The Price of the U.S. Dollar Is Ultimately Our Problem

The Price of the U.S. Dollar Is Ultimately Our Problem
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A sign of weakness, strength, or something else altogether? Back in ’85 when government officials got together at the Plaza Hotel in New York and told the world they controlled currency exchange rates, foreigners held just 14% of US government debt. Things have certainly changed.

So much, national security is supposedly at stake. It has now become a regular feature of daily financial life to hear voiced great concerns about foreigners dumping UST’s. Usually charged by the opposition party, the government is going to push things too far and alienate all those overseas buyers who we really, really need if the United States is to stay in business.

Here's an example written in the Economist:

“The new, politicised weak-dollar policy is scarcely likely to make them want to add to this [huge holdings of US debt], and may even encourage them to sell some of those that they already hold. A big sell-off would mean plunging Treasury prices and thus their yields would rebound and more from their recent falls, leaving America with higher financing costs, the last thing its fragile economy needs.”

It was Robert Rubin who first championed a “strong dollar” policy back in 1995. Why ’95? Alan Greenspan.

The “maestro” in the years before he acquired that pimped-up moniker had crashed the bond market. In 1994, it was rate hikes and then the BOND ROUT!!! Bill Clinton’s government was nonplussed, to say the least. Angry, too.

Higher rates, according to Treasury Secretary Rubin, would mean a weak dollar and weak economy. Thus was born the legend of the strong dollar and the government’s stated aim to make it so.

“A strong currency means that American consumers and businesses can buy imported goods and services more cheaply and that inflation and interest rates will be lower.”

A perfect panacea of economic goodness – so long as the government toes the line. But what line?

The article published in the Economist I quoted above was not written recently, though it does sound like it must’ve been. It was penned instead in September 2003 to slam the Bush Administration for presumably abandoning the strong dollar policy Rubin espoused.

The weak situation and jobless recovery from the mild 2001 dot-com recession was perplexing, leaving both the “maestro” and the President, Bush this time, to grope around for answers. Greenspan kept on lowering the fed funds target even as the bond market beat him to it.

John Snow, who was Treasury Secretary at the time of the Economist’s essay, said his version of the strong dollar policy meant something a little different.

“You want the currency to be a good store of value. You want it to be something people are willing to hold.”

Translation: a currency foreigners won’t just dump.

Rubin’s was a mercantilist view that said a strong dollar meant increasing globalization, a great many benefits therefore accruing to American domestic interests, among them interest rates. Snow’s was a more purely financial view that sprung from the demand perspective before globalization. Therefore, even lower interest rates. Or something.

The funny thing was, even as Secretary Snow was slightly redefining the policy in contemporary terms, the dollar’s exchange value was falling. According to his as well as Rubin’s terms, that should’ve meant higher interest rates and foreigners dumping dollars and government bonds as theEconomist article warned.

It ended up being neither.

The more the dollar fell in the middle 2000’s the more “dollars” showed up all over the place. All over the world. Typically in the form of FX reserves holding, you guessed it, US Treasuries as the primary asset, the aggregate balance of which exploded contrary to mainstream warnings.

Therefore, the falling dollar wasn’t the cause of more of them being redistributed around the world but rather the effect taken from it. Store of value nothing, foreigners interested only in the best possible medium of exchange because, to put it bluntly, they need dollars in a way Americans actually don’t.

How’s that for the modern update to Triffin’s Paradox?

To men like Rubin and Snow, the US economy was a closed system, mostly, and the links between it and others small, minor, and easily disturbed. Even as the evidence accumulated throughout the 90’s and 00’s around them, just in the explosion of foreigners holding all kinds of US$ assets and not just UST’s, the closed system approach prevailed anyway.

Ultimately, it led to enormous confusion and more often silence. Treasury officials would simply mouth the words “strong dollar” and leave it at that; hoping, all the while, American citizens would just believe them when they implied the exchange value was set in Washington, DC, either by the Department or the Fed (which more people have ended up believing).

The temptation to do nothing more was itself upended on August 9, 2007. Though the dollar’s exchange value continued to drop initally, the conditions behind its current paradigm shift were abundantly clear at that early juncture. US$ money markets were breaking down which would only lead to a monetary shortage; starting overseas.

If more US$’s overseas had led to a weaker US$ exchange rate (and more foreign holdings of Treasuries), a dollar shortage would only eventually mean a higher exchange rate and, paradoxically, from the conventional perspective, a surge in demand for US Treasuries if not from foreign governments.

When the lights were dimmed on Bear Stearns in March 2008, that was the signal. While nowhere near a straight line, ever since that specific weekend the dollar has defied all conventional thinking – including the “money printing” critics of the Federal Reserve. Those like Anna Schwartz who in 2009 opposed Ben Bernanke’s reappointment on the grounds he was destroying the dollar leaving the US economy overexposed to a monstrous inflationary outbreak.

That didn’t happen, either. Not that this would’ve pleased Robert Rubin. When he said the strong dollar was preferred because it would lead to low inflation, what he meant was, again, in the sense of globalization. More trade and cooperation leading to economic growth of the sustainable kind.

Beginning in 2008, low inflation and the rising dollar left us with nothing like that. In fact, growth predicated on globalization had meant the very case for the weak or falling dollar. That was what Robert Triffin had been talking about decades before; if the global reserve currency was to be some national currency there had better be enough of it widely available across the world.

Take away the dollars, take away the growth.

The rising dollar, therefore, means lack of strength pretty much everywhere – if not quite all at once. Stealing the juice from domestic and European economies straight away, it would take only a few more years before, beginning with 2011, this dollar condition sapped the economic strength from everybody else.

Mohamed El-Erian claimed it was a “new normal” in 2010, he just didn’t realize that meant a world where the dollar shortage had become that normal. And, once again paradoxically, that would by 2014 lead governments around the world to sell UST’s as the dollar drove higher, often furiously to combat the acute stages of this shortage all the while banks in their countries as well as around them more furiously bought them up.

Again, not at all what either Rubin nor Snow had in mind.

Above them all, the Federal Reserve. Take Anna Schwartz’s main objection to Bernanke’s execution of just the first QE, not even getting to QE2 nor 3 and 4 (there were four under Bernanke).

“Mr. Bernanke seems to know only two amounts: zero and trillions. Before 2008 there were only moderate increases in the Federal Reserve’s aggregate balance sheet numbers, but since then the balance sheet has exploded by trillions of dollars.”

Ah yes, the “money printing” critique. Surely all this irresponsibility with the nation’s currency would lead to its exchange value demise?  The dollar to zero, the Treasury’s debt yields to infinity.

Nope. Not even close, another dollar angle unfamiliar, apparently, to all the experts, officials, and those ceremonial few designated officially expert. We want the strong dollar to go up, these say, because that means reinvigorated globalization bringing lower inflation and interest rates and a higher willingness of foreigners to hold our debt.

When, in fact, the rising dollar since Bear Stearns has, indeed, brought with it low rates and inflation but instead the retreat of globalization as well as the decline of raw global economic growth leaving many foreign countries to sell their US Treasuries to the global banking system desperate to buy them and little else.

And after two months when the current Federal Reserve Chairman has put to shame his predecessor’s legacy that had once so provoked the great monetarist Anna Schwartz, the dollar’s exchange value hardly moved. US Treasury yields similarly clinging near record lows despite the deluge in T-bills and now notes and bonds.

Something’s not right.

Just this week, the President praised the currency situation.

“It’s a great time to have a strong dollar ... Everybody wants to be in the dollar because we kept it strong. I kept it strong.”

Unless Donald Trump is personally phoning the heads of each major global bank and personally depriving them of already-precious balance sheet space (actually, he’d need to phone the various desk managers since bank chiefs have little to no idea what their banks actually do beneath them; see: Dimon, Jamie), he’s neither keeping the dollar strong nor does he realize the implications of inadvertently taking credit for a(nother) looming disaster.

In March 2019, the President had complained, “I want a strong dollar, but I want a dollar that’s great for our country not a dollar that is so strong that it is prohibitive for us to be dealing with other nations.” Then in August Trump protested again, this time recognizing the telltale signs of how first the rising dollar “is sadly hurting other parts of the world.”

In between, the dollar’s exchange value moved significantly higher still – particularly March 2020 after this global dollar shortage behind the currency’s rise finally leapt from the shadows where it normally wrecks pieces of the system unseen and into the bright lights of global financial crisis where it wrecks everything in indiscriminate fashion. The only real benefit of these things, like 2008, is how it finally demonstrates just how little is known about how the currency system really works and how powerless especially central banks are in the way of this illiquidity avalanche.

The modern officialdom where economics is concerned always wants to make this about prices; the price of consumer goods, the relative price of exports, the price of the dollar itself. Nuts to any of that. They don’t know how to do any of these things, and even if they did, without the acquiescence of the banking system, bottom up, it’s not happening regardless of intent.

In its earliest days, before its policymakers got the idea they could and should direct major economic components via prices, the Federal Reserve was led by people like Benjamin Strong who while in charge of the leading, powerful branch in New York was no perfect example. Still, he recognized the mission with uncommon (for these days) clarity.

Writing to his staff in 1923, Strong said:

“Our job is credit [interbank money]. It makes no difference if it’s a deposit or a bank note…To come boldly forward, and volunteer to take the price problem onto our backs, and then fail, as we would surely do – is just criminal suicide.”

The strong dollar, ladies and gentlemen, with not an official clue about what it is or where it actually comes from. Other than some legend spoken about in 1995. It is not some cleanest dirty shirt nor some directive handed down from on high written as an enlightened decree from the duly designated monetary potentate. It is, as Benjamin Strong forewarned, criminal suicide.

Because in chasing after the utopia of price control, understanding of the basics had atrophied to the point of uselessness by the time Robert Rubin was plucked from Goldman Sachs to opine on the matter of international global reserve currency - not the dollar.

Don’t take my word for it, though. Check the Treasury market auctions (particularly the low yields of the distribution), the TIC data for furious official selling, and finally the overwhelmed IMF besieged by emergency emergency funding requests from dozens and dozens of dollar-starved nations. All while the dollar stays “strong.”

Combined, the Fed and federal government are not undermining the dollar either on purpose or by accident. They are both being taught another lesson, so far, each one refuses to learn. The real problem in all of this is that ultimately it is us who pay the dollar’s price. 

Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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