Don Luskin is worried about the dollar, or more precisely, about how the Bush administration appears to be systematically — and irresponsibly — devaluing the dollar to buy the votes of exporters and union members. I was worried a few months ago. Is Don right? Was I right?
Well, gold was cheaper when I first became concerned. Now it’s trading at around $380/oz. Also, the dollar regained some of its lost value after I made that post in June. But now the dollar has fallen sharply from its recent highs, and its downward momentum (relative to the Euro, and especially the Yen) has accelerated since the recent G7 finance ministers’ meeting. Time will tell, but it seems likely that Don is right and that there has been a policy shift. I wouldn’t be surprised to see the dollar make a new low vs. the Euro and to continue weakening against the Yen.
This WSJ editorial (WSJ links require subscription), though typically confused in its approach to exchange-rate policy, cautions reasonably against manipulating the dollar for narrow political purposes.
Economist Allan Meltzer, echoing Luskin, Wesbury et al, argues that the economy is stronger than conventional measures indicate and that the Fed is ignoring this strength and still fighting the last war, against deflation. Meltzer doesn’t write specifically about exchange rates, but all of these issues are related.
If the Fed, for its own reasons, over stimulates the money supply, and the Bush administration, for its own reasons, coordinates an inter-governmental campaign to strengthen non-dollar currencies, it’s no surprise that something has to give. Gold goes up, the dollar goes down, and increasing inflation seems likely (though not, if Bush games things right, in time to hurt his reelection chances). It will be interesting to see how long the Fed can hold off on raising short rates.
The inflation of the 1970s originated in part from guns-and-butter spending policies under LBJ that continued under Nixon. Many things are different now, and policy makers, particularly at the Fed, are much more knowledgeable about the effects of government policy on the economy. But it’s interesting that we seem again to be backing into a situation where unprecedented levels of domestic government spending, combined with unavoidable war costs, are helping to make inflation the political path of least resistance. Nixon had wage and price controls (which of course worsened the problems they were ostensibly intended to solve). Now Bush embarks on a weak-dollar policy with some protectionism thrown in. I don’t think any good can come of this policy. The question is whether its effects on the recovering economy will be a tolerable drag or something worse.