The falling US dollar – bane or boon?

Summary:  The US dollar is falling in value vs. most other currencies and gold.  As usual, much of the material in the mainstream media about this important economic trend is misleading or wrong.  It is potentially both bane and boon.  Which depends upon us.  This is just a sketch; please see the links at the end for more information — those are among the most important on this site.

An excellent summary of the situation:  “Misguided Monetary Mentalities“, Paul Krugman, 11 October 2009 — Excerpt:

The truth is that the falling dollar is good news. For one thing, it’s mainly the result of rising confidence: the dollar rose at the height of the financial crisis as panicked investors sought safe haven in America, and it’s falling again now that the fear is subsiding. And a lower dollar is good for U.S. exporters, helping us make the transition away from huge trade deficits to a more sustainable international position.

Contents

  1. Why is the US dollar falling in value?
  2. Is a falling dollar inevitable?
  3. Is a weaker dollar bad for us?
  4. What should the US do about the dollar?
  5. Other valuable articles about the dollar
  6. For more information on the FM site, and an afterword

(1)  Why is the US dollar falling in value?

As all parents know, “why” is the most difficult of questions to answer.  We can only guess.  The stock market’s ticker tape gives the price and volume of each trade, but not the motives of the buyer and seller.

During the winter 2008-09 crash, as money fled to the safety of US treasury bonds and debtors needed dollars to repay their loans (many of which were in dollars).  So the US dollar rose in value.  Now the global appetite for risk has returned to euphoric levels, so money shifts from treasuries to risk assets (e.g., emerging market bonds and stocks, commodities). 

There might be concerns about the US government’s solvency.  But Europe has equal or greater problems (e.g., worse demographics and higher government liabilities), and the US dollar is falling vs. the Euro.

Our persistent trade deficits might play a role, but probably not a large one.  See this graph from Calculated Risk.  Our trade deficit has become much smaller (-53%) due to imports falling more than exports (-31% vs. -22% from July 2008 – August 2009).   If this decline is just a cyclical one, as in previous recessions, it will expand during the recovery — and again become a serious (or worse) problem.  Or this might be the start of the long-awaited rebalancing — US households spending less (reducing our imports), and saving more.  Much depends on the answer.

(2)  Is a falling dollar inevitable?

Not during the next few years.  A long recession would spur more buying of safe treasuries, reduce or eliminate our trade deficit, and force more scrambling for dollars to repay debts.  All of these things would strengthen the dollar.

As for the long-term — as Lawrence of Arabia says in the movie, “nothing is written.”

(3)  Is a weaker dollar bad for us?

A weaker dollar is beneficial, so long it does not fall too far, too fast.  Mae West said “Too much of a good thing is wonderful.”  She was not an economist.  Economic shocks result from not just the size of a change, but also the speed with which it occurs.

There is much angst about the falling dollar.  For example, “Deficits and the Chinese Challenge“, Zachary Karabell, op-ed in the Wall Street Journal, 12 October 2009 — “Debt can become a real liability for a superpower. Recall what happened to postwar Britain.”  That would have been good advice if acted upon in 1979.  OK advice if in 1989.  Perhaps useful advice in 1999.   But too little too late advice for 2009, after the debt has accumulated.

A weaker dollar is one of the most likely paths to putting America back on a firm foundation.  I believe this cycle will end when the US dollar has declined so that US goods and services are again competitive on world markets, our trade deficit is positive, and we can pay interest and even some principle on our foreign debts.  There are other possible outcomes.  Some better, some worse.  I believe this is best among the likely scenarios.

A weaker dollar will not by itself cure our ills.  No panacea, just another step in the right direction.  After WWI the UK pegged the pound at too high a level out of pride or an overestimation of its strength.  The consequences were ruinous.  Let’s not make the same error.

Articles advocating a weaker US Dollar:

(4)  What should the US do about the dollar?

Building a new global financial regime will be difficult.  Implementing it without massive disruption will be far more difficult.  The massive supply of dollars held overseas will flow home as the dollar weakens, esp as it loses its status as the reserve currency — the global storehouse of value.  These dollars will not come home by parcel post.  Foreigners will exchange them for goods, services, and assets from America.  This could easily collapse the global financial system, resulting in a return to capital controls.

One path to the future is a negotiated agreement with the nations who are our largest creditors, discussed in Effective treatment for this crisis will come with “The Master Settlement of 2009″ (5 October 2008).  Excerpt:

We will need to reschedule our debt and obtain new financing. Our government will have to rollover roughly $500 billion/year, plus the trillion or so in additional borrowing (as tax revenue declines and expenses skyrocket) for the next two years (perhaps longer). Plus measures will be needed to stabilize the value of the US dollar, allowing an orderly decline.

These extraordinary negotiations will be inherently destabilizing, putting in question both the US Dollar’s role as reserve currency and America’s role as global hegemon. This is the price paid by our past folly, getting us into this crisis.

Obtaining and executing this agreement must be concluded successfully. It is a jump across a chasm to a new world. But the chasm lies ahead of us, and must be crossed eventually. Let’s strike a deal while we can negotiate from a position of strength. Rather than waiting until we are desperate.

The cost will be high. An agreement will be in the best interest of all, but that does not mean that we will not have to make concessions. To give just one example, China might ask that the US break our relations (esp military) with Taiwan.

Goals of such a conference:

  • devise a new global financial regime, replacing today’s Bretton Woods II “system”
  • including a replacement for the US dollar as the reserve currency, a role we can afford only by abusing its privileges, and
  • mechanisms to manage the complex and difficult transition.

We must start this process now.  Something this large will move slowly.  Time is our enemy, as our relative strength probably will deteriorate over time.

(5)  Other valuable articles about the dollar

(6a)  For more information from the FM site

To read other articles about these things, see the following:

Reference pages about other topics appear on the right side menu bar, including About the FM website page.

Other posts about the US Dollar:

  1. A brief note on the US Dollar. Is this like August 1914?, 8 November 2007 — How the current situation is as unstable financially as was Europe geopolitically in early 1914.
  2. Economic Warfare, 10 November 2007
  3. The post-WWII geopolitical regime is dying. Chapter One , 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
  4. “The changing balance of global financial power”, by Brad Setser, 22 August 2008
  5. Is America’s decline inevitable? No., 21 January 2008
  6. Geopolitical implications of the current economic downturn, 24 January 2008 – How will this recession end?  With re-balancing of the global economy — and a decline of the US dollar so that the US goods and services are again competitive.  No more trade deficit, and we can pay our debts.
  7. Our metastable Empire, built on a foundation of clay, 3 March 2008
  8. Words to fear in the 21st century: Lǎo hǔ, lǎo hǔ, Lǎo hǔ, 14 July 2008, 14 July 2008
  9. Effective treatment for this crisis will come with “The Master Settlement of 2009″, 5 October 2008
  10. Causes of the financial crisis (no, its not the usual list), 29 October 2008
  11. A look at out future, 2009 – 2010 … and beyond, 9 November 2008
  12. Fetters of the mind blind us so that we cannot see a solution to this crisis, 1 April 2009
  13. Today’s hot rumor: Fisk’s story about a conspiracy to wreck the US dollar, 6 October 2009

(6b) Afterword

Please share your comments by posting below.  Per the FM site’s Comment Policy, please make them brief (250 word max), civil and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

9 thoughts on “The falling US dollar – bane or boon?

  1. The US economy is a lot like a drug addict. Is it good that he’s being weaned off the infinite credit needle and can get his life together ? or is it bad that it’s going to mean a lot of cold sweats, sleepless nights and constant nausea over a few decades ?

    He knows he has to quit one day as it is killing him, but maybe just one more hit, one more bubble in the economic cycle before facing that day.

    Or maybe he’ll try the methadone program like Japan. Not so painful but not really clean either as he drags on half addicted and with even fewer incentive to really kick it.

    I really wonder if Americans and the leadership have decided that today is that day to go cold turkey or that the pushers have decided he’s deadbeat enough that they will cut off supply.

    One thing is for certain being clean is not going to be anywhere as fun as it was when you were high. There are going to be a lot ex-junkies lamenting the good old days.

  2. I have nothing intelligent to say here except, thanks for posting all these links. This topic (trade deficits & surpluses, currencies) is beginning to interest me, and I want to learn more about it.

  3. A weaker dollar is yet another way for the fed to steal wealth from the people and beggar us. As the dollar falls it will buy less goods and services on the global market. For example, that European vacation you were saving up for? – sorry, too expensive. But the European tourists will be able to see America on the cheap.

    The other ways the fed is stealing from the people is by inflating the currency. The government abets and even encourages this by borrowing ever-more outrageous sums and throwing them at campaign donors (sorry, I mean stimulus funds recipients). Then there’s nationalization, starting with the banks and GM

    As FM noted previously, inflation and nationalization are ways of shedding our incredible debt. Then there is repudiation. I guess when we pay off our creditors in inflated and weakened, cheapened dollars, that’s repudiating some of it, eh?

    Audit the Fed!
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    Fabius Maximus replies: The Fed is not stealing from the people by inflating the currency. It’s an persistent problem in our system — perhaps in all monetary systems — that inflation feels good while deflation hurts. Our 19th century political system was run by plutocrats (creditors) for their benefit. A stable currency benefited them. With greater public participation the resulting waves of debt deflation became politically impossible, so persistent and growing inflation became public policy in the literal sense (policy wanted by the public). Plutocrats had to find other ways to yse the government for their benefit, such as its regulatory powers).

    The current adjustment is necessary to end the US dollar’s overvaluation. As the UK learned to its sorrow after WWI, overvaluation is lethal in an open trade system. Imports increase faster than exports, captial and jobs flow overseas. Much of this results from the US dollar’s role as the reserve currency, a poisoned chalice.

  4. From the Krugman column:

    a key cause of the Depression was … the “gold-standard mentality.” By this he means not just belief in the sacred importance of maintaining the gold value of one’s currency, but a set of associated attitudes: obsessive fear of inflation even in the face of deflation; opposition to easy credit, even when the economy desperately needs it, on the grounds that it would be somehow corrupting; assertions that even if the government can create jobs it shouldn’t, because this would only be an “artificial” recovery.

    I think if you want to see the “gold standard mentality” illustrated, you should go to the Lew Rockwell website. The main page currently has an ad at the upper right hand corner that shows a burning dollar bill. On the bottom of the page, there’s a similar graphic of a flimsy dollar on the left, and solid, shiny gold and silver coins on the right, and it has a caption, “When Government Currencies Fail… GOLD & SILVER PREVAIL”.

    I think Rockwell is making a statement about the untrustworthiness of government-backed currencies versus the solid-ness and security of traditional currencies like gold and silver. That is where Rockwell’s worldview is weird to me. As far as I am concerned, there is no true security in trade, rather trade is a generally beneficial activity which always contains an element of risk. In my mind there is no essential worth/wealth in money, essential wealth is in what people need or desire.
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    Fabius Maximus replies: Ecnoomics, like most fields in which the geneal public participates, is to an extent dominated by the search for easy solutions. Gold coins have been debased throughout history (e.g., Rome), and gold-based monetary systems have booms and busts just like ours (e.g., Britain’s panic of 1947, following collapse of the railroad boom). For more about how gold-based currencies made the Great Depression worse, see Fetters of the mind blind us so that we cannot see a solution to this crisis.

  5. After WWII, we were the irreplaceable life of the party. We brought the booze (Capital), and the hot babes (Technologies). Today, we’re more like the drunken jerk who drinks what others bring, spills half, and claims he knows some babes, but can’t deliver. The party goes on, but it’s getting lamer and lamer. You can just hear the world thinking, “If only someone like the old U.S. would show up, we could ditch this guy”.

  6. It is a fine balance that have to achieve, the benefits of currency devaluation and thus better positioning of our exports for sale in the economy and the increased cost of capital (required to expand the economy and pay our debts). Also, (question for FM), what would be the effect of valuing the barrel of oil i with a basket of currencies.
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    Fabius Maximus replies: The demonination in which goods are priced has near-zero effect on currency levels (i.e., prices), in an economic sense. But dollar’s role as the reserve currency has no objective balance, it is a social or psychological phenomenon — a consensus agreement. Major global players — like OPEC — “defecting” from the consensus would shake the structure, weaking the dollar’s status. That might have far-reaching effects.

    This risk has been known since the 1970’s, as seen in these memos (source unknown) to President Carter from Henry D. Owen (White House staff, see his Wikipedia entry).

  7. Re #3 — Oh, yes, inflation was great for my Grandfather, who worked all his life and finally found in his 40s a career that suited him, saved and successfully retired, only to see his savings severely diminished by the double-digit inflation of the late 70s, and then finally liquidated by inflated health care costs since his insurance benefits, previously sufficient, could not keep up with it. Oh yes, inflation feels really good.
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    Fabius Maximus replies: You substitute “inflation is good” for what I actually said — “inflation feels good.” Was this deliberate misrepresentation, or just sloppy? They are obviously different statements. Many things feel good but are in fact bad for one’s health, prosperity, or happiness. With regard to inflation, that’s why they call it the money illusion.

    This refers to society as a unitary entity. More precisely, over the short-term inflation creates winners (e.g., those with fixed-rate loans) and losers (e.g., their creditors).

  8. FM, my apologies for misunderstanding you. I seem to have taken your comment as “turnabout (to the Plutocrats) is fair play” as an endorsement of inflation to help the little guy. Re-reading it I see you said nothing of the sort.
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    Fabius Maximus replies: These discussions are out on the edge of the known, the knowable. Misunderstandings are inevitable. You are among the few, however, that acknowledge them.

  9. While the weakening US dollar is helping US manufacturing, I bellieve ultimately it will cause significant inflation due to our dependence on foreign goods.
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    FM reply: That’s a possible danger. However the US imports a small fraction of goods we consume, unlike the EU or Japan for example. So the dollar would have to collapse. Also, US imports will decline as the dollar falls — further minimizing the danger. I don’t have time to show cites on this, but you can easily find them via GOOGLE.

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