chinese-made goods at Walmart, you’re going to be a loser. Prices are going up. But if you are a union employee in the U.S. manufacturing sector, you’re going to be a winner. U.S. exports look more attractive in a weak-dollar world.
Treasury officials say it’s not about winners and losers. Rather, they say it’s an end in itself for currency values to be determined entirely by market forces — let the chips fall where they may.
The Treasury’s pressure on China and other currency managers will be subtle and quiet — it won’t have the stridency on the subject that Barack Obama employed during his presidential campaign. Recall that Timothy Geithner, back when he was being confirmed by the Senate for Treasury secretary, said un-subtly and un-quietly that China was an outright currency manipulator — and he was just quoting Obama. Last week the Obama Treasury released its semi-annual report to Congress in which, by statute, it must identify nations that manipulate their currencies, and China was not named. Apparently, it clarifies the mind to run a government dependent on China’s purchasing our debt.
The fact is that the Obama Treasury is playing a very difficult hand of poker here. Its failure to wave a magic wand and restore the prestige of the U.S. dollar does not originate in a willingness to acquiesce in American decline. Secretary Geithner told me that he rejects what he called the “existential narrative” so popular among global economic elites — the declinist doctrine of so-called “global imbalances” that envisions a lazy America being overrun by hard-working Asians. No, what’s holding the Treasury back from delivering a stronger dollar is, more than anything else, the absence of magic wands in the real world.
The closest thing we’ve got is the Fed’s magic checkbook, and that’s been wide open for more than a year now. So if you’re worried about our currency, you can spend your time more wisely than hoping for a “strong dollar” speech from Tim Geithner, or even trying to get him to lay off the Chinese for a while. Instead, hope for Ben Bernanke to start closing the Fed’s checkbook — before runaway inflation depreciates the dollar both on foreign exchange markets and in every American’s wallet.
– Donald Luskin is chief investment officer of Trend Macrolytics LLC, an independent economics and investment-research firm. He invites you to visit his blog and welcomes your comments at don@trendmacro.com.