Debauching the Dollar

Tuesday, October 26, 2010

Washington Dollar

By Anthony Rowley

Is the depreciating dollar a victim of market circumstance, or is it being deliberately debauched by US authorities? This is a fair question to ask given the way in which Washington appears to be acquiescing in the alarming slide of the dollar against other currencies, not least those in Asia.

It is also a question to which G20 leaders should demand an answer at their summit meeting in Seoul next month.

Central banks are, after all, supposed to have a duty to maintain the integrity of a nation's currency, especially when that currency happens to be the one in which the rest of the world holds its foreign exchange reserves and which it uses to price international trade transactions.

There are a number of factors which appear to be contributing to the dollar debacle. Some are the result of economic circumstance and others the result of policy actions. Not all of the latter are transparent, and the United States has an obligation to explain its actions, given the dollar's global role.

Of course, the plunge in US interest rates in the wake of the financial crisis and economic recession was bound to trigger outflows of capital into higher yielding assets elsewhere - in Asia especially - and this has helped to weaken the dollar.

All other things being equal, this might not have been alarming. Capital ebbs and flows naturally. But the fact that the US administration has chosen to adopt a policy of doubling exports within five years means that gestures of belief in a strong dollar cannot be used as a corrective this time.

This combination of yield differentials driving the dollar down while mercantilist policy also favors a weak currency would be enough in itself to make what is happening at present more than episodic bout of dollar weakness. But there appear to be other, more powerful, forces at work.

It would appear that Washington is seeking to solve the problem of global current account imbalances (i.e. that of chronic surplus in some, chiefly Asian, countries and deficits in others, namely the United States itself) at a stroke, via a dramatic and generalized depreciation of the dollar.

How, it might be asked, could the United States hope to achieve this single-handedly when the dollar's exchange rate is determined by the foreign exchange market and not by the US Treasury or the Federal Reserve? This is where the opaque nature of US policy is most marked at present.

What appears to be an economic anti-deflation exercise on the Fed's part could equally be used as a cover to secure currency depreciation by flooding the global monetary system with dollars. Their outflow from the United States is virtually guaranteed given historic low yields on domestic instruments.

It may be that this is a side-effect of a policy on the part of a Fed Chairman Ben Bernanke (who has been termed "helicopter Ben" because of his propensity for deploying anti-deflation strategies). But equally the strategy serves the ends of Treasury Secretary Timothy Geithner. It more or less ensures dollar depreciation while also promising a degree of inflation that will erode the real value of the US government debt, a great deal of which is held by Asian surplus countries such as China and Japan, along with many others who keep their reserves in dollars.

This is a brilliant strategy, some might claim, since it results in the appreciation of innumerable other currencies, thereby forcing economic structural adjustment on surplus countries via the exchange rate by causing them to export less and consume more at home.

Again, some might ask how the United States could hope to do this when target countries such as China do not allow their currencies to appreciate readily. But the point is that the United States is countering such efforts by printing dollars at a faster rate than China and others can buy them up in interventions.

Clever and all-embracing as the current dollar strategy may appear to be on the surface, it runs considerable risks of destabilizing the global economic system, and it is these dangers that the G20 will need to address.

China, as People's Bank of China Governor Zhou Xiaochuan has said, is the only nation that currently is driving growth in the global economy, while trying to perform a difficult balancing act by shifting demand from external to domestic sources. Destabilize this and the global economy goes without growth.

The United States is not in a position to revert to being a locomotive itself because its own consumers are too busy repaying debt to be able to borrow and spend more. Additionally, there is little hope that the United States can rely on export-led growth if its own strategy hobbles its trading partners' economies.

Global imbalances cannot be cured at a stroke, and strategies which promise to do this are short-sighted and dangerous. Equally, quantitative limits on current account surpluses of the kind that Mr. Geithner is proposing smack of quick fixes to problems requiring more lengthy macro- and micro-economic adjustments.

Anthony Rowley is the Tokyo Correspondent of the Singapore Business Times and Field Editor (Japan) for Oxford Analytica.

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