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Outside the Box
Oct. 29, 2009, 12:01 a.m. EDT · Recommend (2) · Post:
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Goodyear's little bomb
By Kevin Cook
CHICAGO (MarketWatch) -- As the dollar slowly grinds towards all-time lows, there's been a lot of blustery speech about its fate.
Many economic experts believe this weakness bodes very badly for the country and that government banking authorities should act quickly to prop up the world's most important currency.
Others welcome the slide as an opportunity to boost our economy with rising exports and the chance to repay our growing debts with cheaper dollars tomorrow.
The reality lies somewhere in the middle of these extremes because of much bigger dynamics driving the dollar's value. Economic ascendancy around the globe has put the dollar in a major downtrend for decades, populated by periodic swings of renewed strength. Our large trade deficits with countries like China, creating a transfer of wealth overseas, have been fueled both by American consumerism and the "dirty pool" of the Chinese currency peg.
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The U.S.'s role as a strong world leader has always made it first to borrow heavily in times of war, thus running up the debt tab and increasing the supply of dollars when the Federal Reserve must buy Treasury securities, thereby monetizing the debt.
We are just emerging from the worst financial disaster since the Great Depression -- a systemic, generational crisis that will demand many years to recover. Wall Street's irresponsible use of leverage created an enormous, complex housing and credit bubble.
Once popped, it nearly broke the economy, and was destined to take many more enterprises with it before the Treasury and the Fed stepped in with extraordinary liquidity to restore stability and confidence.
The arguments of the "weak dollar is good" camp are, well, weak and short-sighted. Those of the "strong dollar is vital" camp are far more passionate, interesting, and worthy of consideration.
One of my favorite experts on the topic is Larry Kudlow. His "King Dollar" mantra is well-intentioned and correct, to a point. But I also think it is misleading to suggest the dollar's decline is a new crisis and that the Federal Reserve should be raising interest rates solely for the aims of a new, number-one priority -- defending the dollar.
He is not alone here. David Malpass and Steve Forbes have both written good arguments recently with similar views. All three believe that we can have higher interest rates now that won't harm the economic recovery. Malpass focuses on pro-growth, pro-business tax policy that welcomes investment capital and creates jobs. Forbes wants a return to some type of gold standard, ala Bretton Woods.
Both argue the Fed isn't doing enough to restore credit markets and encourage bank lending to businesses. It's hard to argue with low taxes, banks lending, and attracting capital to our shores. But is defending the dollar with higher interest rates and Washington jawboning about a "strong dollar policy" the way to achieve these?
The strong dollar camp believes that the Obama administration is in favor of continuing the Bush-era "weak dollar policy."
We may never know what the real policy is or was. But the debate eventually begs the question, "Does a Washington dollar policy ever really matter?" The three large forces driving a weaker dollar over the past few decades were not the result of any explicit or secret policy that any economist can identify. They were the result of lots of different policy initiatives and macro economic trends that no single administration could ever control.
The job of the Federal Reserve is to target interest rates and thereby hope to target inflation and growth. To target the dollar and exchange rates is a fool's game, especially on the heels of this systemic, generational banking crisis. The Fed dropped the ball long ago in not seeing the crisis brewing and now we have to pay for it. The problem with worrying about the relative strength of the dollar now, is that you are only focusing on the symptom of a much larger illness.
The Fed's biggest concern for the past year has been a deflationary collapse, and rightly so. Many pundits were critical of the actions of Ben Bernanke and Hank Paulson in the heat of the crisis. Few would argue now that they did the wrong things.
The point is that they took action in the middle of many huge unknowns because they knew what a banking collapse looked like. Even with our economy off of life-support, who knows exactly when or how to exit from intensive care? The strong dollar camp wants the patient, still recovering from heart surgery, to compete for the gold in the 100-meter dash just to prove he's still champ.
While the global economic recovery powers on and lifts all boats, including Uncle Sam's, the Fed does face some critical timing decisions about the gradual exit from quantitative easing. But Bernanke is well-aware of the landscape and is currently erring on the side of fanning inflation's flames. Does he need our help in figuring it out? Probably not, but he also likely doesn't mind all the rhetoric and Monday-morning quarterbacking because it gives him the mood of the market. He can watch the bond vigilantes for clues, listen to the prognosticators and the real money investors, and watch how they all react to one another about market fears and confidence levels.
Bernanke knows there is no short-term fix for the dollar, just as there's none for U.S. national debt. His best course is the one he's on: focus on economic stability and liquidity and the dollar will take care of itself in a free market. The U.S. is still the home of innovation and free-flowing capital. Ideas and markets will win the day. And the key to a strong dollar is confidence in those ideas and markets.
Kevin Cook was an institutional FX trader for nine years before joining PEAK6 Investments in 2008 to help create www.ONN.tv .
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