The front page of the Financial Times captures the concern that has been expressed by this writer for at least the last four years. Today we see “Obama’s critics pounce on falling dollar as fears grow over currency:” (http://www.ft.com/cms/s/0/08ca4832-b36a-11de-ae8d-00144feab49a.html).
I don’t believe the focus is precisely spot on for the cause of the problem is not just Obama and the Obama administration. The Republicans are just as responsible for this crisis as is the current administration. And, the issue, to me, is not “whether or not” the dollar will remain a reserve currency. But, we will get to that.
The underlying problem is the fiscal irresponsibility of the United States government, with the exception of one administration, beginning in the 1960s. In the 1960-1968 period, the Gross Federal Debt increased at an annual rate of 2.8%. This was not bad but the die was cast. President Nixon (“We are all Keynesians now”) oversaw the beginning of excessively rapid growth rates for federal debt. The president that followed him continued these excesses. Between 1968 and 1978, the debt rose by 8.5% a year and between 1978 and 1992 the federal debt rose annually at a rate of 12.6%. During the 1992 to 2000 period the Gross Federal Debt rose by just 3.6% per year, but the budget was in a surplus by the end of the Clinton administration.
From March, 1973, right after the dollar was taken off the gold standard (again by John Maynard Keynes Nixon), until January 1992, the value of the dollar dropped by 14.5% against a basket of trade-weighted major currencies. This decline includes the period of time that Paul Volcker was the Chairman of the Board of Governors of the Federal Reserve System, a time of monetary tightening that actually brought the value of the dollar substantially above its March 1973 level. The drop in the value of the dollar from 1985 through 1992 was precipitous.
After rising by 16% over the 1992 to 2000 period, the value of the dollar plummeted during the fiscal slackness of the Bush (43) administration. By the end of this term in office the dollar was down 23%, but at one time the dollar had declined by about 40%. As the economic and financial crisis beginning in 2007 worsened there was a “flight to the dollar” for safety reasons and that is why the dollar was down only 23% at the end of the Bush (43) administration.
However, the decline has resumed. As the Financial Times points out, the value of the dollar against major currencies has fallen by 11.5% since the Obama administration has taken office.
Why? Because the Obama administration has created the expectation that the Gross Federal Debt will increase by at least the amount it increased annually in the 1968 to 1978 period!
And, although administration officials have said that they support a strong dollar (see my post of October 5: http://seekingalpha.com/article/164848-what-s-the-dollar-s-place-in-the-new-financial-order) the current leadership in Washington, D. C. seems to have about the same credibility in the market place as did the leadership in the Bush (43) administration. “Watch the hips and not the lips!”
Furthermore, yesterday the Congressional Budget Office released figures on the deficit for the fiscal year ended September 2009. It was an all-time record of $1.4 trillion! And, the estimates for the upcoming years threaten this record.
As I said earlier, I am not that concerned about the United States dollar and its reserve status. That will be a lingering concern and will take care of itself. However, there are three things that I am worried about.
First, right now, there is no end in sight of large fiscal deficits. The concern of the marketplace is that deficits at this level are unsustainable. Furthermore, with all the reserves the Federal Reserve has put into the banking system, market participants are rightfully concerned that a large portion of these deficits will have to be monetized in order for the future deficits to be funded.
The last half of the 20th century was a period that international financial markets penalized national governments that created large deficits which where seemingly going to be monetized. The most notable example of this was the time when François Mitterrand was the leader of France and had to back off from excessive budget deficits and a government controlled central bank. But, there are many other examples.
The United States escaped this punishment, although the value of the dollar did decline substantially in the 1973-2008 period, because of its position in the world and the fact that the dollar was the only reserve currency in the world. The Volcker episode and the Clinton surplus postponed the day of reckoning, but the excessive budget deficits resumed with Bush (43). This time period may be at an end!
So, my first concern is that, in the face of continued excessive budget deficits, the value of the dollar will continue to decline. This is my fundamental scenario for the next five years or so.
Second, because of this, the bargaining power of the United States in the world will be weakened more than necessary. With the rise of the BRIC countries and the Euro-zone the relative position of the United States in the world is shrinking. (See my post of October 6: http://seekingalpha.com/article/165088-the-g20-time-for-a-u-s-attitude-adjustment.) If the value of the dollar continues to decline, the bargaining power of the United States will be just that much less. This is not the way to world leadership.
Third, as the value of the dollar declines, American assets, physical assets like companies and resources, become cheaper. The “Buy America” plan can then accelerate from the pace that it has been on over the past eight years. A weaker dollar is nothing more than an invitation for foreign interests to purchase more and more of America.
The problem of the declining value of the dollar is real. Maybe we are at the stage where the political implications of the falling dollar will gather more attention. I can only hope so.