Dollar Free-fall Phobia

October 8, 2009

Today’s financial press has a nice juxtaposition between a front-page article in the Financial Times (“Obama’s critics pounce on falling dollar as fears grow over currency”) and an Op-Ed article in the Wall Street Journal by the former chief economist of Bear Stearns, David Malpass (“The Weak-Dollar Threat to Prosperity”).  Articles like these are symptomatic of a new hysteria over the depreciating dollar.  The Malpass editorial presents a metaphorical T-account of all the things that can go wrong if the dollar keeps dropping and all the potential benefits of having a stable or strong currency, and it concludes with advice to President Obama to “reject the Bush Administration’s weak-dollar policy.  This would invite capital and jobs to come back before interest rates have to rise.”  The FT piece quotes Norm Ornstein of the American Enterprise Institute: “The dollar has always been a testosterone issue among America’s political classes.”

How true!  The Ornstein quote reminds me of something said to me by the head trader at the New York Fed’s Intervention Desk in 1975.  As a newly arrived visiting economist to the Foreign Department, I apparently had viewed a spell of dollar weakness too ambivalently, and he asked me which team I was on.  Later, in the early 1980’s, a soaring dollar became emblematic of the revival of U.S. patriotic pride.  While I believe that a strong currency image is a desirable goal in the long run, it is also true that viewed in short-term spans, there is a time for currency weakness and a time for currency strength.  It’s important to know the difference.

The Malpass article paints the debate in black-and-white terms, and that also seems over-simplistic.  Like many other arguments in economics, the costs and benefits are not set in stone.  Compared to the end of 1998 when the euro was formed from many nation-state currencies, the dollar is presently 20.7% weaker against the common European currency and has fallen by a similar 22.1% against the yen.  Nonetheless, U.S. real GDP expanded significantly more rapidly than GDP in Euroland or Japan over that period.  Using the latest IMF projections for 2009 and 2010, GDP will have advanced in the dozen years between 1998 and 2010 by 27.9% or 2.07% per annum in the United States versus gains of 17.7% or 1.36% per annum in the euro area and 9.3% or 0.75% per annum in Japan.

Moreover, the dollar has been weak during many presidencies other than those of George W. Bush and Barack Obama.  In the nearly 25 years since February 1985, the dollar has lost 66.5% of its value against the yen and 62% against the D-mark.  Although the dollar’s respective losses since 1968 amount to 75% and 67%, the U.S. is considered to have a more dynamic and resilient economy than either Euroland or Japan.   Short of losing its most-favored-reserve currency status, the United States manages handle a slip-sliding dollar pretty well.  In ultra-low inflationary times such as these, the dollar’s erosion has not put upward pressure on either short- or long-term interest rates.

And finally, a point made before on this site, non-Japan Asia led by China is recovering sooner and faster than other regions from the global financial and economic crisis.  Not by coincidence, Asian currencies as a group tend to be the most undervalued according to measures of purchasing power parity.

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



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