Friday, December 19, 2008

The Declining Dollar--Continued

Please note that today’s Wall Street Journal carries an editorial that makes exactly the same points concerning the decline in the value of the United States dollar that I made in my post yesterday. I refer to the comments made in “A Dollar Referendum” which can be found at

Let me just summarize the points made in the Wall Street Journal article.

First, after the dollar rose earlier in the fall due to the international flight to quality to invest in Treasury securities, the value of the United States dollar has fallen precipitously in December as a result of the recent Fed actions opening the gate to flood the world with dollars.

Second, why should international financial markets have any faith in the Federal Reserve to restore discipline to the markets when it “has proven that it is far better at adding liquidity than removing it”? The editorial then refers to the Fed record in maintaining exceedingly low target interest rates earlier in the 2001 to 2003 period.

Third, the editorial discusses the flow of new United States government debt that will be coming to the market…approximately $1.0 trillion…related to the proposed Obama stimulus plan. The implication is that the monetary thrust of the Fed will basically monetize this debt.

Fourth, the concern is expressed that measures of inflation, such as the consumer price index are lagging indicators, and do not capture the market’s lack of confidence in international financial markets that the Federal Reserve will be restore order once the “deflation” psychology has been defeated. The decline in the value of the United States dollar represents this expectation of market participants.

In the words of the Wall Street Journal editorial: “The dollar’s decline is a warning about the future. Mr. Bernanke’s decision to flood the world with dollars will no doubt succeed in preventing a deflation. What everyone wants to know is whether he also has the fortitude—or even the desire—to prevent a run on the world’s reserve currency.”

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