Thursday, May 21, 2009

The Future of the Dollar

We live in a global economy. And, unless we destroy the global economy that now exists the way the world destroyed the first global economy starting with the 1914 conflict and proceeding through the next fifty-five years or so, we will continue to face the duties and responsibilities of operating within a world economy. And, those duties and responsibilities begin with the currency of the country.

It is hard to have confidence that the United States accepts this fact.

I know that we are in a recession (depression?). I know that the immediate pressure on the Obama Administration is to “get the economy going again.” I know that the Treasury Department and the Federal Reserve, both dependent partners in the effort to get the financial system functioning, must provide whatever means it takes to avoid further deterioration of financial markets.

Still, there is a need to listen to what markets are saying about what the government is doing. And, the financial markets are saying that the United States dollar is in trouble. And, consequently, the United State government is in trouble.

The value of the Euro relative to the United States dollar climbed to 1.3768 at the close of business yesterday. This represents an 11.7% decline in the value of the dollar since Ben Bernanke became Chairman of the Board of Governors of the Federal Reserve System on January 31, 2006. It represents a 23.0% decline in the value of the dollar since Bush 43 became President on January 20, 2001 when Alan Greenspan was the Chairman of the Board of Governors of the Federal Reserve System.

The numbers are about the same if you look at a trade weighted series. The trade weighted value of the dollar versus major currencies has declined by 23.6% since Bush 43 was inaugurated, and, has declined 5.4% since Ben Bernanke became Chairman.

Of course, the figures look even worse if one focuses upon the lows in the value of the dollar which came about in March, 2008. Using this as the standard we find that the trade weighted value of the dollar declined 33.4% from the beginning of Bush 43 and 17.5% since Bernanke was sworn in. The current numbers look great compared with these, but the current figures benefit from the ‘flight to quality’ that took place following the September 2008 meltdown of the United States financial system.

All during the Bush 43 Administration, both the United States Treasury Secretary, whoever that was, and the Fed Chairmen gave lip service to the importance of the value of the United States dollar, yet no one did anything about it. And, the dollar continued to decline. Certainly someone should have understood that the decline in the value of the currency indicated something was wrong with the way the finances of the United States government were being run.

It is very apparent that the Federal Reserve System is NOT independent of the federal government of the United States. One has to go back to Paul Volcker and then back to William McChesney Martin to find Fed Chairmen that acted independently of the Executive Branch of the government. President Carter knew that Volcker would be independent of his administration if Volcker became the Fed Chairman but believed that he had to appoint him anyway. Certainly Arthur Burns and Bill Miller (remember him?), were not independent of the Presidents they served. And, people are realizing more and more that Alan Greenspan was nothing short of a water-carrier for the Presidents he served.

Not being independent of the Executive Branch means that the Federal Reserve is very subject to the position of the federal budget. Even Paul Volcker was eventually tainted with the huge (at the time) budget deficits run up by the Reagan Administration. Still, during his tenure as Fed Chairman, Volcker saw the trade weighted value of the dollar against major currencies rise by 6.4%.

Overall, during the time that Greenspan was Chairman of the Fed, the trade weighted value of the dollar against major currencies declined by only 16.7%. Greenspan’s grade improved in the 1990s due to the movement of the federal budget from a substantial deficit when the Clinton Administration took over in 1993 to a surplus by the time Bush 43 assumed office. In fact, this measure of the value of the dollar rose 13.9% during the Clinton administration.

The important thing to remember is that in the last half of the twentieth century world financial markets came to realize that substantial government budget deficits often got financed, one way or another, by the central bank of that country. As a consequence of this realization, participants in these world markets moved against the currencies of countries that began running large deficits if they believed that the central bank’s of that country were not fully independent of the government. The result was that governments became much more conservative in controlling budget deficits and central banks became much more independent of their governments.

The United States, in the latter half of the twentieth century, except for the early years that Paul Volcker was the Fed Chairman and during the 1993-2001 period, seemed to feel that they were exempt from this constraint. Yet, international financial markets responded to United States deficits and the possibility that they could be monetized in the same way that they responded to the “loose living” of other governments. They sold the dollar and the value of the dollar, for the most part, declined.

As participants in world financial markets perceive that things are beginning to settle down and that financial institutions are not going to completely self-destruct, they will continue to move out of United States Treasury securities and will continue to move out of the United States dollar. The foundational belief behind this movement is that the United States government is just putting too much debt out into the world. First, there were the huge budget deficits created by Bush 43 and now there are the huge budget deficits being created by the Obama administration. To people in the world financial markets, the lessons of the last fifty years still apply.

The path the economy and the financial markets follow relating to how the deficit problem works out is anyone’s guess right now. Who would have ever written the script for how the 2000s have evolved up until now? The historical evidence points to the fact that huge amounts of debt issued by governments cause dislocations. These dislocations have to work themselves out. How these dislocations work themselves out is different in every case. The general consequence of large budget deficits, however, is that large amounts of government debt are not good for the value of a country’s currency. I believe that this is as true for the United States as it is for any other country. The value of the dollar will continue to decline over the next several years.

My grades for the past three Fed Chairmen? Paul Volcker gets the best grade. I am assigning him a grade of plus 6.4. Ben Bernanke is second highest with a grade of negative 5.4 and Alan Greenspan comes in last with a grade of a minus 16.7. Unfortunately, when the grade is negative, we all have to pay for it!

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