Buttressing the Dollar
November 12, 2009
Lip services goes only so far. Secretary Geithner’s words yesterday in Asia were a variation on a 14-year-old theme but nevertheless as supportive rhetorically as I ever remember.
I believe deeply that it’s very important to the United States, to the economic health of the U.S., that we maintain a strong dollar.
And this too:
We have a special responsibility for trying to make sure that we are implementing policies in the U.S. that will sustain confidence in investors around the world that as growth recovers and growth strengthens we’re going to bring our fiscal position back to a sustainable balance.
I cannot recall a time when the two major global newspapers ran lead stories about foreign exchange and the dollar specifically, and the backdrop did not involve a coordinated policy move, very disorderly market conditions, or a definitive trend reversal. But it happened today. The lead article in the Wall Street Journal, “World Tries to Buck Up Dollar,” talks about substantial Asian central bank dollar purchases in September and October. A subplot, or major anxiety depending on one’s point of view, is that the squeeze on the emerging Asia’s competitiveness has been magnified greatly by the yuan’s fixed parity to the depreciating dollar. The article quotes a recent IMF assertion that the yuan “remains significantly undervalued from a medium-term perspective.” The front-page of the Financial Times blares “Chinese hint at stronger renminbi,” although the story goes on to indicate that the central bank and government may not agree on this question and to concede that a change of the yuan against the dollar is not expected before the middle of next year.
In spite of Geithner’s statements and the intervention by Asian authorities, the dollar hasn’t been trending wildly this month. It’s worth 1.4867 per euro at the moment, almost identical to the 1.4860 mean so far this month, and JPY 90.42, just 23 pips from its November average so far of 90.19. The euro and yen remain unable to sustain gains beyond resistance at the big round figures of $1.50 and Y 90.0. Likewise, key euro crosses against the pound and Swiss franc, respectively 0.8963 and 1.5164, cannot escape the pull of 0.90 and 1.51.
One can interpret the dollar’s inertia as either a vote of confidence or absence of investor confidence that officials will stop the bleeding. Listen to the pundits, and one hears that of course U.S. officials don’t mean what they say. Rather, it is only in America’s interest that the dollar not go into a free-fall. Foreign exchange history suggests that policy efforts to stop a falling currency are most successful when they carry a clear mission to produce a reversal immediately and when an ability to do that is demonstrated. Hold-that-line currency initiatives generally falter eventually. Alternatively, it is impressive that the dollar has not dropped given the fact that most stock markets, other than Japan’s, have strengthened and in light of encouraging foreign data. (see the next update I plan to post today for a few examples of this).
But first a digression to leave two points. First, the rhetoric isn’t being taken seriously by analysts, who pretty uniformly claim that of course U.S. officials don’t mean what they say. Rather, it is only in America’s interest that the dollar not go into a free-fall. Secondly, Geithner is only partly correct that the main problem for the dollar is investor worries that control of the fiscal deficit will never again be established. Excessive deficit spending is a currency negative only if fully accommodated by monetary policy. The deficits in the early 1980’s broke new ground in terms of size during peace time, but the dollar appreciated sharply because the loose fiscal stance was counter-acted by an expansive monetary policy. Exchange rates are external prices of domestic money. Restrict the growth of supply, and elementary theory suggests the price — in this case the dollar — should strengthen. It helped too that the United States pulled back from the brink of feared runaway inflation to a restoration of much lower and stable internal price inflation. A lessening pace of domestic currency debasement went hand-in-hand with the dollar’s strengthening external value. The lesson then was that monetary policy trumps fiscal policy.
Copyright Larry Greenberg 2009. All rights reserved. No secondary distribution without express permission.
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