The Falling US Dollar – Bane or Boon?

Summary:  The US dollar is falling in value vs. most other currencies and gold.  As usual, much of the material in the mainstream media about this important economic trend is misleading or wrong.  It is potentially both bane and boon.  Which depends upon us.  This is just a sketch; please see the links at the end for more information — those are among the most important on this site.

An excellent summary of the situation:  ”Misguided Monetary Mentalities“, Paul Krugman, 11 October 2009 — Excerpt:

The truth is that the falling dollar is good news. For one thing, it’s mainly the result of rising confidence: the dollar rose at the height of the financial crisis as panicked investors sought safe haven in America, and it’s falling again now that the fear is subsiding. And a lower dollar is good for U.S. exporters, helping us make the transition away from huge trade deficits to a more sustainable international position.

Contents

  1. Why is the US dollar falling in value?
  2. Is a falling dollar inevitable?
  3. Is a weaker dollar bad for us?
  4. What should the US do about the dollar?

(1)  Why is the US dollar falling in value?

As all parents know, “why” is the most difficult of questions to answer.  We can only guess.  The stock market’s ticker tape gives the price and volume of each trade, but not the motives of the buyer and seller.

During the winter 2008-09 crash, as money fled to the safety of US treasury bonds and debtors needed dollars to repay their loans (many of which were in dollars).  So the US dollar rose in value.  Now the global appetite for risk has returned to euphoric levels, so money shifts from treasuries to risk assets (e.g., emerging market bonds and stocks, commodities). 

There might be concerns about the US government’s solvency.  But Europe has equal or greater problems (e.g., worse demographics and higher government liabilities), and the US dollar is falling vs. the Euro.

Our persistent trade deficits might play a role, but probably not a large one.  See this graph from Calculated Risk.  Our trade deficit has become much smaller (-53%) due to imports falling more than exports (-31% vs. -22% from July 2008 – August 2009).   If this decline is just a cyclical one, as in previous recessions, it will expand during the recovery — and again become a serious (or worse) problem.  Or this might be the start of the long-awaited rebalancing — US households spending less (reducing our imports), and saving more.  Much depends on the answer.

(2)  Is a falling dollar inevitable?

No.  A long recession would spur more buying of safe treasuries, reduce or eliminate our trade deficit, and force more scrambling for dollars to repay debts.  All of these thigns would strengthen the dollar.

(3)  Is a weaker dollar bad for us?

A weaker dollar is beneficial, so long it does not fall too far, too fast.  Mae West said “Too much of a good thing is wonderful.”  She was not an economist.  Economic shocks result from not just the size of a change, but also the speed with which it occurs.

There is much angst about the falling dollar.  For example, “Deficits and the Chinese Challenge“, Zachary Karabell, op-ed in the Wall Street Journal, 12 October 2009 — “Debt can become a real liability for a superpower. Recall what happened to postwar Britain.”  Mostly absurd.  Good advice if acted upon in 1979, OK if in 1989, perhaps useful in 1999. Too late for 2009.

A weaker dollar is one of the most likely paths to putting America back on a firm foundation.  I believe this cycle will end when the US dollar has declined so that US goods and services are again competitive on world markets, our trade deficit is positive, and we can pay interest and even some principle on our foreign debts.  There are other possible outcomes.  Some better, some worse.  I believe this is best among the likely scenarios.

A weaker dollar will not by itself cure our ills.  No panacea, just another step in the right direction.  After WWI the UK pegged the pound at too high a level out of pride or an overestimation of its strength.  The consequences were ruinous.  Let’s not make the same error.

Articles advocating a weaker US Dollar:

(4)  What should the US do about the dollar?

Building a new global financial regime will be difficult.  Implementing it without massive disruption will be far more difficult.  The massive supply of dollars held overseas will flow home as the dollar weakens, esp as it loses its status as the reserve currency — the global storehouse of value.  These dollars will not come home by parcel post.  Foreigners will exchange them for goods, services, and assets from America.  This could easily collapse the global financial system, resulting in a return to capital controls.

One path to the future is a negotiated agreement with the nations who are our largest creditors, discussed in Effective treatment for this crisis will come with “The Master Settlement of 2009″ (5 October 2008).  Excerpt:

We will need to reschedule our debt and obtain new financing. Our government will have to rollover roughly $500 billion/year, plus the trillion or so in additional borrowing (as tax revenue declines and expenses skyrocket) for the next two years (perhaps longer). Plus measures will be needed to stabilize the value of the US dollar, allowing an orderly decline.

These extraordinary negotiations will be inherently destabilizing, putting in question both the US Dollar’s role as reserve currency and America’s role as global hegemon. This is the price paid by our past folly, getting us into this crisis.

Obtaining and executing this agreement must be concluded successfully. It is a jump across a chasm to a new world. But the chasm lies ahead of us, and must be crossed eventually. Let’s strike a deal while we can negotiate from a position of strength. Rather than waiting until we are desperate.

The cost will be high. An agreement will be in the best interest of all, but that does not mean that we will not have to make concessions. To give just one example, China might ask that the US break our relations (esp military) with Taiwan.

Goals of such a conference:

  • devise a new global financial regime, replacing today’s Bretton Woods II “system”
  • including a replacement for the US dollar as the reserve currency, a role we can afford only by abusing its privileges, and
  • mechanisms to manage the complex and difficult transition.

We must start this process now.  Something this large will move slowly.  Time is our enemy, as our relative strength probably will deteriorate over time.

For more information from the FM site

To read other articles about these things, see the following:

Reference pages about other topics appear on the right side menu bar, including About the FM website page.

Other posts about the US Dollar:

  1. A brief note on the US Dollar. Is this like August 1914?, 8 November 2007 — How the current situation is as unstable financially as was Europe geopolitically in early 1914.
  2. Economic Warfare, 10 November 2007
  3. The post-WWII geopolitical regime is dying. Chapter One , 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
  4. “The changing balance of global financial power”, by Brad Setser, 22 August 2008
  5. Is America’s decline inevitable? No., 21 January 2008
  6. Geopolitical implications of the current economic downturn, 24 January 2008 – How will this recession end?  With re-balancing of the global economy — and a decline of the US dollar so that the US goods and services are again competitive.  No more trade deficit, and we can pay our debts.
  7. Our metastable Empire, built on a foundation of clay, 3 March 2008
  8. Words to fear in the 21st century: Lǎo hǔ, lǎo hǔ, Lǎo hǔ, 14 July 2008, 14 July 2008
  9. Effective treatment for this crisis will come with “The Master Settlement of 2009″, 5 October 2008
  10. Causes of the financial crisis (no, its not the usual list), 29 October 2008
  11. A look at out future, 2009 – 2010 … and beyond, 9 November 2008
  12. Fetters of the mind blind us so that we cannot see a solution to this crisis, 1 April 2009
  13. Today’s hot rumor: Fisk’s story about a conspiracy to wreck the US dollar, 6 October 2009

Originally published at Fabius Maximus and reproduced here with the author’s permission.

One Response to "The Falling US Dollar – Bane or Boon?"

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