5 Reasons to Save the Greenback

Financial firms have so far announced losses totaling around $160 billion, and UBS feels there could be a total of $600 billion in losses triggered by the subprime collapse. There is more bad news to come, and central bankers know it. If UBS is correct, we've only seen the tip of the subprime iceberg, and central bankers will have to remain flexibile to effectively deal with upcoming challenges. I don't doubt that the dollar's long term trend is down, but I argue here that coordinated intervention to give the U.S. dollar a short-term (2-5 years) lift may be an interesting idea for central banks to consider.

"The already undervalued dollar won't stop falling until it is stopped via coordinated intervention," said Morgan Stanley's Stephen Jen in a note published in December. "While the preconditions for such an action have not yet been met, uncoordinated verbal intervention has clearly commenced, validating the notion that the costs of a weaker dollar are quickly catching up to the benefits for most countries in the world."

Coordinated central bank intervention to save the dollar might sound like a crazy idea, but it's worth pointing out that in the past 30 years, coordinated intervention caused all but one of the changes to the dollar's long-term trend. Morgan Stanley said in November that the Fed, European Central Bank [ECB] and the Bank of Japan [BoJ] may coordinate efforts and intervene once Euro hits $1.50 or if the Yen goes to 100. The analysts suggested that coordinated intervention becomes more likely once the Fed ends cutting rates and the ECB ends hiking rates, and it's probably fair to say we are fast approaching such a condition.

The Morgan Stanley report points out that trade and investment flows rarely offset large currency moves, which implies that the "natural economic mechanisms that should, in theory, have helped halt the greenback sell-off were not, in fact, usually strong enough. This is why multilateral interventions were usually required to facilitate the re-alignments of exchange rates."

Central bank credibility can go down the tubes if they fail to boost the dollar in a coordinated intervention attempt. How long will the Fed's $67 billion of reserves (including $42 billion in foreign currency) last before it's absorbed by a forex market that trades $3,000 billion a day? The Fed will need the help of other central banks to take on the massive foreign exchange market. Assuming central banks can successfully pull off a coordinated intervention, here follows five reasons why saving the dollar makes sense:

1) Record oil prices pose a major risk to the industrialized world, and a higher dollar will probably knock down oil prices and reduce inflation

OPEC is refusing to boost production when the rest of the global economy is faltering, and it's time for central banks to get creative. Lower oil prices, as a result of coordinated intervention to save the dollar, will help to cool inflationary pressures, giving central banks some room to adjust monetary policy. For example, many analysts believe the ECB is behind the curve, especially after recent economic releases that disappointed. Lower oil prices may reduce inflation expectations in Europe, which may allow the ECB to cut interest rates and deal with the economic slowdown and credit troubles.

2) A stronger dollar will boost the buying power of the weakening U.S. consumer

The U.S. remains a consumer nation, and central bankers need to find ways to resuscitate the U.S. consumer. After all, the U.S. consumer has been the driver of growth in many parts of the world. By boosting the value of the dollar, through coordinated intervention, U.S. consumers remain protected from inflationary pressures by boosting their buying power.

3) Japanese exporters need to remain competitive

"Recession is a clear and present danger in Japan," said Tetsufumi Yamakawa, chief Japan economist for Goldman Sachs. "The leading indicators are deteriorating very sharply. Inventory is piling up at a rapid pace. There are clear signs of deceleration in exports of steel and semi-conductors to China," he said. Japanese exporters will have to remain competitive if Japan is going to recover from the current slowdown. Coordinated intervention to lift the dollar will push down the yen, helping Japanese exporters.

4) Coordinated solutions will be more effective than isolated solutions

If countries act in isolation, I doubt they can produce meaningful solutions. A perfect example of this idea is the Fed's recently announced rescue package that will probably benefit the Chinese more than the United States. "Americans will use the rebates to buy Chinese imports offered at Wal-Mart and the $150 billion will then wind its way inevitably back to Asian coffers," says PIMCO's Bill Gross in a recent note. Some might say this is far-fetched, but it illustrates an important point: Global economies are tightly connected, and contagion effects are likely to undermine the impact of domestic policy action. This is a global problem, and it has to be solved by global, coordinated solutions. "Preventing a global downturn is too big a job to be left just to American policymakers," says the headline in a recent article published by The Economist.

5) The timing of the U.S. elections

The world can't always rely on America to save the day, and other nations will have to come to the table and offer solutions. Due to the political transition in the U.S. it might take time to implement policies that will be effective. After all, the $150 billion rescue package has been labeled as "temporary" solution to avoid widespread damage to the economy in an election year, and much work still has to be done to arrive at a permanent solution. Quoting PIMCO's Bill Gross again: "When private demand falters, it becomes the responsibility of the government to fill the breach. Because it likely will not do so effectively until after a new Administration is elected in late 2008, the U.S. economy and its somewhat coupled global companion will sleep walk for some time and a resumption of prosperity as we knew it will be dependent on reforms of monetary and fiscal policy resembling the 1930s more than our past decade."

There are numerous arguments against intervention to save the dollar. Exports have turned into the main driver of US growth, offsetting the housing slowdown and credit crisis. It doesn't make sense to disturb an area of growth, especially when we don't know if U.S. consumption will continue to hold up. A weakening dollar is also helping the adjustment of the U.S. trade deficit, a process that U.S. officials wouldn't want to disturb. Politics may also delay coordinated central bank intervention. The G7 demands currency flexibility in the emerging world, and for that reason any coordinated intervention from G7 central banks will contradict those demands. Some analysts suggest that a more realistic scenario would involve the Europeans undertake some sort of coordinated intervention that would spread the burden of adjustment more evenly between the euro and some Asian currencies.

Coordinated intervention to boost the dollar is not an ideal solution, but the foundation of the idea is simple: we need coordinated solutions. "If the world leaves the Fed to provide risk insurance for everyone, America's interest rates will almost certainly be too loose for too long-just as they were in 2001-04," says The Economist. "Excessively low American rates would raise the odds of new asset bubbles and impede the rebalancing of the global economy."

Disclosure: None

Comments

[fxtrader07]

in short, you make a case for another bailout of the U.S., this time by the rest of the world. The dollar is weak because the U.S. (the govt and the Fed) have inflated it without hesitation and even increase the speed further. tax-rebates?? no such thing. it's printing paper and dropping it on the people. the u.s. govt , already deep in debt, just borrows billions more to dump them on the overlevereraged u.s. consumer. it is nothing else but bernanke's helicopter-idea carried out now. talk about desperate moves!
the dollar can't and will not be saved this time by central bank intervention. the entire world recognizes that it is basically worthless IOUs that are issued at ever increasing speed with less and less real assets backing them. A collapse of the greenback will be painful to other nations , yes. but not nearly as much as you might think. china, india, europe, russia, heck the entire world will be better off taking the losses on their dollar assets than thoring good money after bad. contrary to the u.s. economy they will not collapse. the might go thorug a recession, fine. but afterwards the u.s. will be a shadow of its former self while the rest of the world will be doing fine. and the u.s. will have to restore fiscal prudence and bring their trade balance in order as it will be impossible anymore to just print their way out of their spending bubbles

[sdavid0419]

I thought letting the dollar fall was the solution? With no controls on our borders our total population has made it hard for us to produce enough food to feed everyone so we have to import stuff we used to export. The inbalance in trade was impossible to curb without balancing our budget something the Bush administration demonstrated no desire to do. As long as Benacke's solution to our problems is to throw fuel on the fire (handing out free money thus piling on the runnaway debt) and to artificially keep interest rates low. The only solution is to print dollars and take your medicine as the chips fall.

[bhakta]

I don't believe any intervention can save the USD, not do I believe trying to save it is the proper action. What can save the USD #1 balanced budgets, incentives for manufacturing in the USA rather than in every place except the USA, and higher import tarrifs on all imported materials, making the goods made locally competitive. As long as trade and budget deficits are in excess of $2.5 Billion per day, the situation is hopeless.

[hattryx]

a cheaper dollar helps the americans. therefore it will come to pass. g w bush ftw

[profluigi]

Those who try to stave off economic cycles only worsen them. Calling on the rest of the world to bail out piggish America is not only degrading, but stupid. The party's over, people; get over it.

[kimc]

I rarely agree with these so-called finance experts, but this time, Eben is right. The U.S. dollar is undervalued as compared to the Euro. Americans do consume a lot, but they also work much harder than the Europeans. Many Americans barely get a week off for vacation a year, and work more than 40 hours a week. All of Europe would be protesting if they had to live in those conditions. If the ECB does not lower it's interest rates, Germany may have to eat all those BMWs and Mercedes Benz's they would normally be selling to us flamboyant Americans!

[Steve Agnew]

The time for central bank intervention is only when the frenzy of the market trumps its reality. The dollar must fall in order to compensate for years of trade deficits and the overpriced U.S. stock market. Clearly U.S. productivity has driven and continues to drive much of the global economy. Our economy will survive and indeed strengthen because we allow it to correct itself. However, when a commodity is driven by speculative frenzy, not supply and demand, that is the time for central bank intervention. Clearly oil futures are in the midst of such a frenzy and so an obvious strategy would be for the central banks to short oil...big time. This should be done immediately in order to cool the speculative frenzy in that market. Gold is another instrument in the midst of speculation and would be another place for the central banks to short. Once again, this kind of intervention should only be to address speculation, not hard market reality.

[Grass Ranger]

Steve Agnew - "Clearly oil futures are in the midst of such a frenzy and so an obvious strategy would be for the central banks to short oil...big time."

Short Oil?? Who is going to loan oil to a central bank to put it into the market? Haven't you seen the effects of going short against the commodities lately. These price run-ups are due to demand for commodities in short supply, not just speculators making a fast buck. The reason the buck is so cheap is that there are so many of them floating around the world that no one wants.

[austrian]

Its the gold standard st#@$d. All this Keneysian talk of trade deficits, fiscal deficits, consumer demand and 1930's style government spending in relation to the purchasing power of the dollar is bunk. Gold is telling us that the dollar is weak, which people seem to know, but then they complain about oil and the arabs' reluctance to open their spigots. The reason is that they dont want to get even less of our ever-devaluing dollars for their oil. If the dollar's purchasing power is declining, they must demand more dollars for their oil, just as they did in the 1970's. This is why oil has always tracked the price of gold and why OPEC can say with a straight face that there is NO shortage of oil but rather an abundance of dollars.

Inflation and deflation are purely monetary phenomena. A surefire way to "save" the dollar is for the Fed to mop up excess liquidity (by for example selling from their portfolio via open market operations) until the gold price declines to a more acceptable level, OR the risk to economic activity needs to decline so that at the margin the demand for dollars increases. The latter today means essentially reduced tensions in the Middle East and lower taxation and regulation barriers in the US in order to increase incentive to risk and demand for liquidity. Central bank intervention, government spending a la Bill Gross, and other merely cosmetic solutions will not work for the simple reason that you cannot change the terms of trade by devaluing (or revaluing) the currency. This is why OPEC wants more for their oil and why the baker around the corner now wants more for his bagels. This is common sense. But its not acceptable theory in polite company today because otherwise many a comentating economist would have to find something else to hang his PhD on and speculators would see their FX profits curtailed by this "barbarous metal." Meanwhile, the Fed will face rising inflation numbers as $1000 gold filters up through the economy (bagels now, cars later) while their rate cuts have no effect either on the actual surplus of liquidity or the geo-political risks to economic activity. This is called stagflation, and I would load up on those TIPS, even at these rates.

[pharma]

This is a great idea!

I would only suggest that all world should bail out the USA dollar and economy not just for 3-5 years but for 30-50 years. This will be more fare.

If all these greedy Europeans and Asians refuse, America should declare an operation "European Union/Asia Freedom" and invade /occupy all of them.

People get over it. The USA was living a parasitic way of life for the last 10-15 years exchanging US$ paper for the goods we have consumed. The party is over. The time has come to pay the bills or start "washing dishes".

[bcr]

The major remaining factor favoring the US is our extremely advanced military. "If you don't want our dollars anymore, maybe we should just invade, capture your natural resources, and make you pay us taxes!"

If only our next president could be so brazen.

Disclosure: Half joking

[Kunst]

Exactly what is it that entitles American consumers to buy and buy and buy, all on credit, forever and ever? Are we doing the rest of the world a favor by "giving them jobs" making things for us? Should they be so grateful that they never use those dollars we give them to compete against us for the good things of life?
Americans are spoiled beyond belief. Our glory days were 50-60 years ago, when American industry was bulked up by a war that laid low most of the rest of the world. To be an American meant you could live well with limited effort and education. The rest of the world was shut out. That era is over, and the US just doesn't get it. We are like a aging champion living on past reputation, about to get a whoopin' we just won't understand until we are looking up at the lights.
There is nothing that makes Americans more entitled to live well than other peoples. We are being outworked and outsmarted (prime examples: our dysfunctional government and our non-competitive educational system). Our worst enemy is our own sense of entitlement. America will be a formidable competitor again, but not until we learn some painful lessons.

[fxtrader07]

@kimc: Europeans work as hard as Americans, make no mistake. That Americans often have to take two or even three jobs to make ends meet has two major reasons - both of which are made in USA. First and foremost: the much hailed shift to a "service economy" leads to more and more low-paid service jobs and to a continuous loss of high-paid manufacturing jobs . It is almost unavoidable that these service jobs do earn lower wages because usually they require less skills and most important, they add less value. from a macro perspective, they are seldom exportable adding to a structural trade deficit. That Greenspan and the govt often hail this growing service sector as "modern" is nothing but blinding people and trying to make the loss of high-paid look good. But it isn't good. It's part and parcel of the dollar's and the us economy's problem.
Second reason: low savings and high consumption leading to debt burdens that have to be served and repaid by current income. In other words: all the borrowed money used to buy thinks people couldn't afford and in many cases did not need in the first place has led to a debt burden that needs to be served and for which additional wage-income is required. Third reason: Wakll street and managements robbing main street blind with obscene payments to top-managers, crooked and flawed stock-options schemes etc.
The Euro, at the end of the day is just paper-money as well, granted. But contrary to the Fed the ECB does not just talk about bringing down inflation - they walk their talk, even if it hurts economic growth.
Btw: has anyone noticed that the US government has stopped publishing M3 - the most important measure of monetary expansion? M3 has been used by the legendary German Bundesbank as the core target to fight inflation and plays a major role also for the ECB.
But alas, the Fed "targets" (even though only in its cheap talk) manipulated cooked consumer price indexes instead. The problem is: You can cover up inflation all day and succeed in people not noticing it. It's effects will be there though. It#s the same as if a doctor told a sick man that he has no fever. ultimately the guy will die when the temperature goes too high - even if he still believes that all is well.

[fxtrader07]

@bcr: if it weren't so serious and so close to reality, it could be funny.

[2old2care]

"The problem is: You can cover up inflation all day and succeed in people not noticing it."

I believe they do notice but simply feel helpless.