Yes Ben, the Dollar Does Matter
The weak dollar has been a source of much consternation, at least for me, over the past year. There are those who say “Who cares; a weak dollar helps exports,” and “You need to keep pushing down interest rates until the economy recovers and we work through this crisis.” My position has been pretty clear: a weak dollar is bad, not in and of itself, but because of the knock-on effects of such a policy. Why? Consider just a few reasons:
- The U.S. is a debtor nation. We rely on foreign governments to finance our deficits. If the value of those dollar-denominated holdings keep falling, at some point they will either stop buying or demand an increasingly high interest rate to offset currency losses;
- The U.S. financial system is in a badly weakened state. We need both onshore and offshore sources of capital to bolster bank balance sheets burdened with busted ABS and retained LBO loans. If foreign investors lack confidence in the dollar, this erects an extremely high barrier for investment.
- The U.S. imports a lot of stuff. Paying for this stuff with depreciated dollars means only one thing - rising prices. A weak dollar is fundamentally inflationary and something that could bring us back to a time we’d all rather forget - the 1970s.
But for most of the time I’ve been writing about my frustration with Fed policy, Mr. Bernanke has been turning a deaf ear to my pleas. But now it appears that we’ve reached a tipping point in Ben’s mind, a point that has prompted him to sing a somewhat different song; here are his comments during yesterday’s speech at the International Monetary Conference in Barcelona:
In collaboration with our colleagues at the Treasury, we continue to
carefully monitor developments in foreign exchange markets. The
challenges that our economy has faced over the past year or so have
generated some downward pressures on the foreign exchange value of the
dollar, which have contributed to the unwelcome rise in import prices
and consumer price inflation. We are attentive to the implications of
changes in the value of the dollar for inflation and inflation
expectations and will continue to formulate policy to guard against
risks to both parts of our dual mandate, including the risk of an
erosion in longer-term inflation expectations. Over time, the Federal
Reserve’s commitment to both price stability and maximum sustainable
employment and the underlying strengths of the U.S. economy—including
flexible markets and robust innovation and productivity—will be key
factors ensuring that the dollar remains a strong and stable currency.
Price stability? Maximum sustainable employment? Flexible markets? Hmm, not sure we’ve done such a good job on these fronts. Productivity, yes - so far. Mr. Bernanke is focused on the right goals to be sure. It’s just that it has taken him a while to get there. And now he has to follow through with actions to back up the words. Clearly in his calculus he viewed the need to push down rates regardless of the impact on the dollar as critical in order to help repair the broken U.S. credit markets. It is hard to fault him for his intentions, though one can argue that pain taken quickly and sharply is, in the long run, a better policy than death by a thousand cuts. And given that the impact of Fed policy has a lag associated with it, are inflationary forces already unleashed in the system too far advanced for tighter monetary policy to tame them? Are we destined to suffer higher prices and higher interest rates due to the Fed’s slowness in reining in liquidity to stem a plunging dollar? This is the $64,000 question. And given the way things are looking, I’m not sure I want to know the answer.
