U.S. Dollar Policy

March 25, 2009

The Obama Administration’s policy on the dollar is getting curiouser and curiouser.  At last night’s press conference, the president said, “I would just point out out that the dollar is extraordinarily strong right now.  And the reason the dollar is strong right now is because investors consider the United States the strongest economy in the world, with the most stable political system in the world.”  True, the dollar has strengthened on balance by 3.0% against the euro and 7.6% relative to the yen since the end of 2008.  Those gains are hardly extraordinary, and from the what-have-you-done-for-me-lately department, one needs to add that the dollar has lost 8.1% against the euro and 2.1% against the yen from its highs earlier this month.  Moreover, by calling the dollar strong, not stronger, Obama was presumably referring to the dollar’s levels, not its recent movement.

Dollar levels are in fact weak, not robust.  The U.S. currency is 12.8% and 17.2% below its end-2005 levels against the euro and yen.  It has fallen by 34.3% and 25.8% against those currencies since end-2001.  Compared to levels twenty years ago on March 25, 1989, the dollar has lost 23.0% against the synthetic mark and 25.7% against the yen.  From levels after being devalued in February 1973, the dollar shows additional losses of 50.3% against the mark and 64.8% against the yen, and since 1968 the greenback has seen its external value erode by 63.9% against the mark and 72.9% against the yen.  Between the two world wars, the dollar overtook sterling as the world’s dominant paper currency.  A great paradox of a global exchange rate regime anchored around the dollar has been the fact that its dominance has gone unchallenged in spite of an inability to hold value against other major currencies.  The second part of Obama’s answer, which touts the high regard that investors show for the U.S. economy and political system, is true but irrelevant because it defends an untrue assumption about the dollar being extraordinarily strong.  Calling the dollar extraordinarily strong is no less ludicrous than calling an economy, which has shed almost 3.3 million jobs in a half-year, nonetheless strong because data today on new home sales and durable goods orders each beat market expectations.

President Obama’s remark came in response to the Chinese proposed switch to an SDR-linked foreign exchange system.  The head of China’s central bank laid out reasons for this idea in a well-reasoned statement posted on the People’s Bank of China website.  Governor Zhou’s thoughts have drawn general praise as an initiative with merit that should not be dismissed without serious consideration.  From today’s Financial Times

He has made serious proposals for a reserve currency to rival the greenback and he deserves a hearing.

Treasury Secretary Geithner yesterday initially threw cold water on Zhou’s suggestion, and so did President Obama, who added, “I don’t believe there is a need for a global currency.”  Then Geithner sent a more mixed message today that he is “quite open” to a discussion of the Chinese proposal but confident that the dollar will remain the world’s reserve currency for a long time.

Presidents rarely comment on the dollar, and when they do, the remarks almost invariably are made early in a new administration as we saw last night and provoke a negative dollar reaction.  It is interesting that Obama did not invoke the Rubin mantra that a strong dollar is in the best interest of the United States because it promotes capital inflows, low inflation, and low interest rates.  Sometimes that mantra had morphed into a prediction that the dollar would be strong because other policies were insuring strong growth with price stability.  Obama’s remarks modify this variation further.  An erroneous statement about dollar strength is associated is associated with the unproven assertion that investors are confident that the U.S. economy will outperform others.

On the whole, I thought the president performed well, giving mostly compelling answers to difficult questions.  I was excited to hear a question on the dollar even get answered, but the response left me even less confident about the dollar’s near- and long-term outlook.  I doubt this issue will fade away.  The United States reaps huge benefits from the dollar’s role as a heavily dominant reserve currency.  U.S. monetary and fiscal policies are moving in directions that may scare investors like China, with much to lose if the dollar depreciates.  Currency manipulation represents the cutting edge of protectionism and will thus be a key issue at the upcoming G-20 summit and other international leadership forums.  It will be important for officials representing the United States to hammer out a clear policy on the dollar and international currency market reform and to be consistent in their public pronouncements on such.  Markets abhor any uncertainty in Washington’s stewardship of the dollar.  It seems that doubts on this matter may be impeding dollar strength already given that a string of upside U.S. data surprises has not been mirrored in Europe or Japan.

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



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