Dollar Weakness: The Debate Continues

Today, the editorial pages are full of discussion over the falling value of the dollar and what to do about it.

As could be expected, the fundamentalist preacher of a rigid, dogmatic Keynesianism, Paul Krugman, has his say in the New York Times this morning (see “Misguided Monetary Mentalities”: http://www.nytimes.com/2009/10/12/opinion/12krugman.html?_r=1). As is typical of someone that is locked into a reductionist view of the world, Krugman spends as much time calling people names as he does putting forth his dogma.

In the Financial Times we find two other points of view presented, views that are backed up by experience and historical support.

The first comment is by Roger Altman, who was in the Treasury Department during the Carter administration and was deputy US Treasury secretary in the Clinton administration. He also is an investment banker and private equity investor. Altman was present when the international investment community moved against the dollar in the latter half of the 1970s. He was also present in the 1990s when the Clinton administration had to calm international markets that had battered the dollar from 1985 until attention was given to its falling value. He has seen, at first hand, how international sentiment can respond to fiscal irresponsibility and monetary ease to force a country to adjust its economic policies. And, as he says, it is not a pretty sight.

In his comments in the Financial Times, Altman recognizes that there are still short term economic ills that need attending to (see “How To Avoid Greenback Grief”, http://www.ft.com/cms/s/0/8bdc802e-b675-11de-8a28-00144feab49a.html). But, he argues, “the dismal deficit outlook poses a huge longer-term threat. Indeed, it is just a matter of time before global financial markets reject this fiscal trajectory.”

Washington, right now, is in “a nearly impossible fiscal position.” Amen, to this.

And the problem is exacerbated because no one believes what America’s leaders are saying. In the other commentary in the Financial Times by Wolfgang Münchau (see “The Case for a Weaker Dollar”: http://www.ft.com/cms/s/0/7a6b599c-b679-11de-8a28-00144feab49a.html) the author states “I do not buy the strong-dollar pledges by Tim Geithner, Treasury secretary, and Larry Summers, director of the National Economic Council. They have to say that. It is the official policy line. The bond markets would go crazy otherwise”

But, Altman is right. There are two problems, the short run and the longer run. In the short run, attention must be paid to the weaknesses in the economy. What exactly the right policy is for this period of time is something for another post. However, there is a short run problem.

The difficulty is that financial market participants are not convinced that there is a longer-term policy. Altman states “Vague promises will not work.” And, it has been vague promises that we have been getting.

A firmer approach is needed! Altman argues that “for 2011 and beyond, the fiscal challenge is fearsome.” The United States must prepare a credible approach to its fiscal policy and present a unified front to the world that it will, in fact, bring the federal budget under control and live with that promise. Believability is crucial!

“It is true that Mr. Obama inherited the deficit. But, like Afghanistan, it is his responsibility now. Only he can forge a process for solving it.”

Mr. Münchau, in his commentary, goes through much of the argument that Altman makes, but then takes a more Euro-centric plea for a weaker dollar. To him a weaker dollar would allow for a greater balance of economic interests to be reached in the world today. This is consistent with the view that the European community play a stronger role in the Group of Twenty (the G-20) in order to achieve greater world co-operation. (See my post on this subject: http://seekingalpha.com/article/165088-the-g20-time-for-a-u-s-attitude-adjustment.) A weak dollar, to this author, is desirable because it strengthens the world monetary system. This is a policy coming from the experience of the European Union. It is grounded in the history of that body.

It does not seem, to me, to be in the interest of the United States to adopt a “weak dollar” policy, although that seems to be the one that it has adopted. As Altman states, if Geithner or Summers or Bernanke advocated a weak dollar there would be a run for the exits and the dollar would experience a dramatic decline. No, this does not seem to me to be a realistic alternative.

Thus, we are back to current fiscal (and monetary) policy. I still go back to the statement written by Paul Volcker: “the most important price to a nation is the price of its currency.” The United States cannot afford a “weak dollar” policy.

Yet, almost by default, the Obama administration is taking that path. And, the “true believers”, like Krugman, shout out Amen! Here we have someone that has not even been the chair of the Princeton Economics Department, as Ben Bernanke was before he became the Chairman of the Board of Governors of the Federal Reserve System, preaching the Keynesian gospel to those in his tent and they too, respond, Amen!

There are those that have experienced the response of world financial markets to governments that follow irresponsible fiscal budget policies. Altman is one that was on the firing line. From the past fifty years, we do know that investors will not allow these policies to continue forever.

Now I will introduce my Keynesian argument, a tactic that most commentators do at least once in their articles these days. Keynes, when asked why he changed his mind as often as he did replied: “When the facts change, I change my mind. What do you do?”

It is remarkable that the followers of an individual that was as open to new information as Keynes was keep such a reductionist mindset. Perhaps it is because their only experience comes from reading a book.