The debate rages on: Is the economic policy of the United States on the right track? On one side of the argument we hear that not enough has been done by the government to get the economy going again and to reduce unemployment. On the other side we hear that the government is creating too much debt and that most attention needs to be given to the reduction of the looming federal deficits.
Which argument is correct?
Well, if we look at the value of the dollar for an answer to this question, it seems as if investors are leaning a little more on the side of the latter. (Click to enlarge)Click to enlargeThis chart shows the value of the United States dollar against other major currencies in the world. The grade that is being given the economic policies of the United States government is not a good one. It should be noted that this index includes the euro and the British pound, two currencies that have been quite weak against the United States dollar recently.
Since January 2001, the value of the United States dollar has declined by about 26% against these major currencies. At one time in 2008, the value was about 32% lower than in January 2001, but the "flight to quality" during the Great Recession allowed the dollar to recover somewhat. It then declined again to its current level as confidence rebounded.
Even with the situation in Greece (and Portugal and Spain and Ireland and…) investors in international markets still seem to believe that the United States government is on the wrong path with respect to its fiscal and monetary policies. Federal deficits totaling at least $15 trillion over the next ten years connected with a monetary policy that is keeping its target interest rate close to zero for an unknown length of time is not a combination that builds much confidence.
It could be argued that these international investors are giving the Obama Administration about the same grade it gave the Bush (43) Administration. If it were not for events going on in other countries, the value of the dollar could be even lower.
In fact, the recent performance of the dollar indicates that the international financial community sees little difference between the performance of the current administration and that of the administrations that preceded it over the past forty-five years or so, going back to 1961. Yes, different administrations pursued different specific policies that represented what they thought was best for the country, but in terms of aggregate policies there has been little difference overall. The general thrust has been more federal debt and more private credit. The result: an almost constant increase in credit inflation.
Now, there is the threat of a debt deflation as a consequence of the Great Recession, but world currency markets don’t seem to think that a debt deflation is the most likely prospect.
With a government whose gross debt doubled since January 2001 and is projected to double again within the next decade, and with a Federal Reserve that has injected $1.1 trillion of excess reserves into the banking system, little confidence exists among international investors that the United States government can "exit" this situation without losing control.
You can say all you want to about the policy differences of the different administrations over the last fifty years, but if you look at the aggregate economic data, very little separates the performance of the Republican and Democratic Presidents. President Nixon, perhaps, spoke for all Presidents of the past fifty years: “We are all Keynesians.”
One could argue that the Clinton Administration was the exception in terms of fiscal policy. And, Paul Volcker had to overcome the fiscal prodigals, Carter and Reagan, to achieve some credibility for the United States in international financial markets.
This relatively steady performance has weakened the United States internationally and the continued weakness in the dollar indicates that investors think that the current direction of policy will weaken the United States further going forward. This decline, connected with the ascension of the BRICS and other emerging areas in the world, is shifting power relationships all over the globe. The move from the G8 to the G20 captures this change.
The thing is, power cannot stand a vacuum. If the United States is wobbling a little, China, Brazil and others are there to fill in the spaces. Other nations will not stand still so as to allow the United States to dig itself out of the hole that Bush (43) put it in. In fact, by pursuing the same kind of aggregate economic policies that were followed by the Bush (43) Administration, large deficits and extremely loose monetary policy, the Obama Administration, in many ways, just seems to be digging the hole deeper.
Ben Bernanke is even calling for the Obama Administration to produce an “exit” strategy to reduce future federal deficits. But this just highlights the problems that this administration faces. The government must “exit” both an excessively loose monetary policy as well as an excessively prodigal fiscal policy stance. It will be a truly exceptional performance if this administration can pull it off.
Right now, I believe that world markets think that they cannot pull it off. The place to watch is the foreign currency markets: keep your eye on the value of the dollar!