It seems that to qualify for the job, US
treasury secretaries must be able to recite, "A
strong dollar is in the interest of the United
States," any time and anywhere. Robert Rubin,
treasury secretary during the second half of the
1990s, was highly credible when he said it.
However, when secretary John Snow uttered the same
words, the ritual had been diluted to providing
the appropriate sound bite to the media.
Henry Paulson, successor to Snow and
current treasury secretary, is a straight talker,
but knows that his job comes with
what
amounts to a marketing responsibility. In the
meantime, investors are at a loss as to what the
US policy toward the dollar truly is; there seems
to be a disconnect between what ought to be in the
country's interest and what current policies
promote.
Abby Joseph Cohen, chief
investment strategist at Goldman Sachs, who may be
best known for her perpetual appetite for
increasing price targets for US markets, called
the weak US dollar the "icing on the cake"; she
was referring to the potential positive effect on
stock valuations given that foreign earnings
translate into higher earnings for US companies
conducting business abroad.
The US
Congress would like to pressure the Chinese to
allow their currency to appreciate, ie, to weaken
the US dollar versus the Chinese yuan. If the
Chinese were to oblige, it would almost certainly
increase the cost of goods the US imports from
China; and because the Chinese recycle a lot of
their dollar holdings into US Treasuries, any move
on behalf of the Chinese to reduce their dollar
holdings would put upward pressure on US interest
rates (because of the inverse relationship between
bond prices and interest rates).
Breaking
with the long-standing tradition of leaving all
discussions pertaining to the dollar up to the
Treasury Department, Federal Reserve chairman Ben
Bernanke has not shied away from commenting on the
impact the dollar has on the economy. Bernanke,
who considers himself a student of the Great
Depression, has said: "To understand the Great
Depression is the Holy Grail of macroeconomics."
He laments in his analysis of the Great Depression
that keeping up the value of the dollar (by
preserving the gold standard) increased the
hardship of the people.
But the treasury
secretaries are correct: a strong dollar is in the
interest of the United States. For starters,
Americans live in an interconnected world, and a
weaker dollar makes the US less competitive. Also,
a weaker dollar won't rebuild industries that have
been lost to Asia. Sure, profits generated abroad
through services provided abroad translate to
higher dollar earnings, but the positive impact
may be limited to a quarterly earnings release.
Just as dollar cash is less competitive when it is
devalued, so is a stock price when measured in a
weak currency. Foreign companies can use both
their stronger currency as well as their stock
prices valued in hard currencies to acquire US
assets and enterprises.
As the dollar
weakens, America's purchasing power erodes. Look
at the price Americans now pay at the gasoline
pump if you believe a weak dollar does not have an
impact. The Organization of Petroleum Exporting
Countries has made it clear that its price target
for oil floats upward as the dollar weakens.
American consumers are not irrational;
they react to monetary and fiscal policies. When
interest rates are excessively low, and tax policy
is geared at encouraging consumer spending, people
spend until they drop. A weak dollar further
discourages savings, as those savings erode in
value. But given America's current-account
deficit, it urgently needs policies in place to
encourage more savings and investments to reduce
the pressure on the dollar.
A strong
currency is also a matter of national security.
Politicians are complaining that foreigners hold
too much of US debt. Paulson has rightfully said
that by all means, the US should try to maximize
the demand for US debt to minimize the interest
rate Americans have to pay; this includes allowing
foreigners to buy the debt. The solution, of
course, would be to curtail the supply of debt. In
plain English: cut your spending, or foreigners
will dictate in due course what you may spend your
money on (that would be interest payments to
them).
A weak currency is inflationary.
Wall Street analysts focus on "core inflation"
excluding food and energy; most have forgotten
that the reason food and energy prices have
traditionally been ignored is their volatility.
But these prices have been moving upward for years
now, with US Energy Secretary Samuel Bodman
already forecasting high gasoline prices for next
year. Given the new love affair politicians have
with ethanol, food based on corn (maize) is bound
to be increasingly expensive. So far, we have only
heard of the Mexican tortilla crisis, where
Mexican consumers are complaining that their
corn-based tortillas are no longer affordable; but
US food prices are also affected, as corn (and
notably corn syrup) is in countless food items.
Globalization and the Internet have held
back, but not eliminated, inflation. Items
Americans don't need - mostly those imported from
Asia - have experienced tame inflation (mostly
because of Asian overproduction, partially a
result of their weak currencies). But just about
everything Americans do need, from health care to
education and local craftsmen, has experienced
significant inflation.
Preserving
purchasing power should be in the interest of
every policymaker, and in particular be in the
interest of the Federal Reserve. But policymakers
allow eroding purchasing power to act as a
substitute to finding solutions on how to pay for
obligations ranging from government debt to social
security. Once a country is hooked on growth
through inflation, it is difficult to change bad
habits. Italy is still struggling to cope with the
rigidity of the euro after decades of inflationary
policies.
The Fed has allowed an
unprecedented credit expansion to take place.
Bernanke seems to believe there is no need to
impose tighter credit to fight excesses that have
been building up in the economy. However, if one
allows a credit bubble to take place, one must
also be willing to allow a severe recession or
depression to take place to rid the economy of
excesses that have been built up.
Those
who are most concerned about the dollar do not
believe the Fed will allow such a correction to
take its full course; there is already talk of a
Fed interest rate cut in a few months. In our
assessment, the Fed is rather concerned that a
credit contraction combined with high levels of
consumer debt could create a Japanese-style
deflationary spiral; to avoid having to deal with
deflation, the Fed should induce inflation.
The Fed can tighten money supply. The Fed
can make money available. But the Fed has very
limited tools to encourage people (or businesses)
actually to borrow money. As consumers have
overextended themselves, they may be reluctant to
take on more debt. Aside from lowering interest
rates, one of the few tools the Fed has to
encourage credit expansion is to apply a tax on
savings through inflation. This, of course, is in
direct violation of its mandate to pursue price
stability.
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