The Dollar's Fall: Deal With It

The dramatic recent fall of the value of the U.S. dollar grabs headlines every day, even as the U.S. stock market surges to new recovery highs. People are talking about a "dollar crisis," and it's not just the usual rant-and-rave topic on CNBC. There are serious hints from government authorities around the globe that maybe we should think about dethroning the U.S. dollar as the "reserve currency" held by the world's central banks, and maybe global markets like oil should stop being priced in dollars.

There are some currencies that are as weak as the dollar now, such as the British pound. And there are some that are weaker, such as the Malaysian ringgit. But against a basket of the world's major currencies, the dollar has fallen 15% in just seven months. That's a big move in any market, but for a currency it's practically a crash. If it falls another 6%, it will make historic all-time lows.

You'd think with all this going on, officials at the U.S. Treasury would be running around in a flat-out panic. But they're not. This week I met in Washington with a group of the most senior men at Treasury (please forgive me if I don't name names), and I was surprised to learn that they are not terribly worried.

Here's why.

First, they think that the 15% decline in the dollar is actually a sign of economic strength. They point out, quite correctly, that the value of the dollar surged during the recent credit crisis, as investors around the world suddenly craved the safety of dollar liquidity. At the most, the dollar soared 24%, reaching its top on exactly the same day last March that the stock market made its bottom.

That puts the 15% drop in context. And it also helps to explain why foreign governments are suddenly so interested in dropping their dependency on the U.S. dollar. It's not so much because the dollar is weak. It's because the credit crisis revealed that the dollar is intolerably unique.

By that I mean that when the world economy came off the rails last year, everyone in the world needed dollars — not pounds, not euros, not yen, not yuan, not ringgits — because the U.S. dollar is the de facto unit of global trading and investment. Why should the economies of the world be so dependent on a single nation's currency?

So while it may feel like a blow to our national prestige to have the dollar be just another currency, that's probably inevitable — and probably all for the best. It's in America's interest to live in a world more resilient to credit shocks than the dollar-dominated world turned out to be.

Another reason the Treasury isn't in a twist about the dollar is that they recognize there is nothing they can do about it. Oh, sure, Secretary Tim Geithner could give a speech or two about his "strong dollar policy," for all the good it would do, which would be precisely none. By the way, when I visited Treasury, nobody even mentioned the expression "strong dollar."

The reality is -- and the Treasury knows this -- that it's the Federal Reserve that ultimately determines the value of the dollar. That's because the Fed's monetary policies are what determines inflation —and obviously, a currency undergoing inflation is worth less than a currency not undergoing inflation. So if you want a strong dollar, write a letter to Fed Chairman Ben Bernanke, not Geithner.

There is one thing that the Treasury could do to support the dollar. But what I heard this week in Washington convinces me that they aren't going to do it. They are going to do the exact opposite.

What I mean is that the Treasury is going to every diplomatic means at its disposal to get countries like China to make their currencies more valuable vs. the dollar. Rightly or wrongly, the Obama administration's Treasury believes — exactly as the Bush administration's Treasury did — that China, and other giant exporting nations manipulate their currencies, to keep them cheap so that their exports will be cheap on world markets.

U.S. consumers benefit from cheap foreign goods at Wal-Mart. But U.S. manufacturers can't compete with the foreign manufacturers that make those cheap goods. And U.S. manufacturers make bigger political contributions than U.S. consumers. So the Treasury, naturally, is committed to getting governments like China to effectively raise their prices by appreciating their currencies.

Now when Treasury officials talk about this, they don't admit that they're trying to get China to stop manipulating its currency lower and start manipulating it higher. Instead, they say they want China to stop manipulating it altogether, on the theory that when the yuan floats freely on world markets, it will inevitably move higher.

Maybe it will and maybe it won't. But there's one inescapable truth here — at least when it comes to the Chinese yuan and several other exporting nations' currencies: They want the value of the dollar to be lower. There's no way around it. If you want the yuan to be higher relative to the dollar, then you necessarily want the dollar to be lower relative to the yuan.

So let's put it all together. I'm not worried that there's going to be some kind of "dollar crisis." But all the facts do point to a lower dollar.

First, if the Fed ultimately controls the dollar's value, then the dollar is going lower — with interest rates at zero for as far as the eye can see, inflation is inevitable.

Second, if the dollar gets stronger during times of credit stress, the dollar is going lower — because global credit markets are recovering, and getting stronger every day.

Third, the Treasury will be actively pursuing diplomacy to get China and other exporters to strengthen their currencies, so the dollar is going lower.

So as an investor, what do you do?

Just what I've been saying to do for many months — buy gold. I think of gold as an alternative currency. It's the alternative to all currencies, not just the dollar.

If the United States isn't the only country that's going to experience inflation coming out of the credit crisis, then gold would be the perfect universal hedge.

That's why while other markets like stocks are making impressive recoveries — but are still well off their old highs — gold has moved to a new all-time high.

Donald Luskin is chief investment officer of Trend Macrolytics, an economics consulting firm serving institutional investors. You may contact him at don@trendmacro.com.

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RT @nlitenmebabe $USD has fallen 15% in just 7 months If it falls another 6%, it will make historic all-time lows. http://bit.ly/xvrZ6

$USD has fallen 15% in just 7 months If it falls another 6%, it will make historic all-time lows. http://bit.ly/xvrZ6