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.
Is it possible that this is part of an effort to reduce our trade deficit/account imbalance for larger reasons?
ie: To reduce the potential shock if Saudi Arabia were to withdraw their massive investments (wage monetary war on us), or if OPEC were to turn towards the Euro?
Seems to me that, due to the ongoing struggle with the oil-producing region, this is a weapon we don’t want them to have, and it *might* be prudent to take the edge off that sword.
(I should point out that I’m way out of my league here. So, uh….be gentle)
Jon, some of the commenters to this post, starting with someone who signed himself “Mishu,” have already addressed your question.
Another point is that Saudi Arabia would hurt itself more than us by liquidating its dollar-denominated investments. First of all, the Saudis must hold those investments because they think they’ll earn the best returns, so alternative investments would, by definition, be worse. Second, a liquidation on such a large scale would depress prices, meaning that in selling their assets the Saudis would effectively be transferring a lot of wealth to (mainly) Americans. I assume that Saudi investors are not foolish enough to do this, and I assume that U.S. policy makers are not foolish enough to believe that Saudi/OPEC dollar divestiture is a threat.
Political expediency seems a more likely explanation for the Bush administration’s apparent abandonment of the U.S.’s strong-dollar policy.
Interesting….thanks for the tip, and the information.
My impression is that our non-agreesive policy towards Saudi Arabia has been pretty consistent for decades now.
We don’t mess with them, and they mess with us a little bit, but they don’t do it too overtly.
So, it seems that there has to be something besides “Bush is helping his friends”….something more structural in the relationship. A trump card, that we don’t want to trip.
Thanks for the education on the euro/dollar score.
My own personal summary: We are (possibly) headed towards a stagflation situation. For those of you who weren’t around in the mid-’70s, stagflation is when prices go up while wages remain flat and demand remains weak. This apparent violation of supply-and-demand laws is caused by a sharp decrease in productivity. In the 1970s, there were several causes of loss of productivity: Domestic manufacturers who had placed their capital investments on cruise control for the past decade found themselves with obsolete plants and featherbedded payrolls, unable to compete with Japanese imports. The direct costs of government went up, with increased taxes, but more importantly the indirect costs of compliance with government mandates went up even faster — there was an enormous increase in government regulation during that period, with new regulatory agencies appearing and existing ones gaining huge increases in their powers. These factors combined with high interest rates made investors very cautious. Why risk your hard-earned savings on a new risky business venture when you can earn 10% on a money market account that’s as safe as Grandma’s house?
Some of these factors are appearing today. We see huge new government entitlement programs being proposes, which are almost certain to result in tax increases if enacted. We see new regulatory mandates and the dawning implications of older ones (such as the ADA). We see the trial lawyers’ bar in effect becoming a quasi-governmental regulatory agency, one with almost unlimited powers and no visibility into how they operate. All of these things are making investors very nervous. This I think explains the “jobless recovery”; demand is doing OK and prices are holding steady as long as interest rates don’t go up (the one factor that isn’t present, at least not yet). But investors are playing it very safe. The message is: now isn’t a good time to start a new business.
There are a few things that could be done now. The first, used successfully by Reagan and Bush Sr., would be to declare a 90-day moratorium on publication of new government regulations. The second would be for Bush to allow the steel tariffs to expire (or did we miss the window on that? Did the window close September 30?) But some things are going to be harder. There needs to be new restraint on domestic spending; Social Security and Medicare privatization would go a long way. And some form of tort reform is way overdue. (However, I dislike the approach of capping jury awards because I think that’s just a band-aid over the real problem. The question nobody seems to ask is, if juries are handing out huge awards in cases where the plaintiff clearly doesn’t deserve it, doesn’t that indicate that something is broken in the system? If so, what?)
Cousin Dave,
Time will tell. Inflation was the big problem of the 1970s. As I wrote in my post, I think the Fed is more on the ball than it was then, but that doesn’t mean they won’t screw up. Also, I don’t hold out much hope that W will control spending or support the other reforms that you mention (even though he supported some of them in the past). He seems to be pulling out the spending and law-passing stops in order to get reelected.
Thanks, Jonathan. I should know better than to try to lecture about economics in a place inhabited by economists. :-) I just hope that once the Iraqi situation settles down a bit, the Bush administration can start remembering some of the other reasons they got elected.
Thanks, Cousin Dave. I think we’re mostly on the same page here. You’re giving me more credit than I deserve.
It’s all about smoke and mirrors. We live on the willingness of foreigners to send us stuff for pieces of paper, our money. Our job is to maintain the illusion that encourages them to do that. First, we must maintain a stable government; second, a stable currency; third, make our capital markets appear secure. Bill Clinton, good con-artist that he was, understood that paying down the deficit would cause money to flood into the country. If your going to live on borrowed money, you must keep your credit good. Our problem was we didn’t know what to do with the money when we got it and it went into a stock market bubble. A lot of that money is still laying around according to what I read in the financial papers. As a nation we need to spend it profitably. My personal preference would be to spend it on education and health care. First, it would make the lives of the people around me better. Second, it would create jobs here that would keep the money flowing in our system. Third, I don’t really like rich people and they already have plenty of both.