The dollar "decline" is definitely a decision made

EDITORIAL: "The Dollar Adrift," Wall Street Journal, 9 October 2009.

FRONT PAGE: "U.S. Stands By as Dollar Falls: Traders Question Commitment to Strong Greenback; Asian Central Banks Intervene," by Jon Hilsenrath and Mark Gongloff, Wall Street Journal, 9 October 2009.

LEADERS: "The debate about Chinese asset prices: A bubble in Beijing? Not yet. But China will soon look dangerously frothy unless policymakers allow the yuan to rise," The Economist, 10 October 2009.

There is a quiet sort of tectonic movement afoot with the dollar's continued slide. Naturally, some are alarmed by this, especially since the Obama administration seems quietly in favor of the decline.

A bit first on terminology: it is extremely unfortunate that we use the terms "strong" and "weak" with regard to currencies, because the instinct is always to desire the former over the latter, when in reality, a "weak" currency means your exports are more attractive whereas with a "strong" currency, your ability to buy more in other currencies/markets/imports is improved. So a strong buck means we're more likely to live beyond our means (import too much, export too little) whereas the weak buck is the exact opposite (import less, export more).

Obviously, right now, it's a far better thing to have a weak buck.

The counter to this is to cite the global reserve currency role of the buck and to say that a weak dollar will encourage other major economies to hold fewer dollars and to start pricing certain key goods (like oil) in a currency more stable than the buck.

So we see here the fundamental tension between what's good for America-the-national-economy right now (weaker buck) and what's good for America-as-global-reserve-power in the longer-term sense. Now, the latter concept has, for decades now, been strongly associated, in the minds of most experts, with the health of the global economy (strong buck means America imports a lot and that's good for rising, export-driven economies, plus encouraging them to hold dollars means their reserves are safe because the superpower dollar is so sound, plus it's a powerful advantage for the U.S. to see its dollar remain the world's primary reserve currency). For that logic to no longer hold sway over the more nationally-selfish logic of a weak buck (i.e., helping our recovery and helping us rebalance our trade relationship with the world) would be a sea change in global economics.

Some nationalists would herald it as a sensible tack, but others, thinking more long-term, could just as strongly decry the "death of the dollar" as the global reserve currency.

My take? The dollar's role in birthing and expanding modern globalization was incalculably important, but there are plenty of solid arguments that say globalization has now outgrown the dollar's capacity--as well as American discipline on spending, as a result--to play that dominant role. This is why the rise of the euro is good, and this is why we need China to let the yuan float (and become the beginnings of a third pillar reserve currency--hopefully as the anchor of a basketed "asia" that combines the yuan with the rupee (India), yen (Japan), and won (Korea)).

Does China want to go down that path anytime soon? Beijing, timid as always, would love to delay that day for as long as possible.

Does the US want to force that reality sooner? Yes, thus the Obama decision to not stop the dollar slide.

Does that worry the Chinese? Got to.

Does it worry the Europeans? Absolutely, because they suffer as well due to the yuan's continued de facto peg to the dollar (dollar devalues as it should, but it pulls the yuan down with it, making the euro too strong in relation to the yuan and thus making that part of the global rebalancing unachievable).

So we're watching a bit of a strong-arming going on here, with both the U.S. and the EU ramping up their pressure on China to revalue the yuan in the short term and move toward convertibility sooner as opposed to later. In short, the recent crisis has set in motion the necessary dynamics.

The WSJ call the dollar's continuing slide "the biggest story in the world economy," saying it causes angst everywhere in the world save DC, "the place most responsible for its declining value."

So we're already seeing, for example, Asian central banks intervene to stop the buck's slide against their currencies--to little effect.

Then there's the much passed-around story of a secret effort by several nations to set up an oil market in currencies other than the dollar.

As the WSJ opines, none of this will stop the slide, which is based in an irrefutable reality: "there is a much larger supply of dollars than there is global demand for them."

Big culprit is the U.S. Fed, which "has been flooding the world with dollars in the name of preventing a U.S. deflation after last year's panic." There are no signs the Fed will constrict money any time soon. What the Fed says with this behavior is "that it is concerned primarily--perhaps only--with the domestic U.S. economy"--matching my description above (Team Obama errs on the side of the U.S. versus the world right now, and since that dovetails with the rebalancing goal, it's hard to argue with, in my opinion).

The WSJ doesn't deny Obama's logic, saying it goes along with all manner of market signals right now that say the U.S. will be a harder place to make high profits in the near term.

But the WSJ does question the "virtue" of the falling dollar, citing the reality that "capital flows dwarf trade flows as a source of wealth creation."

Moreover:

The only way to build wealth and create more high-paying jobs over time is through the productivity gains that come from greater investment and innovation. As the dollar falls and capital flees the U.S. for other countries, those global competitors reap its benefits and become more productive and relatively more prosperous.

Then there's the fear that the dollar's long, slow slide speeds up into a rout.

Now, the WSJ is always on board for the strong dollar, but a strong dollar means China feels no short-term pressure to revalue the yuan or make it convertible or participate in the necessary rebalancing of the global economy, so there's clearly a trade-off here, or a bit of a showdown in the works.

The question may be, Who blinks first?

Again, I get Obama's logic here, as I don't see how we can exit the crisis with no progress in terms of rebalancing. It would just seem too irresponsible given all the bailout/stimulus money. But I also get the larger WSJ bias toward the strong dollar. Plus, there's the fear that Washington is playing a dangerous game, if the confidence drops so much that the rout is triggered.

What is the sweet spot on such a strategy? That answer is full of perceptions impossible to pin down definitively. There will always be a significant gambling aspect to it.

Why to think Obama's approach is working: stock prices have done well despite the decline.

Also:

... interest rates that the Treasury has to pay on its borrowing have stayed down. As long as that is the case--and the dollar's decline is gradual rather than a confidence-shattering crash--Obama administration officials are likely to stay on the sideline while they stick to a "strong dollar" mantra. The dollar was left notably unmentioned in the communiqué issued by the Group of Seven finance ministers this week after meeting in Istanbul.

Finally, popular expectations of inflation just don't seem to be appearing.

What can throw a wrench in all of this? The giant Chinese stimulus package triggers a bubble burst there that comes too fast to teach Beijing the utility of letting its yuan rise. And the longer China keeps pegged to the weakening dollar, the more likely that asset bubble grows too big and bursts, according to The Economist.

Again, it all strikes me like a bit of a game of chicken: how long does Obama let the dollar slide go on versus how long does Beijing stay pegged to the dollar despite the bubbling?

Time will tell.

Comments

[TheodoreLosAngeles]

Thank you for your brilliant analysis of current economics. I agree 100%: "[T]here are plenty of solid arguments that say globalization has now outgrown the dollar's capacity." The changing relationships between the dollar, euro, and the yuan+yen+won+rupee compound is nerve-wracking and stressful.

I try to remember the anxiety felt by the Homesteaders who faced similar economic changes in the 1860's. Hopefully the changing relationships between different kinds of money will avoid a "dustbowl" which was caused in 1930 by immature understanding of crop rotation.

[Jeff J]

Perhaps The Wall Street Journal should be more interested in how the capital that does come to this country is used. Will the Wall Street firms take their recent profits and actually invest in companies that can create the wealth and jobs as opposed to creating new financial derivatives and new fees. I know that takes effort and money and there is more risk involved. Manipulating the order in which checks clear to maximize the chance of overdraft fees is much easier, less risky and more profitable but does little long-term for the economy.

[William R. Cumming]

Its always of interest to me that the decline of the dollar is not called "devaluation" and since the greatest devaluation occurred under REPUBLICAN President Richard M. Nixon and has continued more rapidly under Republicans than DEMS it is of interest that that fact of Republican policy is never established. Devaluation is of course the preferred choice of debtor nations witness the Weimar Republic. The question of course is who exactly benefits from that devaluation? My guess is that the policy was in part a reflection of the fact that foreign oil was also thus cheapened for US consumers. I can argue with you Tom that the dollar has long ago served its purposes as the key currency. Once again like much of US history of finance became strong because of warfare not brain power or competent management of the nation's affairs.

[Tom Barnett]

William,

A constant reliance on nefarious explanations weakens the strategic mind. It's just elevated conspiracy thinking.

But I suppose it's comforting to think Washington runs the world according to its "war" schemes.

Better the Devil you know...

[Louis Heberlein]

So, China now invests in American emerging value businesses with domestic and foreign markets instead of depending on our consumer market. Transformation.

[Tom Barnett]

But Louis, while good for us and logical for Chinese, this dynamic will scare people.

We never feared Euro money over the many decades, but many will say this is different--and it is and isn't.