Trick or Treat

October 24, 2013

This is the month when people are asked to choose between forking over a treat or suffering the consequences of a practical joke.  The fiasco of a U.S. debt ceiling debate earlier this month ended thankfully without a government default but with a considerable dose of national disgrace. Knock on wood, but the treat during this first post-crisis week has been that both fixed income securities and share prices strengthened.  The trick, if you will, was played on dollar bulls, and there were many of them at the beginning of 2013.  Since the end of the third quarter when the government shutdown began, the U.S. currency has lost about 1% against the yen, around 2% versus the euro and even more against certain other currencies like the Australian dollar (off about 3%).  From a peak around Independence Day, the dollar has depreciated somewhat more than 5.0% on a trade-weighted basis.  Translating such a move into equivalent change in monetary conditions, that’s like having about a 50-basis point cut in the Federal funds rate.

Currency fundamentalists like to list the U.S. economy’s intrinsic advantages that are supposed to keep the dollar’s external value in good stead over the long run.  These include superior demographics, a smaller relative government debt burden than Europe or Japan, the own-currency composition of that debt, a more flexible labor market, fewer government regulations than in other countries, a culture and legal system that encourage and reward entrepreneurial spirits, enormous supplies of energy and other natural resources, a political system of extensive checks and balances designed to limit abuses of government power and preserves individual freedoms, and a melting pot immigration system that solicits the best and the brightest people from other lands to join.  Because of these and other innate strengths, U.S. currency has never been seriously challenged as the world’s preeminent money since the second world war.

The reserve currency role hasn’t generated a steady-to-rising long-term trend in the dollar’s external value against certain other major currencies like the yen, mark, euro or Swiss franc.  At times the U.S. had relatively high inflation, but that is no longer the case.  A more enduring drawback is the chronic current account deficit, equal now to about 2.5% of GDP.  Switzerland’s current account surplus is huge.  Euroland is almost comparable in relative size to America’s shortfall, and Japan retains a surplus even though its trade position is currently in the red. 

America’s most worrisome economic imbalance is the jobs gap.  Jobs grew by 2.1% per year over the twenty-five years between mid-1950 and mid-1975 and by a similar 2.2% per annum in the ensuing twenty-five years to mid-2000.  Since mid-2000, however, jobs have risen at an annualized pace of only 0.3%, and employment growth of 1.0% since the mid-2009 start of the current business upswing is merely half the pace between 1950 and 2000.  The yawning gap from the old jobs gap is further compounded by minuscule income growth for most of the population since the early 1980s, and it’s an affront to what for two centuries made the country a beacon, namely the American Dream.

U.S. policymakers are not chasing down the labor market’s malaise but rather the budget deficit.  While such has been more than halved, fiscal debt continues to rise, but that’s not why the dollar has failed to appreciate.  Currencies often struggle when the worst economic problems do not command top policy priority and in a manner that investors believe credible and likely to yield results.  The arbitrary across-the-board fiscal cuts, moreover, have potential to undermine U.S. economic properties such as excellence in education and a state-of-the art infrastructure that heretofore were highly responsible for the nation’s rising standard of living.  Being as good as your competitor in these two critical public goods is as important to an economy’s long-term prospects as having a system of laws that protects patents, permits contracts, adjudicates disputes, and promotes private-sector competition. 

Finally, negligence on other policy fronts puts the burden of maintaining economic growth squarely on the Federal Reserve. Fed stimulus has exceeded expectations not so much because the Bank’s leaders are too timid to begin normalization but rather because of soundly based judgement that the economy couldn’t handle monetary tightening without serious risk of faltering growth and a setback in the labor market.  The Bank of Japan is also engaging in aggressive quantitative easing but since the Great Recession has offered less than the Fed.  The Bank of England stopped augmenting quantitative support about a year ago, and the European Central Bank has maintained a more hawkish image than the BOJ or Fed by adhering strictly to a sole mandate of medium-term price stability.  U.S. monetary policy has been a dollar negative additionally because of the coming change of Fed leadership.  Not only is Janet Yellen incorrectly perceived as more dovish than Ben Bernanke, but additional vacancies on the Board give President Obama the opportunity to promote a continuing tilt in the central bank predisposition toward a low interest rate/weak dollar stance.

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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