Is the buck back?

October 31, 2008

diana-furchtgott-roth1Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is a senior fellow at the Hudson Institute. The opinions expressed here are her own.

“The Buck is Back,” proclaimed a Wall Street Journal headline on Tuesday. But even if it is, and that’s a big if, a strong currency is a mixed blessing.

True, in spite of the financial crisis, over the past six weeks the dollar has strengthened substantially against the euro and the British pound, although Wednesday’s half percentage point Federal Reserve rate cut caused the dollar to slip. But the dollar has lost value relative to the Japanese yen.

What’s really happening is not that the dollar is strengthening on its merits, but that European currencies are weakening.

“For the dollar to depreciate, it has to depreciate against another currency. America isn’t looking great, but Europe is looking even worse,” explains American Enterprise Institute resident fellow Desmond Lachman.

Europe’s worsening economic problems — greater than America’s — are causing some investors and the army of regular foreign exchange speculators to prefer dollar assets, what foreign exchange traders call a “flight to quality.”

Approximately 40 percent of America’s subprime loans are held abroad; the British housing market is deteriorating; the British government is bailing out the City of London’s famed banking sector; and European banks hold risky investments in slowing Eastern European economies, especially Russia.

As a result, the European Central Bank is likely to cut interest rates soon, further dimming the attractiveness of the euro, and the Bank of England may well follow suit.

Although a stronger dollar might appeal to Americans’ patriotism and pride, it will have mixed consequences. It makes exports more expensive and imports cheaper, which implies lower economic growth and a loss of jobs in export industries.

The relative weakening of European currencies versus the dollar could hurt America more than Europeans.

America’s 2.8 percent annualized second quarter GDP growth rate was supported by exports, and third quarter GDP would have declined by more than three tenths of a percent without them. As consumers reduced spending, rising exports helped employment.

With a weaker currency, Europeans will see more Americans visiting for vacations and shopping trips, and it will be easier for Europeans to sell their products in American stores for Christmas — if the recession doesn’t completely empty the stores of shoppers.

Japan, with its strong currency, is the country that may be in real trouble. With interest rates in Japan only at 0.3 percent, reduced on Friday from 0.5 percent, the Bank of Japan has little room to cut to let the yen fall against the dollar and the euro. In addition, its low interest rate makes the yen the currency of choice for hedge funds, which borrow yen and invest in euro- or dollar-denominated assets.

No wonder, then, that, shares in export-oriented Sony have fallen 68 percent this year, and that the Nikkei stock market index has declined by 56 percent.

Some, such as Encima Global President David Malpass, criticize Washington for not doing more to promote a stronger dollar. The weak dollar, according to Malpass, was one of the major causes of the financial crisis, resulting in inflation, the asset price bubbles in commodities and housing, and withdrawal of capital from America. Although America benefited from exports, this was outweighed by damage done to other sectors of the economy.

Yet with the economy in recession, the Fed won’t raise interest rates soon to strengthen the dollar. Domestic considerations trump the dollar in determining economy policy.

As the global economy works its way out of a recession, Japan, with its strong yen, has more to lose than Europe, with its weak euro. As for the buck, it is not back, but it is fine where it is.

You can contact the author at dfr@hudson.org

23 comments

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USD will turn to 1.46 after 1.22 against eurO if 1.2328 isn’t already bottom. Small chances are for 1.13 and then 1.3665. it’s always silly to forecast future in currenices pair but force is strong.
good lucke

Really? Europe is in worse shape than the US and that’s why the euro fell? The author cites the UK and Russia but these countries aren’t even using the euro. There are lots of reasons why the euro is weakening against USD (for example, corporate America repatriating the then-weak USD by selling foreign currencies to “window-dress” their balance sheet) but Europe being in worse shape is hardly one of them.

Posted by TheContrarian | Report as abusive

So you think the UK is in a worse state than America?
I have just been over to the states and I think personally you are on the edge of a cliff waiting to topple over.The only real jobs going seem to be in the food are taxi industry that are very low paid.I have spoke to many that can’t even think about getting a job in their given profession because they simply are not there any more so they have to take anything on offer.
The period march 2009 onwards will be the interesting time imo because all the bailouts and government intervention will have been tried by then.The new president will be in power and the bear market rally will be well behind us.This is the time when you will realise that the American people are broke and have nothing to spend themselves out of a recession or as I think could poosibly happen,a full blown depression.
Watch what happens to the price of the Dollar then???????
Your country has been living the American dream yes,but I’m afraid its been on borrowed money.You will now have to live the American nightmare if things don’t pick up soon.This is just my opinion of the outlook for the U.S economy.

Posted by clive ling | Report as abusive

The root of the lack of financial discipline of the US dates back to August 15,1971 when President Richard Nixon disconnected the greenback from gold, because the gold-exchange standard was warning that the USA were overspending (at that time: the Vietnam’war). Had the warning been heard, the USA would not find themselves almost bankrupt. Prestige costs but is it worth?

The temporary strength of the dollar in ForEx markets is simply an artifact of a high demand for dollars because the big guns are seeking a stop-loss strategy by buying US government debt which is “guaranteed”. When this massive repatriation has played out, the dollar is likely to sink like a lead balloon, because the ForEx markets will return to normal activity. With the government “pumping liquidity” (read: printing money)as it has also been doing, the dilution of the currency’s value will only hasten the dollars decline. My money’s in New Zealand with the highest interest rates on developed countries savings accounts with a $1 million deposit guarantee. Totally liquid in a simple savings account with a guaranteed 7.6%interest.
The interest may go down some in the near term (because they are in a lowering mode) but still it will remain the best bet on the planet as far as I can tell.

Posted by Jonathan Cole | Report as abusive

The writer has it quite wrong. This dollar pump is not possible without extensive central bank intervention. The USA is a nation issuing a currency with an $850 billion per year current account deficit. Yet, in spite of this, the currency is now in shortage all over the world? This defies common sense, unless the central bankers have created a type of derivative whereby they are paying various money center banks a nice interest interest rate, on a couple of trillion worth of dollars, to keep them off the market. Keeping this money off the market has created the shortage of dollars, and the increase in the dollar’s value. But, foreign central banks will eventually run out of appetite for costly dollar supporting activities. When the dollar pump ends, the American currency will fall very fast and hard.

Posted by John | Report as abusive

Aren’t the dollars off the market because European banks have had to buy dollars to cover their positions in the $55 trillion credit default swap market? I think this would explain why the dollars are scarce and the Euros are everywhere.

Posted by Ron | Report as abusive

The current situation seems to be like most of the countries and their central banks are trying to intervene in order to rescue their financial markets. Euro in the same way is trying its luck with the cascade starting from the US amid its market meltdown. Although a strong dollar may worsen the export industries yet the same does not imply lowering America’s economic growth as cited by the author. The story of hedge funds with Japan is true as traders always had a close watch on Bank of Japan’s action on its interest rates. But if this is the case then Japan’s economy is not at all in trouble as investors may try borrowing yen and invest elsewhere resulting in higher foreign reserves.

Posted by Ajit Dhillon | Report as abusive

In my humble opinion, the cause of appreciation of USD is merely US$ returning home, of course for various reasons. However, what’s next, and the key question is where US is going to get the 700 billion or more. Borrowing, definitely.. but eventually US will still have to print more notes, if not already, to increase liquidity, to repay bond bills and to lend to others countries. Now the timing is perfect, an appreciating currency.

Posted by Doglous Wayber | Report as abusive

we are headed for a 2 currency world -the yen and the dollar, and it will be by request not force. the only way to stabilize these intermingled economies is to have 1 stzble currency and the only way to have a stable currency is to have complete transparency. Think about how simple it would be if everyone used 1 currency. we could eliminate thousands of hours a year companies waste trying to balance money issues. WE could eliminate the need for 1 million accountants and we could simplify the tax codes. Lets put everyone on an equal basis with open borders and trade for anyone under that 1 currency

Posted by dominick speziale | Report as abusive

What was the omen again? “When trees come marching over the hill”? (MacBeth)I’ve also heard it say “When the US consumer is maxxed out on his/her creditcard and stops consuming what becomes of an economy which is (70%) composed of consumer spending?”. Come New Year we are definately there. Tax income will be down, outlays will be up. Remember that S&P warned the USA Comptroller in 2007 that the USA debt level was deemed un-sustainable and they would likely lower the rating of the USA? How about USD interest rates at 0.5%, and nobody taking up any more T-Bills? The turn-around in the value of the USD v.v. other currencies will be too fast to fathom. At the moment anyone with wealth preservation in mind MUST be at least 50% in Euro. Better still, if you dare, move towards 80%, get 4% on a deposit, sit back and wait for the New Year’s fireworks.
Respectfully yours,

Posted by Johan vW | Report as abusive

I think that this are hard times for the USA. It’s going to take time but eventually the economy will fix. What it make me wonder is the great amount of people who wish the fall of the dollar. All this years and people do not understad that we are in this together. If the USA falls the whole world would fall too. RC

Posted by Raul Cabral | Report as abusive

For the past 30 years US exports have steadily declined while its imports increased significantly. The United States exported its industries; manufacturing and selling ever-less each year, to the point that America became a consumer-based economy. That consumption relied upon ever increasing debt and little else. Unless/until the United States become more a producer than a consumer its economy can do nothing other than decline. It truly is that simple. Do not let the voodoo economics fool you. These simple rules are not altered by politics. Throughout time they hold true. The still do.

Posted by Jon | Report as abusive

Raul is right that these are hard times for the USA. America is in a recession, and we don’t know how long that will last. However, an overly strong dollar will hinder the economic recovery,because exports will become uncompetitive and shrink, hurting employment, rather than helping the recovery. It’s bad enough that American consumers have stopped buying, we don’t want foreigners to stop buying our products also. Exports increased in the second and third quarters, helping to sustain GDP growth in the second quarter and preventing more of a downturn in the third. A rising dollar will not help America right now.

Diana Furchtgott-Roth

Posted by Diana Furchtgott-Roth | Report as abusive

All money systems are going to fail because God(Yahweh) is taking them away. He has recognized that people have begun to put more faith in money than in Him, the one who created all things. The only countries that will survive are the ones that begin again to put their faith in Him and return money to its rightful place. Below God. I know this is tough but it is for our own good. When man bases his existence on a man made system it will fail everytime. Thank-you.

Posted by ezekiels watchman | Report as abusive

The best analogy of why the USD is climbing is that of a bunch of drunken soldiers on a partying spurge. All the fiat currencies are likened to a group of drunken soldiers–as one falls down, the others just pick him up and so the merry rousing continues for a bit longer. The USD will fall dramatically after the U.S. elections are over.

The current “strength” of the dollar is underpinned by hedge funds dumping their foreign stocks and then crossing the currency floor to convert the proceeds to dollars to PAY debts written in dollars and to settle redemptions.

When that need abates, soon, the dollar will fall like a ton of bricks, especially when Bernanke and his pal Hank Paulson are throwing them out of a helicopter with relish.

Posted by Kent | Report as abusive

Richard Russell, http://www.dowtheoryletters.com, was correct in his assessment that there has been an artificial short in the US dollar created by massive debts around the world. We are currently experiencing that short-covering rally. Next come the high interest rates as countries, states and cities compete for scarce dollars.

Posted by Marty | Report as abusive

Kamran,
Heed to this article. Decide for yourself. Must read the comments. The USD may crash in coming months real hard. Just wanted to let you know. Dont tell me, I didn’t warn you so. Decide for yourself though.

Posted by Mamoon Kundi | Report as abusive

SMALL PICTURE STUFF. Big picture: This is not about the global “economy” (literal mosnomer), nor our various fiat currencies. This is about running up against the limits of the of the planet.

Posted by ehswan | Report as abusive

I don’t understand this constant desire for a weak currency. How low do you want it to go? Is 70 percent lower than it is now a reasonable target?

Boeing has certainly killed Airbus because of dollar weakness, but relative to the American domestic market for cars, the foreign demand for Chryslers and Cadillacs is negligible. I am an Airline Pilot and I can tell you that Boeing builds a better aeroplane, as to the desirability of Chryslers and Cadillacs, you can decide.

Relying on a deflating currency encourages domestic producers to be lazy instead of encouraging innovation. The US still has to source its raw materials from foreign suppliers and components for end products are sourced from abroad in huge quantities. Net net there is no great change in the bottom line. If you won’t innovate then you tell your employees that wages have to be cut to compete with the countries that have an even weaker currency, like China, India or maybe Bangladesh. The wages bill goes down but the employees have trouble meeting their mortgage payments. That straegy has worked out well hasn’t it?

If the US economy is in bad straits after five years of constant dollar depreciation, where is the evidence that it is a good thing?

Posted by Leigh | Report as abusive

what a joke! comparing fiat money with another fiat currency. did you notice our money has gone up at the same time they have monetized 2 trillion in bank bailout/garauntees, the real value of money is what will it buy..ill bet grocery prices are going up no matter whos monopoly money you have.

Posted by brian mcnamee | Report as abusive

I agree with printing of FIAT will lead to inflation at the end, however curently the trend de-multiplication of deposits is accelerating

multiplication is a process when USD 1 deposited with the bank is multiplied by the banking system, and USD 9 new dollars are created out of thim air, with all forced repayments of margin loans etc. and brake on all new loans this multiplication process has halted and actuallyreversed into opposite process, while everybody is wandering where are these dollars disappearing, FED can not print trillions in such a short time

as demultipication of USD currency is progreesing the most, this creates enormous short term demand for USD currency at the moment

Posted by Marek | Report as abusive