Myth of the Strong Dollar Policy

Here are five great myths and/or lies of the modern financial system:

1. "The check is in the mail"
2. "I'll call you right back"
3. "We are long-term investors"
4. There is a secret cabal of gnome-like creatures that manipulate the gold price (up or down, depending on your druthers)
5. "The United States believes in a strong dollar"

When the strong dollar policy was formulated by Bob Rubin in 1995, it was sincere and served a purpose. After all, the Treasury market had experienced a horrible sell-off the previous year and the buck made all-time lows against the JPY and DEM in 1Q95, prompting the last bit of multilateral currency intervention in which the US was an enthusiastic participant.

And one could argue that the policy served a useful purpose throughout the 90's; by maintaining tight monetary conditions, it replaced some element of Fed rate tightening, while at the same time affording the US a useful (positive) terms of trade shock. It was only a decade ago that oil flirted with $10/bbl!

However, in the Noughties, a decade dominated by global imbalances, the bond conundrum, and a host of other resource misallocations, it's been quite clear for some time that the strong dollar policy is a farce worthy of Rabelais. It's a well-known fact that the strong dollar policy is a hollow one, and Macro Man can only conclude that in diplomatic circles, it must represent the epitome of poor taste for JCT, among others, to reiterate their support for what has become a "strong dollar" policy (emphasis on the quotes).

'Tis a pity, really; the strong dollar policy once served a useful purpose, and it's not difficult to envisage it doing so again. By failing to withdraw its support of an overtly strong dollar when one was no longer desirable (quite the contrary), the US Treasury has done America and the rest of the world a disservice.

Of course, it's a tad rich for JCT to dance around someone else's linguistic parlour tricks; after all, he is the undisputed master of speaking in a literary code of his own devising (remember 'strong vigilance'?!?!). And even in the currency realm, the Europeans have their own form of linguistic semaphore; when Europe warns of "excessive volatility" in currency rates, they are really moaning about the level of the euro.

For if it really were volatility that Europe cared about, then they should be chuffed to bits. As the chart below demonstrates, one month realized vol in EUR/USD has collapsed in recent months and is now, at 6.9%, at the low end of the post-Bretton Woods range.

Belatedly, of course, the Europeans seem to have noticed that the Chinese aren't exactly playing "good neighbours" when it comes to global currency policy. And so after years of American financial diplomats trudging to Beijing to wag their fingers at the unrecalcitrant Chinese, Messrs. Trichet and Juncker will be making a similar pilgrimage over the next couple of months.

For some reason, Macro Man can't shake the Kim Jong-Il/ Hans Blix scene from Team America from his mind, though he suspects that feeding the European worthies to a shark tank would probably not escape notice.

The best that the Eurppeans can probably hope for, however, is if the Chinese response is something like this:

Meanwhile, Brazil has re-instituted a punitive tax on foreign capital, a week after Turkey was rumoured to be contemplating a similar arrangement. Taxes on capital, moaning on currencies, nothing on interest rates. You can almost literally see the wagons circling as each country looks out for #1.

It's entirely possible for this liquidity/positioning/DGDF rally in risky assets to continue through year end; in many ways, it's in everyone's best interest for this to happen. But Macro Man can't shake the feeling that we're all repeating the mistakes of the last cycle (in fast forward, no less!) and that when the reckoning comes, it won't be much fun.

Comments

[Dave Wrixon:]

Dollar policy per se is nonsense, either strong or weak. Dollar strength is determined largely by the markets in accordance with how badly the economy is being run. If it is being run only moderately badly, then the Dollar will be comparatively strong. If it is a complete shambles it will be be a bust. Having said that the Fed has been able to pull the wool over the eyes of most market participants for the last twelve months or so. Those that feel this economy is being run only moderately badly are completely deluding themselves.

Oct 20 05:55 AM

[Dave Wrixon:]

The other thing I find a tad annoying is that the same people that profess a strong dollar policy, bleat like mad when China unilaterally imposes one on them.

Oct 20 06:00 AM

[Moon Kil Woong:]

A weak dollar isn't in our best interest as long as the RMB is pegged to the US $ which it is. I wonder how long it will take for the Federal Reserve to get that fact through their thick skulls. I hope it comes before the dollar drops (any your assets might I remend everyone) another 15% without anything to show for it but higher commodities prices, looming inflationary pressures, and a strong incentive for companies to give up trying to sell to poor Americans and trying to peddle everything to Europe that is understandably getting quite protectionist these days.

In this global recessionary cat and mouse game we are clearly the free market losers vs the Chinese pegging and the ROW protectionist schemes. The only card we had up our sleeves was a strong dollar joker which was actually a haha you just got junk paper parlor trick. LOL, I wonder how many times they will be fooled by that one.

Protectionism is bad but it's your only choice when the rest of the world is being protectionist. If you aren't you are the ultimate greatest fool.

Oct 20 07:16 AM

[Michael Clark:]

"Protectionism is bad but it's your only choice when the rest of the world is being protectionist. If you aren't you are the ultimate greatest fool."

Yes, Moon, exactly. Anti-protectionism is some academic stance taken 'in the best possible worlds'. We don't live in the best possible worlds. The currency market is rife with protectionism, always has been, always will be. All countries engage in protection of their own economies, at one level or another. The fantasy is that America has to 'remain' anti-protectionist because everyone else is playing by the same rules. There are no same rules. There's give and take. There's negotiation and retaliation. There has never been a time in the history of the world where nations haven't engaged in some for of protectionism -- and there never will be.

Oct 20 08:02 AM

[tripleblack:]

Its "protectionism" when you let domestic politics cause you to erect trade barriers against a trading partner who allows you open access to their markets and who trades in a fair and open manner.

Its "national defense" when you do it against those who insist on tilting the playing field their way, LOL.

As for the bizarre "relationship" between China and the U.S., we have become the sticky "tar baby" for China's fox. Much as they might like to let go now, when the relationship is uncomfortable, losing all that fur is not acceptable. When will the pain of staying stuck become less than the pain of pulling free? Ah, yes, THAT is the 64trillion dollar question.


On Oct 20 07:16 AM Moon Kil Woong wrote:

> A weak dollar isn't in our best interest as long as the RMB is pegged
> to the US $ which it is. I wonder how long it will take for the Federal
> Reserve to get that fact through their thick skulls. I hope it comes
> before the dollar drops (any your assets might I remend everyone)
> another 15% without anything to show for it but higher commodities
> prices, looming inflationary pressures, and a strong incentive for
> companies to give up trying to sell to poor Americans and trying
> to peddle everything to Europe that is understandably getting quite
> protectionist these days.
>
> In this global recessionary cat and mouse game we are clearly the
> free market losers vs the Chinese pegging and the ROW protectionist
> schemes. The only card we had up our sleeves was a strong dollar
> joker which was actually a haha you just got junk paper parlor trick.
> LOL, I wonder how many times they will be fooled by that one.
>
> Protectionism is bad but it's your only choice when the rest of the
> world is being protectionist. If you aren't you are the ultimate
> greatest fool.

Oct 20 08:55 AM

[tripleblack:]

Correction: "When will the pain of staying stuck become MORE than the pain of pulling free".

Dang typos!


On Oct 20 08:55 AM tripleblack wrote:

> Its "protectionism" when you let domestic politics cause you to erect
> trade barriers against a trading partner who allows you open access
> to their markets and who trades in a fair and open manner.
>
> Its "national defense" when you do it against those who insist on
> tilting the playing field their way, LOL.
>
> As for the bizarre "relationship" between China and the U.S., we
> have become the sticky "tar baby" for China's fox. Much as they might
> like to let go now, when the relationship is uncomfortable, losing
> all that fur is not acceptable. When will the pain of staying stuck
> become less than the pain of pulling free? Ah, yes, THAT is the 64trillion
> dollar question.

Oct 20 08:57 AM

[Old Trader:]

I'm waiting for the time when the US will "walk the walk", not just "talk the talk" when it comes to a strong dollar, but I'm certainly not holding my breath. I never thought I'd hear of the "dollar carry trade".

Oct 20 09:23 AM

[Socialism c...:]

Protectionism is NOT bad. Never was. Get over this globalist infatuation: it has cost the U.S. our lead in the world and many millions of jobs!! Our leaders have sold us this lie for their political and financial gain.

It's about bl00dy d@mn time we put America first again!!!


On Oct 20 07:16 AM Moon Kil Woong wrote:

> Protectionism is bad but it's your only choice when the rest of the
> world is being protectionist. If you aren't you are the ultimate
> greatest fool.

Oct 20 01:50 PM

[thiazole:]

I like this Charles Wheelan article for explaining why protectionism really is the devil. finance.yahoo.com/expe...
While unemployment is high right now that we are at the end of a recession, it is high almost everywhere in the world, including most protectionist countries - prior to this recession when "all" our jobs were supposedly getting shipped away, the unemployment rate was still only about 4.5% here. Since 5% is considered full employment, we clearly didn't have enough people in our population to handle all those jobs we shipped away.
But lets look which other countries ship jobs to the United States. Do you think that Toyota or Honda are suffering for the thousands of jobs they outsourced to the US? Basically US citizens are paid $X to build cars that sell for $X+$Y, and the $Y goes back to Japan. How is taking our money hurting them again?


On Oct 20 01:50 PM Socialism cannot compete! wrote:

> Protectionism is NOT bad. Never was. Get over this globalist infatuation:
> it has cost the U.S. our lead in the world and many millions of jobs!!
> Our leaders have sold us this lie for their political and financial
> gain.
>
> It's about bl00dy d@mn time we put America first again!!!

Oct 22 04:44 PM