G7 Faith in Long-Term Dollar Fundamentals

July 8, 2008

The G7 summit did not produce a breakthrough on dollar management.  The dollar was not explicitly mentioned in the Group’s joint statement.  It’s wording conformed to what G7 finance ministers and central bankers have been saying.  The main initiative involves emerging market currencies, which G7 governments do not control.  President Bush keeps reiterating that his administration supports a strong dollar, and leaders in Europe and Asia keep expressing their appreciation for the president’s verbal support.  But what exactly does that verbal cheer-leading really mean in the present context.  The dollar has depreciated 40.7% against the euro and by 35.7% on a trade-weighted basis during the Bush43 Administration’s stewardship of the economy.  There has been no U.S. intervention support for the dollar.  Questions about possible future intervention have elicited evasive answers from the authorities.   U.S. officials have called more frequently and forcefully for a rise in emerging market currencies against the dollar and in trade-weighted terms than they have complained about dollar depreciation against other G7 currencies.  The Fed has not raised interest rates to support the dollar, nor left any credible clue that it might tighten for that reason.  On the contrary, the Federal funds rates was from 5.25% to 2.0% since September amid rising oil prices and accelerating inflation, as well as in the face of additional erosion of the dollar’s value.

Led by President Bush, the U.S. dollar policy is faith-based.  Officials believe the dollar will rebound because they retain no doubt about the strength of U.S. long-term economic fundamentals, and market-set exchange rates will conform to long-term fundamentals without policy interference.  How many years does it take to constitute a long-term block of time?  Surely, eight years ought to be a sufficient interval. The table below presents U.S. consumer price inflation, growth in jobs and real GDP, oil price appreciation, and the rate of rise in the Dow Jones Industrials Average as percentage changes per annum.  The results suggest that the long-term trend of the U.S. economy is adverse.  If one throws into the mix such additional factors as huge deficits in the nation’s current account and federal budget balance, a tiny and historically inadequate household savings rate, wounded balance sheets at numerous financial institutions, an imploding housing market, a neglected infrastructure, flawed education, and defense and health industries with voracious appetites that leave no means to regroup, one is left to conclude that long-term dollar fundamentals have not only deteriorated but are likely to remain unsound.  The case for a dollar upswing then rests heavily on one of two premises.  Either economic fundamentals in Europe and Asia are even worse and expected to deteriorate more rapidly than U.S. fundamentals, or present exchange rates have already overshot dollar equilibrium.  I find the latter argument to be the more compelling of the two.  However, a rise from unreasonably low levels gives reason to be optimistic about short-term prospects only and does not create a basis for being satisfied with the policy status quo.


  Clinton Bush
Real GDP 3.6% 2.4%
CPI 2.6% 2.8%
Employment 2.4% 0.5%
DJIA 15.9% 0.8%
Oil 7.2% 22.4%

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