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.

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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