A Word on the Dollar from Mr. Wolf

Another commentary on the state of the dollar, well worth reading, is that written by Martin Wolf and presented by the Financial Times this morning (see “The Rumours of the Dollar’s Death are Much Exaggerated”: http://www.ft.com/cms/s/0/9165b8b0-b82a-11de-8ca9-00144feab49a.html.)

Wolf begins by stating that “It is the season of dollar panic.” He then specifically lists two, gold bugs and fiscal hawks that believe that the dollar “is on its death bed. Hyperinflationary collapse is in store.”

I presume that Mr. Wolf would classify me as a “fiscal hawk”, but I do not believe that “Hyperinflationary collapse is in store.”

I do believe that the dollar will remain weak as long as the fiscal stance of the United States government remains as it is, so that the trend in the value of the dollar will continue to be downward. I do not believe that a “hyperinflationary collapse” is imminent.

The reason I believe that this will be the case is that the international investment community will continue to be on the sell side of the dollar as long as the United States government continues to run the size of deficits that it is now running and has no credible plan to bring future deficits under control.

I believe this for the same reason that was stated by Robert Altman, former deputy US Treasury secretary, in his commentary in the Financial Times yesterday (see “How to Avoid Greenback Grief”: http://www.ft.com/cms/s/0/8bdc802e-b675-11de-8a28-00144feab49a.html.) 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, this response on the part of international investors was a common thread in the latter part of the 20th century. France, as well as a dozen or more other countries can provide similar stories.

And Altman argues that “the dismal (US) deficit outlook poses a huge longer-term threat. Indeed, it is just a matter of time before global financial markets reject this fiscal trajectory.”

I support Wolf’s reading of the recent decline in the value of the dollar. He states: “In the recent panic, the children ran to their mother even though her mistakes did so much to cause the crisis. The dollar’s value rose. As confidence has returned, this has reversed. The dollar jumped 20 per cent between July 2008 and March of this year. Since then it has lost much of its gains. Thus, the dollar's fall is a symptom of success, not of failure.”

Note, however, Wolf’s statement, I believe, that the mother, the United States, “did so much to cause the crisis” through “her mistakes” needs to be clarified. What he doesn’t say is that United States monetary and fiscal policy contributed a decline in the value of the United States dollar of about 40 per cent ending in July 2008! I agree with Wolf that the jump of 20 percent came about due to the fact that “In the recent panic the children ran to their mother.”

The subsequent decline in the value of the dollar, in a perverse way, is therefore “a symptom of success” because through the actions of the United States government (as well as many other governments throughout the world) the financial panic ended and so “failure” was avoided.

To me, the return to a declining value for the dollar is nothing more than a return to the pre-crisis situation in which the world investment community is concerned with the huge deficits being produced by the United States government and the fact that there is really no credible scenario being presented by the leaders of the government that these will be in any way reduced in the future. The connected concern with this fact is that, historically, governments cannot contain the underwriting of these deficits by the nation’s central bank over the longer haul. It’s not the fact that the international investment community sees hyperinflation coming down the path, just that historically the evidence is not in place to have a strong belief that an independent monetary authority will be able to offset the substantial increases in debt that are forecast.

I also agree with Mr. Wolf’s assessment that nothing, at the present, can replace the dollar. Whereas I don’t have the space in this post to go into the very cogent discussions that are presented by Mr. Wolf on this issue, I can come out where he does, without having travelled exactly the same road that he has followed.

I believe that over time the global role of the dollar will lessen. I believe with Mr. Wolf that “the global role of the dollar is not in the interests of the US. The case for moving to a different system is very strong.” I agree that the reason that a different role for the dollar is needed is because the current role “impairs domestic and global stability.”

I would just like us to get to this new system by a different path than that proposed by Mr. Wolf or by his colleague at the Financial Times, Gideon Rachman (see my post of October 6, 2009: “The G20: Time for a US Attitude Adjustment”: http://seekingalpha.com/article/165088-the-g20-time-for-a-u-s-attitude-adjustment.)

The world has changed and will continue to change. The United States and the United States dollar will continue to be powerful; they just will not be as relatively powerful in the future as they have been in the past. This has to be taken into consideration by the United States government as it goes forward, but the new system must not be negotiated with the United States government reeling and in a defensive position from continued pressure on the value of its currency.