More Than Ever, We Need Currency Leadership

"I have lost money in sterling. I have lost money in dollars. I have never lost money by holding gold." - A Scandinavian bank president, Economics and the Public Welfare, p. 254

Now that the dollar has risen from modern lows against most major foreign currencies, many commentators have begun to suggest it is fulfilling its historic role as the world’s reserve currency. Due to greatly heightened uncertainties in the financial world, the dollar is said to be reasserting its strength.

It would be more realistic to say that the dollar’s weakness is presently being masked by what H.C. Wainwright’s David Ranson and Penny Russell once referred to as “another classic run on paper currencies.” The dollar is only strong right now insofar as other currencies are very weak.

In an article from February of 2008, it was questioned whether commodity currencies are actually bolstered when commodities themselves show nominal strength. What was found is that with periods of commodity strength merely a function of dollar weakness, commodity currencies have historically weakened in real terms, while showing relative strength against a greatly debased dollar.

Similarly, it was found that in periods of dollar strength like 1997-2001, commodity currencies didn’t so much move into inflationary territory as become less strong than the dollar. In each instance gold was used as the objective benchmark.

So when gold is factored in today, another scenario reveals itself; albeit similar to those previously mentioned. Dollar strength against other paper currencies is simply masking weakness among them all. Indeed, in the six months from the end of August to the end of February, the dollar has gained against the euro, sterling and Canadian dollar, but when gold is factored in, we find that while gold has risen 14 percent in dollars, it has risen 32 percent in euros, 37 percent in Canadian dollars, and 46 percent measured in pounds.

Bloomberg financial writer Michael Sesit recently damned the dollar with faint praise by suggesting that the greenback is the “Looker” in an “Ugly-Currency Parade.” His assessment was correct. The dollar is wilting and, as has historically been the case, relative currency movements have whitewashed over this reality.

Russian premier Vladimir Putin has lately suggested that the world’s reliance on the dollar is “dangerous”, and he called for an “irreversible switchover” to a system of multiple reserve currencies. Putin doubtless has a point given the dollar’s mismanagement, but the sad fact is that the dollar remains the only currency possessing worldwide stature.

At present the dollar factors into 90 percent of all trades in what is a $3.2 trillion currency market. And nearly two-thirds of the world’s central bank reserves are held in dollars. Furthermore, the dollar remains the go-between currency for the great bulk of cross-border transactions between countries with thinly traded currencies.

So while it might comfort us to think about another country taking on the currency leadership that we’ve abdicated, none can dispute the dollar’s widespread use. Most troubling is what this potentially tells us about the future.

The dollar price of gold has shown its most impressive strength going back to the third week of January, when the confirmation hearings for then Treasury Secretary-designate Tim Geithner were held. After mouthing the familiar line that a “strong dollar is in the national interest,” Geithner later added that “President Obama—backed by the conclusions of a broad range of economists—believes that China is manipulating its currency.”

What’s interesting here is that while all three of George W. Bush’s Treasury secretaries needlessly hectored China about the yuan to the dollar’s detriment, all of them stopped short of formally accusing China of “currency manipulation.” This is important because while sentient minds know all currencies are manipulated, this public accusation communicated to the markets a clear statement that the new administration (like the old one) would prefer a weaker dollar.

That is the case because probably more than any cabinet position, newly nominated Treasury secretaries are coached with great care when it comes to what they’ll say publicly. With the U.S. Treasury the mouthpiece for what is the most important currency in the world, it’s easy to move world markets with ill-expressed or ill-timed statements. Notably, the dollar plummeted one day in 2001 when then Treasury Secretary Paul O’Neill simply suggested that a “strong dollar” meant very little in policy terms.

For the same reason, it’s no surprise that gold jumped $70/ounce within two days of Geithner’s comments about the yuan. Put simply, Geithner would never have uttered such clear words about the yuan’s alleged “manipulation” unless they were meant to announce the Obama administration’s position on the matter. Just as the Bush administration made a weak dollar its implicit policy to the detriment of the president’s popularity, it seems the Obama administration intends to go down the same mistaken path.

Especially as we’re in the midst of a crisis, it would be hard to imagine a worse stance for the Obama administration to take. More than ever the world needs currency leadership, yet Geithner seems eager to abdicate at a time of market peril. Looked at from an historical perspective, it is hoped that Geithner gathers his thoughts and changes his tune.

Back in 1931, with the world economy falling into what is now known as the Great Depression, Britain finally departed from the gold standard. This destabilizing decision, made when the pound was still the world’s reserve currency, had a worldwide impact. As Chase economist Benjamin Anderson observed at the time, after England’s departure from gold, “Fear gripped the world regarding the value of every currency.”

And in much the same way, uncertainty about the dollar at the moment has led to a run on non-dollar currencies worldwide. The price of gold has been the big winner amid broad currency declines, and as its rise foretells a further flight to real goods, this bodes ill for economic growth here and elsewhere. That is so because if the “credit crunch” is as dire as is presumed, capital will become even more scarce as money flows into tangible items, rather than the entrepreneurial economy.

Looking ahead, we can only hope that Barack Obama’s economic brain trust, one that includes former Fed Chairman Paul Volcker, will set the Obama Treasury on a surer path. As history has regularly made clear, the words of the Treasury secretary matter a great deal. It’s essential that Secretary Geithner reverse course and talk up the dollar in such a way that confidence grows among investors with regard to all currencies.

If not, and the dollar’s continued decline is ignored due to its illusory strength versus other paper currencies, it’s fair to say that world inflation has the potential to get much worse. To quote Anderson yet again, when currency values are uncertain, there “is no worse fear than this, from the standpoint of economic functioning.”

Right now currencies aren’t functioning properly, and as they are the lubricant for all economic activity, it’s essential that a renewed trust is developed in each. More than anyone, this is a job for Treasury Secretary Geithner. What’s still unknown is if he’s equal to the task.