Dollar Crisis: Fact or Fancy

October 14, 2009

An Op-Ed column by economist Judy Shelton in today’s Wall Street Journal entitled “The Message of Dollar Disdain” contains more dire warnings about the U.S. currency.  Invoking the Weimar Republic, she blames eroded confidence in the dollar “excessive government borrowing” and the collateral “threat to monetary stability” given the potential risk of the Fed accommodating the surge in government debt.

I have a couple of large problems with this hypothesis and the implication that it was wrong to stimulate fiscal and monetary policy.  The United States and world economies were in a terrible recession early in the first quarter of this year.  Fear of depression was rampant.  The DOW and Nasdaq on March 9th closed 44.1% and 47.6% below their closings of the prior August 28 just over six months earlier.  Money markets weren’t functioning, and panic was at a high pitch.  We will never know for sure what would have ensued had the new U.S. government had announced its confidence in the self-healing properties of the economy and taken no further steps to promote recovery.  But seven months later finds the debate having shifted from when recovery might begin to how strong it will be.  Following the lows on March 9, the DOW, Nasdaq, and S&P recovered 16.2%, 17.3%, and 21.0% by March 31, another 11.0%, 15.7%, and 20.0% during the second quarter, 15.0%, 15.0%, and 15.6% in the third quarter, and 2.8%, 2.7%, and 2.0% so far this month.  Inflation is contained even though oil has climbed almost 60%.  Long-term interest rates are about 50 basis points higher than their extremely depressed early-March levels, but the 10-year note is closer to 3% than 4%. The future remains very uncertain, but right now, the economic landscape looks a whole lot better than what investors dared to imagine last March.

Some credit belongs to similar pro-growth policies pursued by emerging nation officials like China and other advanced economies.  The United States is not the only nation with a hangover of debt, and yes, that will become an albatross if not handled in the proper time.  But the mistake of the 1930’s lay in removing fiscal stimulus too soon, not too late.  Let’s at least see how the economy and final domestic demand are performing once inventory restocking slows down.

As I’ve written before, I am not ready to concede that the dollar is in a crisis.  Sure, it is depreciating, but that’s a normalizing process in large part, removing the gains from safe-haven capital inflows during the worst parts of the recession.  The dollar remains 12% above its all-time yen low set 15-1/2 years ago, and it needs to climb another 7.5% or so to return to last year’s high against the euro. In the strictest sense of appreciating or depreciating in the marketplace, the expression “strong dollar” is an oxymoron and has been for over forty years baring a few impermanent upward flingsThe meaning of “strong dollar” lies in the willingness to invoice international commerce disproportionately in dollars and store capital reserves likewise disproportionately in dollars in spite of the currency’s long-term perennial downtrend.  Part of the explanation for this riddle lies in the absence of good alternatives to unseat the dollar, either from other paper currencies or other assets like gold or the IMF’s synthetic but non-marketable SDR (special drawing right).  This is not the first time that dissatisfied dollar holders have threatened to diversify away from the U.S. currency or to price their goods in non-dollars.  Complaints are inevitable when the dollar is falling, but a system with the dollar at the center has persevered.

Much bigger slides of the dollar have occurred in the past than what’s occurred this year.  The buck lost 24% against the mark in the first four months of floating exchange rates during the spring of 1973.  It dropped from 300 yen in December 1975 to 176 yen at end-October 1978 and from DEM 2.41 in December 1976 to DEM 1.70 in October 1978.  The Plaza Accord facilitated similar drops of 55% against the mark and 54% against the yen from February 1985 until end-1987.  Later, the dollar lost 29% against the mark between June 1989 and February 1991, and it suffered another 24% drop against the German currency from its 1994 high to its 1995 low.  A dollar would buy around 125 yen when President Clinton was inaugurated in January 1993 but just 79.85 yen at its record low on April 19, 1995.  In the present decade, the dollar fell 39% against the euro from October 2000 to late-2004, regrouped for a while and then fell by 27.5% from $1.1640 to $1.6038.  There’s nothing new in having a slip-sliding dollar.  That’s been the default setting.  And this time, unlike some others, the collateral damage has been limited and seemingly outweighed by the potential benefit of encouraging more export-led growth in the United States and less of such in big surplus economies.

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.

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