"Strong Dollar" Policy as Financial Alzheimer's

Blame it on former US Treasury Secretary Robert Rubin. During the Clinton years, he began repeating the mantra of a "strong dollar" policy with considerable gusto when his predecessors were more circumspect in doing so while alluding to basically the same idea. Back then, of course, the US was actually reducing its budget deficits if not its external imbalances. The dollar has bounced around significantly since that time. If you recall, the euro once commanded only $0.85 in 2000, prompting coordinated intervention by the G7. In retrospect, the final days of the Clinton administration may come to be regarded as the last high water mark for dollar strength in our time prior as America plunges to Stygian depths of more borrowed money, more borrowed time.

Robert Rubin, Larry Summers, Paul O'Neill, John Snow, Henry Paulson, Tim Geithner; euro from 0.85 to 1.60 and back down again; gold from below $300 to over $1,050; it didn't matter. The song has remained the same from the sitting Treasury chief come hell or high water: Washington has a "strong dollar" policy (albeit with some curlicues attached). In recent years, the "strong dollar" policy has alternately been a source of amusement and target for derision in FX circles; a largely empty slogan without tangible policy implications. As Asian countries are once again intervening heavily to prop up the fast-falling dollar and gold is hitting record highs daily, we once again find ourselves hearing cold comfort from US authorities. Here is former Treasury honcho and current Obama chief economic adviser Larry Summers invoking that old voodoo:

The chief economic adviser to President Barack Obama on Thursday reiterated the administration’s support for a strong dollar as concerns mount about the currency’s sharp decline. Lawrence Summers, director of the National Economic Council, supported recent statements by Tim Geithner, the Treasury secretary whose office customarily voices the US stance on the dollar...

“I think he made very clear our awareness of the responsibilities we have in the US, and the special role of the dollar in the international system,” Mr Summers said of his colleague. The Treasury secretary had made clear “our commitment to a strong dollar based on strong fundamentals”, Mr Summers said.

Along the way, Summers throws in that old chestnut of countries being unable to devalue their way to prosperity. True enough, but that hasn't stopped very many from at least trying to do so to tilt the playing field in their favour. Ironically, it may be up to a source treated with some disdain in this parts who can shed light on the continuing mantra of a "strong dollar." David Malpass, formerly deputy assistant Treasury secretary during the Reagan-Bush Sr. years. Among other whoppers, Malpass has argued that declines in savings rates didn't matter since home and equity prices in America kept going up. The demise of the housing and equity bubbles has put paid to that Cheneynomic chestnut, but Malpass may still have a finger on the matter of the "strong dollar" policy's emptiness. From Bloomberg:

Timothy Geithner, the current Treasury secretary, has tolerated the greenback’s 12 percent slide from its peak this year in March as measured by the Federal Reserve’s trade- weighted Real Major Currencies Dollar Index. While he said as recently as Oct. 3 that “it is very important to the United States that we continue to have a strong dollar,” the last time the U.S. intervened in markets to support its currency was 1995.

The weaker dollar may boost America’s exports as the economy recovers from the deepest recession since the 1930s. The risk is that it may also drive away America’s largest creditors just as the Treasury relies more than ever on foreign investors to buy the bonds financing Barack Obama’s stimulus spending. The dollar’s share of global currency reserves fell in the second quarter to 62.8 percent, the lowest level in at least a decade, the International Monetary Fund in Washington said on Sept. 30.

“Since the dollar has been weak and weakening for years, Geithner was using a code phrase, a carry-over from the Bush administration,” said David Malpass, president of research firm Encima Global in New York. “It means that the U.S. approves of a constantly weakening dollar but doesn’t want a disruptive collapse,” said Malpass, the former chief economist at Bear Stearns Cos. and deputy assistant Treasury secretary from 1986 to 1989.

It is said that Alan Greenspan voiced its approval of the unvarying "strong dollar" statement in putting off those who would try to read policy shifts:

“By not varying the statement, an issue never arose about whether a comment involved a subtle change or not in the policy toward the dollar,” former Fed Chairman Alan Greenspan told his colleagues on the Federal Open Market Committee in 2001, according to a transcript of the meeting. “It was boring, it was dull, it was repetitive, it was nonintellectual, and it worked like a charm.”

Returning to Malpass, he faults the current (Democratic, naturally) administration for believing that foreign creditors have unlimited willingness to lend to America:

“The Washington theory is that dollar weakness will benefit the U.S. by inflating our way out of debt and causing more exports,” Encima’s Malpass said in a Sept. 25 note to clients. “The problem with this theory is that it assumes capital stays put while the dollar devalues.” While the dollar dropped in global currency reserves, holdings of euros rose to a record, the IMF report shows. The U.S. currency’s portion declined to 62.8 percent from 65 percent in the first quarter. The euro’s share rose to a record 27.5 percent from 25.9 percent while the pound and yen gained.

Note that the IMF Composition of Foreign Exchange Reserve (COFER) figures cited by Bloomberg are only for those countries which report the composition of their reserves. Major LDC reserve holders, particularly Middle East oilers and China, do not do so. As I write, the dollar is up a touch on Fed Chairman Ben Bernanke saying interest rates Stateside will rise once the US economy recovers. I simply don't think a sustained US recovery driven by real income growth instead of government hyper-profligacy is foreseeable in the near future. Hence, this is an empty statement that may nevertheless have the effect of temporarily buoying a sinking ship.

In any event, I think Malpass may read it right although the idea is certainly not novel: the US is glad for the dollar to drop, the US will not raise interest rates to help stem dollar weakness in particular, and the US has no intention of intervening to defend the dollar whether on its own or with G7/G20 countries. What is wants to avoid is a disorderly exit that may bring about kingdom come-style scenarios of 10% long rates, the euro at $2.00 and so on in short order. Given its current course, it cannot be ruled out that we will see one or both of those things happening.

In typically short-sighted, kick the can down the road, contemporary American fashion, the Yanks would rather have them come in a gradual, Alzheimer's-style decline of a long goodbye instead of a big bang. The "strong dollar" policy is no more than a "let her go, but gently" policy. Yippee, USA#1, etc.