Have you seen what’s happened to the dollar of late? It’s hitting all-time lows on a trade-weighted index. Must be Ben Bernanke’s fault: him and his QE2. Except it really isn’t. And Mark Dow, today, does a great job of explaining not only why the monetary-policy theory is wrong, but also what the real reasons for dollar weakness are.
For one thing, the dollar is basically just back to where it was before the crisis: the recent weakness is to a large degree an unwinding of the flight-to-quality trade we saw when everybody was worried about the world coming to an end. The real decline in the dollar took place between 2002 and 2008, when it went from 110 to 70 on the trade-weighted index. And there wasn’t any QE2 back then.
And if lax monetary policy were the main cause here you’d think that the dollar would be appreciating at the very least against the yen, given how the Bank of Japan is pumping hundreds of billions of dollars into its economy. But in fact the yen is strengthening against the dollar.
Meanwhile, says Dow, there are two “tectonic forces” driving the dollar lower. On the one hand there’s the simple fact that the world had 50 years of wealth creation in the wake of World War II, and much if not most of that saved wealth found itself in dollars. Over the past 10 years or so, however, the need and desire for global savers to hold their wealth in dollars has been evaporating, and citizens around the world — not to mention their central banks — have been much more comfortable holding assets in their own domestic currencies, as well as the euro. That trend is likely to continue:
This stock adjustment will continue until a new equilibrium is found. The dollar is some 63% of global reserves, but the U.S. is now only 20% of global output. I am not suggesting that equilibrium is at 20%, but 40% doesn't seem like an intellectual stretch.
On top of that is the fact that US workers are massively overpaid compared to their equally-productive and well-educated counterparts in countries all over the world. There are a number of ways that the discrepancy can be narrowed: wages in countries from Slovenia to South Africa could go up; US wages can go down; or the dollar can simply depreciate. Which is a lot easier than nominal or even real wage cuts.
None of this is under the control of the Treasury Secretary or anybody else, no matter how often he repeats that a strong dollar is in the national interest. And the clear implication is that the dollar is going to continue to weaken for the foreseeable future. That’s not going to do much if any harm to the US economy. But it does add a certain amount of fuel to commodity-bubble fires.
Krugman touched on this previously. As anyone that has traveled outside this country knows, the dollar fell during the Bush years quite significantly. It hasn’t been a bargain to go to Canada for nearly a decade.
I dont know. A huge CA deficit, meager private savings, and a huge gov deficit sounds like a reason to avoid the dollar. We don’t have a credible path forward
The Brazilian Finance Minister disagrees.
http://en.mercopress.com/2011/05/03/us-p rinting-press-is-flooding-the-world-with -dollars-claims-mantega
All of you are right! 1. The dollar has been stronger than it should have been because it is THE reserve currency. 2. The world economy has mostly recovered from WWII and the idiocies of Russian Communism, as a result the US Economy is NOT dominant, and we get less of a premium for the dollar, since other currencies can substitute. 3. The inactivity of Bush/Carter/Bush/Obama toward energy policy is swamping the world with dollars, making dollars worth less. 4. The political calculus of Democrats, Republicans towards balancing the budget creates the currency needed to run the government and provide the benefits people do not want to be taxed to provide. (Inflation is just a tax, like any other, caused by the laxity associated with a Fiat Currency.) Inflation is a regressive tax, hurting those least able to adjust their income, the old, the poor, the less educated, the disenfranchised. It is a tax voted for by the Poor, who think they are getting something for nothing from the Democrats, and by the Rich, who easily benefit, using financial tools. The Middle Class, decreasing in numbers, cannot easily defeat the politicians, from the Left and Right, who promote these policies.
The result is an increasing divergence in wealth between the poorest and the richest, while the center is torn apart. The long term result will be disaster for all, unless action is taken.
The last point doesn’t work. If the dollar is falling, but US inflation is lower than (say) Chinese inflation, then its only a notional convergence of wages, not a real convergence.
The dollar is falling because taxes are too low.
This has meant increasing government Budget Deficits, and extra money for consumption of increasingly foreign goods which increases the Trade Deficit.
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