Defenders of the current economic policy of the Bush administration are now surfacing. Apparently, enough concern has been raised to cause a need to defend the status quo. There are two arguments for not changing policy at the present time. First, there is the argument that the value of the dollar has bottomed out along with signs that there could be an upturn. The second argument is that the United States is still too important in the world for the dollar to have to play by the same rules as all other nations. We will present these two defenses in turn.
The argument for the strengthening of the dollar is the growing attention that has been given to the weakness in the dollar over the past six years or so. Some analysts have discerned such concern being expressed in recent speeches of Ben Bernanke. The feeling is that the ‘balance is shifting’ from the emphasis on financial market crisis to greater emphasis being placed on what has been happening in the foreign exchange markets. Just the added attention on the foreign exchange market has given people hope.
Another factor in this glimpse of optimism is what is happening in Europe. Last Thursday, the Bank of England and the European Central Bank left their interest rates where they were. The concern expressed by these leaders is with inflation and they, the leaders of these banks, stated that ‘their mandate’ is to maintain price stability within their domains. Given the recent rise in the price of oil and other commodities, greater concern is being expressed that inflation could get out-of-hand and the need right now is to keep a lid on price pressures. The underlying theme is that these central banks will do what they have to do in order to fight these inflationary trends, but this could cause an economic slowdown in Europe, taking the pressure off the central banks to further raise rates or even to let them fall.
This, of course, is taken as a hopeful sign by those arguing for the stabilizing of the dollar because it would help to change relative interest rates between Europe and the United States, something that has contributed to the weakness in the dollar. Higher short term interest rates in Europe have drawn investors away from the U. S. during the recent period when the Federal Reserve has been dramatically lowering their target for the Fed Funds rate. In addition, the Federal Reserve Open Market Committee, after their latest meeting, announced that their latest reduction in the Fed Funds target may be the last one…at least for a while. [see my May 1, 2008 post, “Where is the Leadership?”] This has been taken as a hopeful sign that the yield differential between Europe and the United States will become more favorable to the United States.
Finally, although not noticed at the time, the finance ministers of the G-7 nations called attention to the problems, including that of the dollar, in international currency markets and stated that they could not ignore these going forward. [see my April 13, 2008 post, “Finance Ministers Concerned with the U. S. Dollar.”] Analysts have now gone back to this and claimed this to be another piece of evidence that the concern over the decline in the value of the dollar has risen on the agenda of world bankers. This, they argue, is just another sign that maybe the decline in the value of the dollar is over and that some rise might be expected in the future.
In terms of the second argument, analysts are arguing that, yes, the dollar has declined in value but we needn’t be overly concerned with the decline because the United States is too important in the world for nations and other investors to ‘dump’ the dollar. The United States, they argue is still a great place for people to invest and, in this respect, will continue to be a haven to world investors in this age of uncertainty and changing technologies. Also, just the fact that the United States possesses the major military machine in the world gives it the ability to continue to pay off its debts. Even though China and India are becoming major economic powers in the world, the United States and the dollar will maintain its position and prevail over other currencies [including the Euro] in the foreseeable future.
Essentially, the argument here is that it is in the best interest of other nations [China and India included] to see that the role of the dollar is maintained. And, as long as the United States and the U. S. dollar serve as the lubricant for world trade, there is plenty of incentive to see that the current system continues to work. Others, like the G-7, will do what they have to do to keep things as they are.
There are several responses I would like to make to these arguments:
People seem to forget that the United States had a budget surplus as recently as 2001. Why do we think that fiscal discipline is not a viable alternative?
Most of the first argument is based on wishful thinking. There has been talk before by Treasury Secretaries and Federal Reserve Chairman about a strong dollar, but nothing ever came of this. The situation in England and Europe may require higher interest rates before lower rates are considered, and the Federal Reserve has only suggested a pause in the lowering of interest rates here. And, what is the G-7 going to do for the dollar if United States policymakers do not show a real commitment on their part.
No country in the world has considered itself ‘too’ important to ignore the rules that other nations play by. Although a ‘go-it-alone’ attitude has prevailed in Washington, D. C. over the past 7 ½ years, it has already come back to haunt us in many different areas. In the early 1990s, Robert Rubin convinced Bill Clinton that the United States could not afford to be out-of-step with the rest of the world and needed to bring the Federal budget under control. Clinton listened to him, and by the time he left office the United States was, fiscally, in very god shape and the dollar was doing quite well. This strength was recognized in world financial markets. We are a part of the world and can play by the rules that everyone else plays by. We only hurt and isolate ourselves if we consider that we are above the rules.
Will we continue on the path suggested by those arguing for little or no change in United States economic policy? Yes, for at least the short run.
We have a lame duck administration. There is nothing dramatic that will be done before a new administration comes into office. All that we can expect is efforts to protect the legacy of the current administration.
There is a question as to whether a new administration will accept the economic and financial realities that exist or will they try and enact legislation reflecting the promises they are making to get elected. Before confidence can be restored in the U. S. government, there must be real commitment on the part of a new administration that market participants in international markets can trust.
There is still the lingering financial uncertainty. How fragile is the financial system at this time and how will continuing economic weakness contribute to any future dislocations? Banks and others seem to be working out their problems in an orderly fashion, but will this continue?
How will United States citizens respond to more and more foreign ownership of their physical assets? Sovereign wealth funds and other investors will keep investing their dollars in American companies. The use of these dollars in this way has recently increased every year and there is no reason that this will stop. How will the electorate respond in the future to seeing U.S. firms coming more and more under the control of foreign nations and other foreign interests? Globalization is coming home to America.
Will the United States enact an effective energy policy? This, sadly, is still in the distant future.
The future: The dollar may fluctuate around the current range for a while, but it seems to me that unless things change, the longer-term picture contains more weakness in the dollar's value.