It seems nobody in this country wants to take responsibility for the secular decline in the value of the U.S. dollar. When Fed Head Bernanke is asked a question about the currency's decline, he refers you to the Treasury Department. When the President is asked about the dollar, you often get the tired old platitude that the U.S. has a strong dollar policy, but his vacuous words seem more like a perfunctory utterance than a bona fide dollar boosting strategy.
Recently, in an interview with CNBC's Maria Bartiromo, Treasury Secretary Timothy Geithner had some startling comments about the world's reserve currency. When asked about the chronically weak currency and what specifically he was doing to safeguard the dollar, Mr. Geithner said, ...if you look generally, you know, I don't talk about developments in the exchange markets. He continued, If you look at what's happened over the last year, you've seen really a lot of confidence in the US economy. When the crisis was at its peak...you saw the dollar rise when people were most concerned about the future of the world.
Now that the US dollar has resumed its condition of a vicious secular bear market and has lost nearly 16% of its value since March alone, the Secretary of the Treasury opts to take the fifth. Even worse, he claims that last year was a good example of global confidence in the currency even though it is down over 8% for the year. Is he really relying on another collapse in the global economy to pull the dollar out of its down trend? To use the previous year as an example of confidence and strength in the country or the currency is spurious in nature. And it illustrates that our Treasury Secretary either tacitly condones the fall in the dollar or has no idea what causes a weak currency.
The progenitor of our weak dollar is the skyrocketing monetary base, which reached an all time record high of $1.86 trillion last week. The Fed's monetization of banks' assets has caused real interest rates to become negative and increased interest differentials with more sober central bankers like Glenn Stevens from Australia. In addition, our profligate spending habits have caused record budget deficits and even caused our erstwhile healing trade deficit to reverse course and head higher. All those trends seem unfortunately well intact and are actually growing worse.
There is however, no shortage of gurus who will tell you that a weakening dollar is great for America. They'll tell you that it boosts exports and boosts the earnings of domestic companies that conduct business on foreign soil. I can assure their logic is flawed. First off, a falling dollar has actually had the opposite effect on our trade deficit. If a weak dollar bolstered our economy and our manufacturing base, then why has the trade deficit surged since 2001 even though the dollar has lost nearly 40% of its value based on a basket of six currencies involving our largest trading partners?
Let's look at a specific example to disprove the theory that you can balance a trade deficit by crumbling your currency. In 2005 China announced it would increase the value of its currency and abandon its decade-old fixed exchange rate to the U.S. dollar in favor of a link to a basket of world currencies. Since then the Yuan has rallied from .1208 USD to .1465 USD. But the falling dollar has had a negligible effect on U.S. exports. For all of 2005 the U.S. deficit with China was $201.5 billion. In 2008, three years into the dollar devaluation, it soared to $266.3 billion. Why didn't the falling dollar help boost exports? Because the price of goods produced in the U.S. went up. That means that foreign importers were immune from our domestically produced inflation, not that they could afford to buy more of our goods. There just isn't any amount of dollars the Fed can create that can serve as a substitute for manufacturing and producing more of the things that foreign countries want to purchase.
Also, Multi National Corporations are more protected from the falling dollar than those companies that strictly sell their goods inside the US. The foreign currency MNCs earn translates to more USDs once the cash is repatriated. But the purchasing power of those dollars becomes attenuated. So again, there just isn't as much real return produced from owning MNCs as most investors like to espouse. And it is certainly isn't worth the price of causing rampant inflation at home. To claim that a falling dollar is great because it boosts the earnings of MNCs is tantamount to saying: If we can increase the number of car crashes in the United States it would be a wonderful thing for most Americans, because they can always invest in companies that make air bags.
It would be better if the Chinese allowed their currency to strengthen rather than to pursue our policy of USD weakness. There is a big difference if the former occurs. If the dollar loses its value because of our own inflationary domestic policies, it means all Americans will experience suffering from the loss of their currency's purchasing power right here in the USA. If however the Chinese sell the dollars accumulated from their trade surplus, the Yuan will rise without the destructive inflation being generated here at home-provided that the US repents from their profligate spending habits. That doesn't mean the Chinese will necessarily buy more US made goods, but it might. The problem is that if the Chinese no longer need to park their savings in US debt, Treasury prices will fall as yields soar. And the dollar will suffer greatly in the short term as measured against the Chinese currency. But again, that is inevitable and much better in the long run for the United States.
Finally, I'm just so tired of hearing there is no substitute for the USD. As if the Chinese will be compelled to ruin their environment, work very hard and squander their savings forever and are powerless to do anything about it. Does it make sense for them to keep buying Treasuries if their prices fall and the currency they are denominated in continues to crumble? Wouldn't it make sense to diversify their holdings into other currencies and commodities? In fact, that is exactly what they are doing. They have moved their holdings of Treasuries to the short end of the curve for an easy exit and are buying more Euros, gold and commodities. According to Wikipedia, in 2008 the 16 countries that use the Euro currency have an economy that is more than 76% the size of that in the United States. So is it incredulous to believe that the Chinese could and should and are diversifying from the current $800 + billion of their Treasury holdings, or from their $1.3 trillion in US reserves, or from having 65% of their reserves in USD?
It looks like the plan the US wants to pursue is to continue to discourage foreign investment, punch our bankers (the Chinese) in the nose and punish those who are savers by crumbling our currency. But please Mr. Geithner, let's not pretend it benefits anyone except those who are heavily in debt, and chief among them is our government. And even the US government will be surprised to learn that the price for devaluing that debt through the process of inflation is the eventual destruction of our own economy.
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Delta Global Advisors