Please Mr. Geithner, Don't Pass the Buck on the Dollar
It seems nobody in this country wants to take responsibility for the secular decline in the value of the U.S. dollar. When Fed Chairman Ben Bernanke is asked about the currency's decline, he refers the query to the Treasury Department. When the president is asked about the dollar, he often gives the tired old platitude that the U.S. has a strong dollar policy, but his vacuous words seem more like perfunctory utterances than a bona fide dollar-boosting strategy.
Recently, in an interview with CNBC's Maria Bartiromo, Treasury Secretary Timothy Geithner had some startling comments about the world's reserve currency. When asked about its chronic weakness, and what specifically he was doing to safeguard the dollar, Mr. Geithner said, "...if you look generally, you know, I don't talk about developments in the exchange markets." He continued, "If you look at what's happened over the last year, you've seen really a lot of confidence in the U.S. economy. When the crisis was at its peak ... you saw the dollar rise when people were most concerned about the future of the world."
Now that the U.S. dollar is once again caught up in a vicious secular bear market, losing nearly 16% of its value since March alone, the Treasury Secretary is once again opting to plead the fifth. Even worse, he claims that last year was a good example of global confidence in the currency, even though it was down over 8% for the year.
Can he really be counting on another collapse in the global economy to pull the dollar out of its downtrend? To use the previous year as an example of confidence and strength in the country, or the currency, is spurious in nature. It illustrates that our Treasury Secretary either tacitly condones a falling dollar or has no idea what causes a currency to be weak.
The progenitor of our weak dollar is the skyrocketing monetary base, which reached an all-time record high of $1.86 trillion last week. The Fed's monetization of banks' assets has caused real interest rates to become negative and increased interest rate differentials with the currencies of more sober central bankers, like Glenn Stevens from Australia. In addition, our profligate spending habits have caused record budget deficits and even caused our healing trade deficit to reverse course and head higher. Unfortunately, all those trends seem firmly intact and are actually growing worse.
There is, however, no shortage of gurus who will tell you that a weakening dollar is great for America. They'll tell you that it boosts exports and the earnings of domestic companies that conduct business on foreign soil. Their logic is flawed. First off, a falling dollar has actually pushed our trade deficit higher--not lower. If a weak dollar bolsters our economy and our manufacturing base, then why has the trade deficit surged since 2001, even as the dollar lost nearly 40% of its value based on a basket of the six currencies of our largest trading partners?
A specific example is illuminating in disproving the theory that you can balance a trade deficit by crumbling your currency. China announced in 2005 plans to increase the value of its currency and abandon its decade-old peg to the U.S. dollar in favor of a link to a basket of world currencies. Since then the Yuan has rallied from 0.1208 to 0.1465 to the dollar.
This rise in the Yuan, and fall in the dollar, has had a negligible effect on U.S. exports. For all of 2005 the U.S. deficit with China was $201 billion. In 2008, three years into the dollar's devaluation, it soared to $266 billion. Why didn't the falling dollar help boost exports? Because the price of goods produced in the U.S. went up.
That means foreign importers were immune from our made-in-America inflation, not that they could afford to buy more of our goods. There just isn't any amount of dollars the Fed can create that can serve as a substitute for manufacturing and producing more of the things that foreign countries want to purchase.
Multinational corporations are also better protected from the falling dollar than companies that strictly sell their goods inside the U.S. The foreign currency MNCs earn translates to more dollars once the cash is repatriated. But the purchasing power of those dollars becomes attenuated.
So again, there just isn't as much real return produced from owning multinationals as many investors espouse. And it certainly isn't worth the price we pay for rampant inflation at home. To claim that a falling dollar is great because it boosts the earnings of MNCs is tantamount to saying a rise in the number of car crashes would be wonderful for Americans because they can invest in air bag makers.
It would be better if the Chinese allowed their currency to strengthen rather than to pursue a homegrown U.S. policy of dollar weakness. There is a big difference if the former occurs. If the dollar loses its value because we pursue inflationary domestic policies, it means all Americans will suffer from the loss of their currency's purchasing power right here in the U.S.A. If, however, the Chinese sell dollars accumulated from their trade surplus, the Yuan will rise without the destructive inflation being generated here at home--provided that the U.S. repents from its profligate spending habits.
That doesn't mean the Chinese will necessarily buy more U.S. goods, but they might. The problem is that if the Chinese no longer need to park their savings in U.S. debt, Treasury prices will fall and yields soar. The dollar will suffer greatly in the short term as measured against the Chinese currency. But again, that is inevitable and much better in the long run for the U.S.
Finally, I'm tired of hearing there's just no substitute for the U.S. dollar, as if saying it enough will make it so. Or that the Chinese will be compelled to ruin their environment, work like dogs and squander their savings forever and remain powerless to do anything about it.
Does it make sense for them to keep buying Treasuries if their prices fall and the currency they are denominated in continues to crumble? Wouldn't it make sense to diversify their holdings into other currencies and commodities? In fact, that is exactly what they are doing. They have moved their holdings of Treasuries to the short end of the curve for an easy exit and are buying more Euros, gold and commodities.
In 2008 the 16 countries that use the Euro currency have an economy that is more than 76% the size of that in the U.S., according to Wikipedia. So is it incredulous to believe that the Chinese could, and should, diversify out of their current $800 billion-plus in Treasury holdings, or from their $1.3 trillion in U.S. reserves, or from having 65% of their reserves in the dollar?
It looks like the plan the U.S. wants to pursue is to continue to discourage foreign investment, punch our bankers (the Chinese) in the nose and punish those who are savers by crumbling our currency. But please, Mr. Geithner, let's not pretend it benefits anyone except those who are heavily in debt--chief among them our government. Unfortunately, even the U.S. government will be surprised to learn that the price of devaluing that debt through the process of inflation is the eventual destruction of our own economy.