The United States Dollar in 2011

I still believe that the long term trend for the United States dollar is downward. For the near term, for 2011, I believe that the United States dollar will remain relatively strong, at least against the other major currencies in the world.

My reasoning for the belief that the long term trend for the United States dollar is downward is based on the fact that the fundamental economic policy of the United States has been and will continue to be one of credit inflation. I explain this stance using the following chart.

The general trend in the value of the United States dollar reflected in this chart is downward. If one begins in March 1973 when the value of the index was set at 100, in November 2010, the value of the dollar declined by 27 percent.

The decline in the value of the dollar since the United States floated the price of the dollar internationally in August 1971 is even greater. Rough estimates place the decline in the value of the dollar from the time it began to float against major currencies until March 1973 between 15 percent and 20 percent. This would place the decline in the value of the dollar since it was floated through November 2010 roughly at 35 percent to 40 percent.

The underlying cause of this decline in the value of the dollar began in the early 1960s as the fundamental philosophy of economic policy in the government shifted to one in which a low level of unemployment became the over-riding goal of the fiscal and monetary policies of Washington, D. C.

The immediate results of this shift in economic philosophy was the destruction of the existing “fixed-rate” international foreign exchange system as capital flows opened up throughout the world and it became impossible to maintain fixed exchange rates in the face of independent national economic policies. A world of credit inflation became the norm.

There were two interludes, that of the Volcker monetary tightening in the early 1980s and the Clinton efforts to balance the government budget in the late 1990s. These periods, however, were just temporary diversions from the basic economic thrust of the policies of both Republicans and Democrats over the full 1961 to 2010 period.

I believe that the longer term trend in the value of the United States is still downward because the fundamental economic philosophy of the United States government has not changed. Credit inflation is still the basis of any policy being proposed by the government and this has been re-iterated over and over again by the economic policy spokesman of the Obama administration, Fed chairman Ben Bernanke.

I expect that federal budget deficits over the next ten years will total more than $15 trillion and the monetary policy of the government will just support the placement of that debt over time.

I don’t see any leader in Washington with the foresight or the strength to build a more sensible economic policy. That is, I don’t see anyone “in place” or on the horizon to pull off efforts at constraint like we saw in the early 1980s or the latter part of the 1990s. Thus, the basic fundamental economic strategy of credit inflation will continue to rule Washington, D. C. for the indefinite future.

The thing that will arrest this decline in the value of the dollar in the short-run is the situation in Europe. In a real sense the United States dollar is being protected in the short-run by the fact that the lack of leadership in Europe exceeds the lack of leadership being exhibited in the United States. One does not see this situation reversing itself in 2011. The value of the United States dollar will not deteriorate further against the Euro (and some of the currencies of other major developed nations) in the coming year.

Here the scale is reversed from the above chart. The Euro weakens against the United States dollar in the early part of 2010 as the sovereign debt crisis worsened in Europe. Around June in the year some confidence picked up as the European “bailout plan” for some of the perimeter European nations seemed to be coming together. As the summer wore on, doubts arose about the potential success of the effort. This backing off continued until the speech administration spokesperson Bernanke gave at Jackson Hole, Wyoming putting forth the idea of what is now referred to as QE2, Quantitative Easing 2.

The European financial situation once again came to dominate this foreign exchange market as the problems in Greece, the accelerating political and economic problems in Ireland, were coupled with downgrades to Portuguese debt and this has now expanded to potential downgrades to Spanish debt and other “non-perimeter” countries like France and Belgium. Confidence in the leadership within the European Union continues to fall: this chaos is seen as the dominating drama still to be played out.

So to summarize: in the longer-run, the value of the dollar can be expected to decline. The reason is that the political and economic leadership of the United States does not seem to have learned much over the past 50 years. However, this decline will be further interrupted for a while as European leadership continues to exhibit its greater incompetency.

There is one other development that I think it will be important to keep one’s eye on and that is the growing movement to conduct world trade in currencies other than the United States dollar. We see that Russia and China have moved in this direction. Brazil is also interested in moving in this direction as are several other countries that have not made a “big deal” out of it yet. The important point is that the “rest of the world” seems to be moving without the United States. This is just another example of the receding influence of the United States in world economic affairs.

The "New" Economic World Order

Experts tell us that one way to solve trade problems is to let the value of your currency fall. When the value of your currency declines relative to other currencies, your exports will rise and your imports will fall. This seems to be the accepted theory.

This seems to be what the Federal Reserve is trying to do. “U. S. officials are determined to push the dollar lower” we read in the Wall Street Journal Wednesday commenting on the minutes from the September meeting of the Fed’s Open Market Committee. (See “Fed Viewed as Trying to Devalue Dollar”: http://professional.wsj.com/article/SB10001424052748703440004575547553908304106.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj.)

Maybe, however, there is another part of this theory that is not being considered. Remember, in economic theory there is a “ceteris paribus” assumption attached to all models: thus we assume “all other things the same.”

One of the other assumptions made when discussing the value of a country’s currency is that the relative productive power of all the countries considered remains the same.

My question is, can we assume that the United States, over the past fifty years, has maintained its relative position in the world with respect to its productive power?

I ask this question because it appears as if the continued decline in the value of the dollar has not improved the trade balance of the United States, especially against many of the emerging nations.

The value of the dollar goes down…the trade balance…if anything…worsens.

This is not the way it is supposed to be. Thus, something else must be at work.

The United States has been on the top of the world since the late 1940s. It continues to act as if nothing has changed.

I will respond with just two broad comments on this situation.

First, the economies of the emerging nations are developing: they are developing rapidly; and they are developing in a very competitive way.

Second, the United States has followed an economic philosophy in terms of policy over the past fifty years that has weakened it in many ways. I have presented this case on many occasions in recent weeks.

“Other things” have not remained the same, yet leadership in the United States continues to assume that they have.

As a consequence, to the leaders of the United States, the problem is “out there.” The problem is China!

One of my favorite Stephen Covey quotes is this: “If you believe the problem is ‘out there’; that’s the problem.”

My belief is that as long as the leadership of the United States believes that the problem is ‘out there’, that will be the problem.

Excess Capacity and the Slow Economic Recovery

Ben Bernanke spoke in New York yesterday and, depending upon which paper you read this morning, he basically said one of two things. First, he said that the Fed was interested in a strong dollar and would continue to keep the value of the dollar in mind in deliberations concerning monetary policy.

Chuckle, chuckle.

Second, Bernanke said that the pain in the labor market was going to last for a long time and that we shouldn’t expect the unemployment rate to fall anytime soon.

That is, don’t expect interest rates to begin to rise in the near future.

Remember, the number one policy goal of the Federal Reserve (and the federal government) is full employment and don’t you forget it. Put inflation, commodity prices, and the value of the United States dollar on the back burner.

So much for an independent Fed!

But, we knew that.

The problem with the economic recovery and unemployment is captured by an article in the Wall Street Journal, “Auto Industry Has Room to Shrink Further,” (see http://online.wsj.com/article/SB125832250680149395.html?mg=com-wsj.) Although the article focuses upon the auto industry, the situation that is described can be extended to many other major (and minor) industries throughout the world.

“Over the past two years, the global auto industry has endured one of the worst downturns in its century-plus history. Auto makers around the world have consolidated, restructured and slimmed down—and yet they still have too much of just about everything, especially too many brands and too many plants.”

“According to CSM Worldwide, the auto industry has enough capacity to make 85.9 million cars and light trucks a year—about 30 million more than it is on track to sell this year, the equivalent of more than 120 assembly plants.”

Furthermore, an auto analyst is quoted as saying, “government intervention to save auto-related jobs has forestalled the inevitable—broad and deep restructuring that would shut down unneeded plants and close loss-making enterprises. Not as much capacity has come out that should have.”

This is just talking about the auto industry. But, it is true of industry in general. The United States and the global economy have become leaner due to the current contraction: still, much excess capacity remains.

Even though capacity utilization for all industry is up in the United States (note that capacity utilization for manufacturing in October did not change from September), giving further indication that the recession is over, the problem of too much capacity lingers. As I have mentioned many times before, every economic recovery since the 1960s has seen a pickup in capacity utilization as economic growth increased, but the peak reached in each cycle was no higher, and was generally lower, than the peak reached in the previous cycle.

That is, capacity utilization rose during the expansion phase of each economic cycle since the 1960s but the trend in the United States was for more and more plant and equipment to remain idle.

In addition, this contributed to the under-utilization of labor as is evidenced by the rising trend in those of the population that are labeled underemployed .

Also, as the federal government, and the independent Federal Reserve System, tried to pump up the economy so that fuller employment could be achieved, the pressure was always on for inflation to rise. Since January 1961, the purchasing power of the dollar has fallen by about 85%. This is not a coincidence!

Furthermore, these policy efforts just put people back to work in the jobs they had been in and reduced the incentive for companies to innovate and change moderating productivity growth.

The performance of industrial production in the United States carries with it the same story. (Industrial production is up in October, but at an anemic 0.1% rate.) The growth rate of industrial production rises and falls through the swings in the economic cycle, but each rebound does not bring with it the same expansion as was achieved in previous cycles. This is just another indication that although recovery takes place, the overall trend in the productive utilization of resources in the United States continues to wane.

This fundamental weakness resource utilization is resulting in changing attitudes throughout the world. David Brooks writes in the New York Times about the underlying optimism that seems to be present in China these days, an optimism that used to be present in the United States. Simon Shama writes in the Financial Times about how China is now “wagging its finger at the United States about it wayward monetary and fiscal policies, as yet, still unaccustomed “to being the strong party in the relationship.” Clive Crook, also in the Financial Times, writes about the looming political battle in the United States concerning the “big questions” that voters have to answer “about the entitlements they demand and the taxes they are willing to pay.”

The United States is strong and will continue to stay strong. But, its relative position is changing. And, the way its leaders go about attempting to resolve problems is missing the point.

The United States economy is recovering. But, unless policy prescriptions change, there will continue to be an under-utilization of capacity, a weakness to productivity growth, a bias towards inflation, further declines in the United States dollar, and the threat of protectionism.

It is said that people and a nation do not change their habits until there is a real crisis. Right now it looks as if we have wasted a pretty significant financial crisis in returning to our old ways and old policy prescriptions and will just have to be content with an economy that produces mediocre results. No one seems anxious to change how we attack our problems.

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.

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.