Euro Drops Below $1.30

This morning the value of the Euro dropped below $1.30.  The United States should thank the European Union for the diversion it has created.  With all the turmoil taking place in Europe, little attention is being paid to the monetary and fiscal policies of the United States and the impact these policies are having on the value of the United States dollar against other major currencies. 

As can be seen in the following chart the value of the United States dollar against other major currencies in the world continues its secular decline.  In terms of monetary policy and fiscal policy, international financial markets continue to give a negative rating to the United States and continue to see further future declines in the value of the dollar.

I continue to believe that, given the current policy leanings of the United States government, that the value of the United States dollar will continue to decline in the future.  Since the early 1960s the United States government, both Republican and Democrat, has generally followed a policy of credit inflation that resulted in the United States going off the gold standard and then resulted in the secular decline in the value of the dollar since President Nixon floated the dollar’s price in August 1971.  The two exceptions to this secular decline occurred when Paul Volcker was the Chairman of the Board of Governors of the Federal Reserve System in the early 1980s and when Robert Rubin was the Secretary of the Treasury in the Clinton administration in the latter part of the 1990s.

To me, there the Obama administration has continued the policy of credit inflation carried on by his predecessors and perhaps even improved upon it. 

The only times that the value of the dollar has rebounded over the past several years has been when there has been a “flight to quality” in US Treasury securities.  Other than this the value of the dollar has continued to decline except relative to the Euro.

Again, it seems to me that the United States should thank the European officials for all their follies because they have taken attention away from the political mess in the United States and the continued weakness in the value of the United States dollar in the world.   

Winning Strategies

Good teams find ways to win even when the calls go against them, even when the weather is bad, and even when their opponents change their strategy. 

Bad calls are a part of sports…and business…and politics.  You have to go on.  It is a part of the game.  Yes, the ref missed the call, but you still have to play out the rest of the game.  Sure, Standard & Poor’s may have not handled the ratings adjustment and timing in the best way possible, but the Obama administration knew that the government’s bond rating might be changed and it also knew that the United States had fiscal problems, political problems, and economic problems. 

The announcement on Friday evening was not a surprise.  Yet, the administration chose to claim that Standard & Poor’s was “incompetent and not credible.”

To some this puts the United States right up there with Greece…and Portugal…and Spain…and Italy.  The blame rests elsewhere.  This is what losing teams do.

The weather, the external environment, is a part of games…and business…and politics.  Yet, your opponent, others, has to face the same external environment that you do.  The snow or wind or rain made playing rough, but the game continues.  Sure, the economic conditions being faced by the United States are difficult, but the Obama administration has been facing them for two and a half years, as have many other countries, and blame cannot continually be placed upon the Bush(43) administration or the rest of the world. 

Again, losing teams put the blame on somebody or something else, like speculators, like rating agencies, like previous Presidents.  And, then they keep on doing just what they have been doing in the past.

Opponents change their strategies during games, or, they may change personnel.  Given the refereeing, given the weather, given the strategy you are pursuing, your opponents may alter the way they do things in order to take advantage of your strategy or your personnel or the weather.  Yes, the Republicans won the mid-term elections, sure the Tea Party advocates came on very strong, and sure the economy did not respond the way that the Obama administration expected, but that is not a reason to blame these factors as a reason why the Obama team didn’t succeed. 

President Obama relied on the same strategy and game plan established at the start of his presidency.  Every issue was addressed by a speech after which the construction of a plan, whether for health care, financial reform, or debt control, was turned over to Congress.  The opponents of President Obama changed how they played the game and largely succeeded in their efforts because the Obama team played the game exactly as they had in the past.      

Losing teams always seem to blame other factors, like their opponents changing strategies for their failures. 

It is obvious that there is great concern in the world over the financial affairs of governments in the United States and Europe.  Yet, these governments continue to claim that others are imposing the problems upon them.  And, as this attitude continues, we all are worse off for it.  This is the way losers play the game. 

The conditions are what they are.  The people in power need to make adjustments to their game plans…they cannot continue to follow the same strategies they have been pursuing in the past.  When is it going to become obvious to these people that what they are doing is not working.  When are they going to realize that the past is the past and that maybe they need to listen to new voices?   Politicians are supposed to be pragmatic…so let’s seem some of that pragmatism.

Where should they start?   

I believe that the United States government needs to change its economic objective.  For more than fifty years, the primary economic objective has been to achieve high levels of employment…a low unemployment rate.  Under this objective, the percentage of people working in labor force has dropped to an historic low of about 55 percent and the underemployment rate has risen to about 20 percent of those of employment age.  Furthermore, pursuing this policy objective has resulted in an income/wealth distribution skewed more toward the rich than ever. 

To continue to maintain this policy as the number one priority of the United States government is like a football team continuing to run the same play over and over again even though the opponent has stacked the defense to stop that very play.

To me, the primary objective of United States economic policy should be the maintenance of a strong dollar.  Although every presidential administration for the past fifty years has supported a “strong dollar”, the policy of credit inflation followed by both Republicans and Democrats to achieve high levels of employment for the past fifty years has achieved exactly the opposite end.  First, the United States dollar was taken off the gold standard on August 15, 1971 and its value was allowed to float.  Next, the credit inflation policies followed by these Republican and Democratic administrations have resulted in a decline in the dollar in world markets of about 40 percent since 1971.

The game plan of credit inflation to achieve low levels of unemployment has not succeeded and the standing of the United States in the world has suffered for it.  That game plan needs to be changed. 

A strong dollar is the foundation for a strong economy because the emphasis is placed upon the competitiveness and innovative capabilities of the businesses and workforce of the economy.  The government must be concerned with education and training, with the ability of companies to innovate and change, and with incentives for people to start and grow companies.  High levels of employment and labor participation are achieved in this way. 

Putting all the emphasis on credit inflation to ensure high levels of employment works against the things mentioned in the previous paragraph.  Credit inflation works to put people back in their old jobs rather than encourage innovation and training to raise productivity and change.  Credit inflation puts emphasis on financial leverage and financial innovation and leads to the financial sectors of the economy becoming more important than the manufacturing sectors.  And, credit inflation results in the income/wealth distribution becoming more skewed toward the wealthy. 

If the basic philosophy of the Obama administration continues to be one based on the further application of credit inflation to the economy it will have fundamental problems going forward.  One, economic growth will continue to stagnate.  Two, the administration will face greater and greater opposition, first, from its opponents because they will see that nothing has changed in the game plan and that the game plan is not succeeding; and second, because its supporters will become more and more dissatisfied with its performance.  Three, potential outside opponents, like China, Russia, Brazil, and so forth, will prepare much more aggressive game plans against the United States because they can smell the weakness.  Note the responses of China, Russia, and others, to the Standard & Poor’s downgrade. 

Winning teams focus on building strong organizations with the best personnel for the times and with the best game plans for the game they are playing.  They adjust with the conditions.  They find ways to win.  And, they do not make excuses.  

A Problem With Large Government Deficits

 When one discusses large government deficits the discussion generally centers on either the ability of the government to finance those deficits in financial markets or the need to “monetize” the debt, thereby creating the possibility of substantial future inflation.

There is another problem that doesn’t get as much attention yet is very, very important for the running of the government.  It is a problem the United States government is now facing. 

If a government (or anyone for that matter) is running a large deficit in its financial budget then the very existence of such an excessive budget restricts the government in what else it might be able to do.  That is, the government’s flexibility in taking on new expenditures is severly limited. 

The United States government is facing this problem in several areas at this very moment.  Let’s review a couple of them.

The United States government is facing tremendous competition from China in international trade and finance.  The United States is very limited in its ability at this time to respond to the initiatives that the Chinese are making in the world…politically and economically. 

“Flush with capital from its enormous trade surpluses and armed with the world’s largest foreign exchange reserves, China has begun spreading its newfound riches to every corner of the world—whether copper mines in Africa, iron ore facilities in Australia or even a gas shale project in the heart of Texas.”  This comes from the article “As China Invests, U. S. Could Lose,” in the New York Times. (http://www.nytimes.com/2011/05/04/business/global/04yuan.html?ref=business)

A “study, commissioned by the Asia Society in New York and the Woodrow Wilson Center for International Scholars in Washington, forecasts that over the next decade China could invest as much as $2 trillion in overseas companies, plants or property…”

The United States government and United States business does not have that much “dry ammunition” to combat such an investment program.  And, as U. S. government policy continues to underwrite a weak dollar, the ability to take on such an investment program internationally continues to fade into the background.  But, other BRIC nations pose such a challenge as well.

Yet, the United States cannot afford to be un-competitive in this area.

Also this morning we read about the plight of United States regulatory agencies: “US Regulators Face Budget Pinch as Mandates Widen.”  (http://dealbook.nytimes.com/2011/05/03/u-s-regulators-face-budget-pinch-as-mandates-widen/?ref=business)  In effect, as Congress has given banking and financial regulators more to do, due to the recent financial crisis, the regulators find that they are finding less and less money to carry out the new charge they have been given. 

Many of us may not be upset with this situation, still it points to the fact that with the large budget deficits forecast into the future, the United States government just cannot commit to fund certain programs people have wanted to see become more aggressive. 

One final situation that has recently occurred.  This has to do with the situation in Libya.  Many have argued that the United States cannot take on more military roles in the world because it just cannot pump up the expenditures on the budget to meet such responsibilities.  Consequently, since it favors military actions in selected spots, such as the one in Libya, it cannot fully participate in the exercise and must get others, like NATO, to carry the burden of the effort.

The question then becomes, “Is this budget constraint keeping the American government from doing things in other areas it believes it should be involved in?”  Like in Yemen or Syria?

The problem is that one can’t do everything…even if that “one” is the richest and most powerful nation in the world and oversees the reserve currency of the world.  And, this is the problem with lots of debt.  It allows “one” to live beyond ones means for a while…but then there is always the possibility that “one” will need to do more…and can’t.

It is an issue of management and discipline.  One cannot constantly push debt limits to the extreme and then expect to be able to go further into debt should the occasion arise at some time in the future. 

Boy, this idea seems “old fashioned”!

But, this is exactly what the United States government has been doing…and it has been doing it for an “extended period”…it has been doing it since the 1960s.  This is the foundation of the credit inflation we have been experiencing for the last fifty years.

And this is the foundation of the decline in the value of the United States dollar for the past fifty years and for the terrible balance of trade situation the United States finds itself in which has led to the surplus of dollars in the hands of the Chinese and others. 

I know…if the value of the dollar declines, the trade deficit should get smaller.  I tried to respond to this issue earlier.  See my post “Does a Decline in the US Dollar’s Value Reduce the Balance of Payments Deficit”: http://seekingalpha.com/article/265072-does-a-decline-in-the-u-s-dollar-s-value-reduce-the-balance-of-payments-deficit. 

The value of the dollar continues to decline because those in international financial markets don’t observe the “management and discipline” in the Unites States government that is necessary to change what goes on relative to the budget of the United States government. 

In my view, the United States government does not have to do much to gain the confidence of world financial markets.  The first thing the government must do is accept the goal of maintaining the value of the United States dollar in foreign exchange markets as its primary economic objective.  (I have discussed this in a post to my Instablog, “What is Needed to Reduce the Federal Deficit”: http://seekingalpha.com/author/john-m-mason/instablog.)

This would allow two things to happen.  First, the United States government could get away from its current primary goal, the Keynesian goal of achieving full employment, which it cannot accomplish anyway. (See my post from yesterday: http://seekingalpha.com/article/267307-the-new-way-of-conducting-business.)  The exchange rate goal incorporates an inflation goal within it.

Second, the government needs to focus on “good” long-term management and discipline in its budgetary practices.   Good, long-term management pays off.  My recent example of this is the efforts led by Treasury Secretary Robert Rubin in the latter part of the 1990s to balance the United States budget.  International financial markets saw this effort; believed that President Clinton and others within his administration supported the effort; and the value of the US dollar began to climb in foreign exchange markets even before a balanced budget was achieved. 

The important thing to note is that the economy also got stronger during this time so that the government achieved not only a greater balance in the budget and a rising value of the US dollar, but it also saw the US economy continue to grow.  International financial markets approved of the “management and discipline” that it believed it saw in the United States government.  Plus, this effort created some room for the Bush 43 administration to add additional “unexpected” expenditures to the budget ,as they were needed, such as the “war on terrorism.

Almost One-Half of Cash Assets in Commercial Banks are Held by Foreign-Related Institutions

Check this out: on April 6, 2011, Commercial Bank Reserve Balances with Federal Reserve Banks totaled $1.503 trillion (Federal Reserve Release H.4.1); for the two weeks ending April 6, 2011, Excess Reserves at depository institutions in the United States averaged $1.431 trillion (Federal Reserve Release H.3); and on March 30, 2011 Cash Assets held by Commercial Banks in the United States were $1.558 trillion (Federal Reserve Release H.8).

All these measures of excess cash in the commercial banking system seem to center around $1.5 trillion.

The Federal Reserve also reports that on March 30, 2011 the cash assets held by Foreign-Related (banking) Institutions in the United States totaled $702 billion or right at 45 percent of the cash assets held by commercial banks in the United States on that date!

The Federal Reserve policy of Quantitative Easing (QE2) is supposed to spur on bank lending which, hopefully, will contribute to a faster growing economy and lower unemployment.

The published figures indicate that a very large portion of the funds the Fed is injecting into the economy is going into the “carry trade” and contributing to the spread of American liquidity throughout the world.

One rationale that has been given for the policy that the Fed has been following is that when commercial banks aren’t lending (that is, there is a liquidity trap), the Federal Reserve needs to inject as much liquidity into the banking system as possible until the banks begin to lend again. This is the essence of quantitative easing.

This rationale was developed by people who studied the history of the Great Depression. Milton Friedman contended that a central bank should follow such a policy when faced with a banking system that was not expanding the money stock. Professor Ben Bernanke also suggested that such a policy be followed.

However, in the current environment, there are two things that seem to be different from that earlier period. The first relates to the international mobility of capital: in the period around the 1930s nations did not support the free flow of capital throughout the world because the international financial system was based on the gold standard and foreign exchange rates fixed in terms of the price of gold.

Thus, with international capital flows constrained, it was argued that a country could keep a fixed foreign-exchange rate for its currency and conduct its economic policy independently of other countries, thereby allowing the country to focus on reducing unemployment to more acceptable levels. The policy prescription advocated by Friedman…and Bernanke…could, therefore, be followed within such a world without major foreign repercussions.

This is not the situation that exists now. Capital flows freely throughout the world.

The second factor is that there was no designated national currency that was designated as the “reserve currency” of the world. Thus, currencies were seen as either fixed in value or were allowed to freely float in foreign exchange markets. (I am not dealing with “dirty” floats and so forth at this time because they are related to currencies that are not designated as “reserve” currencies.)

And, since the United States dollar serves as the reserve currency of the world and, because of this, is the default currency when there is a “flight to quality” in world financial markets, the value of the dollar does not fall to the level that is needed to allow the Federal Reserve to conduct its monetary policy independently of all other nations.

The consequence is that the Federal Reserve is inflating the whole world!

It is great for the currency of a country to be the reserve currency of the world. However, being the reserve currency of the world carries with it responsibilities.

One of these responsibilities is that the United States cannot conduct its monetary policy independently of everyone else!

The value of the United States dollar is higher than it would be if it were not the reserve currency of the world. As a consequence, the behavior of the value of the United States dollar does not act exactly as if it were determined if it were a freely floating currency in the foreign exchange markets.

Therefore, the monetary policy of the Federal Reserve, given the free-flow of capital throughout the world, cannot be conducted in isolation.

We are seeing the result of this situation right before our eyes.

The Federal Reserve is pumping money like crazy into the commercial banking system. And, 45 percent of the money is ending up in foreign-related financial institutions.

This, I believe, is not what the Federal Reserve wanted.

This, I believe, is not what the people of the United States wants.

And, I believe, that this is not really what the rest of the world wants.

Still, QE2 continues, unabated.

How Much Should the United States Cut the Deficit?

How much should the United States government cut its budget deficit?

This seems to be the big debate in Congress surrounding discussions/negotiations related to the new fiscal budget.

The problem as I see it is that the United States government is focused on the wrong objective! It is focused on an objective, low levels of unemployment that it cannot achieve without creating all other kinds of distortions in the economy, distortions that produce, in many cases exactly the opposite result from what the government is attempting to achieve.

Let me tell you what objective I believe the United States government should focus upon in determining its economic policy stance, which includes its fiscal budget.

I believe that the primary economic focus of the United States government should be on the value of the United States dollar. I believe that the United States government should attempt to stabilize and maintain the value of the dollar in international currency markets.

The current focus of economic policy in the United States government is employment…or low levels of unemployment. This objective was memorialized in The Employment Act of 1946 which set placed the responsibility for achieving high levels of employment, or low levels of unemployment on the back of the United States government.

In 1978 this objective was re-enforced by a new act, The Full Employment and Balanced Growth Act (known informally as the Humphrey–Hawkins Full Employment Act). This act just made stronger the government’s commitment to the achievement of low levels of unemployment.

The ability of a government to achieve full employment was contested in 1968 by the economist Milton Friedman who contended that continued governmental stimulus to achieve a “hypothetical” level of employment, called “full employment” would only achieve more and more inflation as people came to expect the government’s efforts to stimulate the economy through the creation of credit expansion…credit inflation.

Friedman’s expectations proved to be true as the government continued to promote government deficits and the expansion of government debt in economy.

From 1960 through 2010, the gross federal debt of the country expanded at an annual compound rate of more that 7% per year.

From 1960 through 2010, the purchasing power of the United States dollar declined by about 85%.

From 1960 through 2010, the United States removed itself from the gold standard and allowed the value of the United States dollar to float in foreign exchange markets. The value of the United States dollar has declined by more than 30% since it was floated and expectations are for it to decline further.

From 1960 through 2010 under-employment in the United States has gone from a relatively modest number which was not measured at the earlier date to more than 20% in the current environment.

From 1960 through 2010 manufacturing capacity has declined from about 95% to about 75%. The peak capacity utilization has every cycle since the early 1970s has been at lower and lower levels.

From 1960 through 2010 the income distribution of the United States has become dramatically skewed toward the higher levels of income earned. This is the most skewed income distribution curve ever for the United States.

I cannot see how the United States government can continue to keep “full employment” as a goal of its economic policies. Not only has “full employment” not been maintained, it has generated side effects that, it seems to me, has substantially worsened the life of many Americans.

Why should the government substitute the maintenance of the value of the United States dollar as its primary objective for the conduct of its economic policy?

Here I quote Paul Volcker: “a nation’s exchange rate is the single most important price in (the) economy; it will influence the entire range of individual prices, imports and exports, and even the level of economic activity. So it is hard for any government to ignore large swings in its exchange rate.” This quote is from Paul Volcker (“Changing Fortunes: the World’s Money and the Threat to American Leadership,” by Paul Volcker and Toyoo Gyohten, Times Books, 1992, page 232.)

Yet “ignore large swings in its exchange rate” is exactly what the United States did and is doing. The consequences of ignoring this value? I have reported those above.

By focusing on the level of unemployment the way the United States government did and pursuing an economic policy of credit inflation, the United States government actually weakened the country and hurt its citizens. The “unintended results of good intentions!”

The United States government should not, and realistically cannot, reduce its budget deficit too rapidly. Markets realize that.

But, the United States government must signal that it is changing the objective of its economic policy and is sincerely pursing a path to reduce or even eliminate the credit inflation it has inflected on its country…and the world…for the last fifty years.

My guess is that until international financial markets see this shift in policy objectives and sense a realistic change in the attitudes of the politicians in Washington, D. C. the dollar will continue to decline in value because participants in international financial markets will just see the government continuing to act in the same way it has over the past fifty years, acting in a way that will continue the policy of credit inflation.

And, if the government continues to act in this way, the economic health of the economy will continue to deteriorate and the standing of the United States in the world will continue to become relatively weaker.

In my view the government does not have to reduce the deficit by massive amounts this year. It does, however, have to signal that it is changing its goals and objectives and then provide enough evidence of this change in focus to convince the international financial markets that it is sincere.

In the current political environment, however, this may be too much to ask.

Inflationary Expectations, the Dollar, and the 10-year Government Bond Yield

On Saturday, Allan Meltzer made the statement that “Inflation is coming.” Like the 1970s, we are in for another bout of high unemployment and inflation, which “flummoxed” the Federal Reserve’s policy committee and created a situation in which ”inflation and unemployment rose together throughout the decade.” (http://professional.wsj.com/article/SB10001424052748704709304576124033729197172.html?mod=ITP_opinion_0&mg=reno-wsj)

The market evidence for this?

“Commodity and some materials prices have increased dramatically in the past year. Countries everywhere face higher inflation. Despite the many problems in the euro area, the dollar has depreciated against the euro, a weak currency with many problems, suggesting that holders expect additional dollar weakness.”

The above chart shows that value of the United States dollar relative to the Euro. As the line rises the dollar weakens. In the early part of 2010, the Eurozone seemed to fall apart as the fiscal problems faced by sovereign governments created a financial collapse. The Euro declined against other currencies in the world.

By the summer of 2010, some quiet had returned to Europe and the Euro began to strengthen again against the dollar moderating late in the season around$1.27. However in late August 2010, Fed Chairman Ben Bernanke announced that QE2 was on the horizon and, as can be seen, the value of the dollar fell dramatically reaching the $1.40 neighborhood in November.

Although the value of the dollar rose again toward the end of the year, it again appears to be under siege as the dollar has fallen back into the $1.36-$1.37 range. So, in spite of its weakness, the value of the United States dollar seems to be losing ground relative to the Euro.

The key to this behavior Meltzer believes is the expectation of inflation. It is assumed by many that inflationary expectations get built into interest rates. I have just written on the current situation, the recent changes in inflationary expectations and the possible future movement in interest rates. See my post, “Long-Term Treasury Yields and Inflationary Expectations.” (http://seekingalpha.com/article/250838-long-term-treasury-yields-and-inflationary-expectations)

Here we have a chart the yield on 10-year Treasury securities. Note the decline in the yield that took place in the early part of 2010 to the fall. Many argue that this decline was due to a flight-to-quality as the investors left the sovereign debt of Eurozone countries and brought their money to invest in US Treasury securities.

Whereas the announcement of the coming of QE2 came in late August (and rates bounced up on the very next trading day after the Bernanke speech), the actual plan of action for QE2 was released in October and the Fed began conducting the QE2 in November. As can be seen in the above chart, the yield on 10-year treasuries has risen ever since. The last day in this chart is February 4. On February 8, the yield on the 10-year treasury security closed over 3.70 percent, a rise of 150 basis points since the late August date of Bernanke’s speech.

The argument can be made that participants in the financial markets are so sensitive to the possibility for future inflation that on the very next market trading day following the Bernanke statement, inflationary expectations began to build in the bond markets. And, the buildup of these inflationary expectations was also experienced in the market for the United States dollar and the dollar traded weaker even to the Euro even though the Eurozone was experiencing many fiscal and financial problems.
One can see this more clearly in tracing the value of the dollar indexed against major currencies. Here it is obvious that the dollar is trading at the lows reached over the past year and is even threatening the post- World War II lows reached in the summer of 2008.

It appears as if many investors in world financial markets agree with Allan Meltzer that, in fact, “Inflation is coming.” It is just the United States government that doesn’t see this.

How Long will the United States Dollar be a Safe Haven?

“The U. S. dollar is recapturing its role as the primary safe-haven currency, eclipsing the yen and the Swiss franc, as tensions in Korea and Europe escalate.

That re-emergence as the ultimate sanctuary for those fleeing risk will likely result in continued strength against major rivals in the next few weeks, analysts expect.

‘Recent events just reinforce the underlying message that during times of turmoil, almost no matter what the source, the U. S. dollar is seen as a safe harbor for investors,’ said Doug Porter, an economist at BMO Capital Markets in Toronto.” (http://professional.wsj.com/article/SB10001424052748704008704575639022158300444.html?mod=ITP_moneyandinvesting_1&mg=reno-wsj)

The question is “how long will the U. S. dollar remain a safe haven?

Twice in the past three years, the United States dollar has served as a “safe haven” for the world. Once, following the financial collapse in the fall of 2008, the value of the United States dollar against the currencies of major currencies rose from a trough in March 2008 of 70.3 to a peak of 84.0 in March 2009.

The next trough came in November 2009 at 72.2, but the sovereign debt crisis in the Euro-Zone in early 2010 caused the value of the dollar to rise again as a “safe haven”, peaking at 79.0 in June of that year.

After June the dollar, once again, continued to decline, falling to 71.0 in the first full week of November 2010. As mentioned above, the value of the United States dollar is now climbing.

Most analysts, including myself, believe that the long term trend in the value of the dollar is down. The United States government is basically un-disciplined with little or no self-control. This is not a slam against the Democratic Party because I believe that the Republicans have acted in a similar way. Fiscal deficits have led to mountains of federal debt, and the example set by the federal government has been emulated by the public at large over the past fifty years building up more-and-more debt over time. The Federal Reserve has supported this credit inflation and has even underwritten a large portion of it…and promises to underwrite a whole lot more.

The consequence of this lack of discipline and self-control has been reflected in the decline in the value of the dollar over the past forty years, since President Nixon floated the dollar. The chart below just shows us what has happened over the past ten years where the primary culprit has been the Republican Party.

From the peak value reached in February 2002 the dollar reached a trough in March 2008, 37.3 percent below the earlier peak. The dollar became a “safe haven” in the fall of 2008 and moved from its March trough to a short-term peak in March 2009, rising by 19.4 percent. Once this move was over, the value of the dollar dropped once again, this time by 15.5 percent.

The point is, the long-term pressure on the value of the United States dollar is to decline. This can be observed very clearly in the accompanying chart.

Since the value of the dollar was floated and the current data series began, January 1973, the dollar has declined by about 34.4 percent. So, the general trend of the value of the dollar since it was set free has been downward. Over the longer haul, nothing has really changed much in the way of American economic policy.

The bottom line to all of this is that nothing has changed in the past fifty years as far as the fundamental philosophy behind the economic policy of the federal government. The long run prospect for the value of the dollar is down!

There will be upswings, flights to the “safe haven”, but the basic trend will be downwards.
But note, the 2008 recovery in value of the dollar went on for about one year before the decline set in again. Therecovery in value associated with the euro-zone sovereign debt crisis lasted only seven months before the movement down began once more. The short-term peak reached in 2010 was 6.0 below the previous peak in 2009.

How long will this move into the dollar “safe haven” last and how high will the value of the dollar reach?

My guess is that the value of the dollar will move upwards for several months. The peak will be somewhere in the neighborhood of the March 2009 peak and the June 2010 peak. But, the decline will begin once again.

And, the longer run? As the periphial countries in the euro-zone get their acts together and become stronger over time, attention will look for other countries that need to be chastized. After Greece, Ireland, Portugal, Spain, Italy, and possibly France…will the focus of the financial markets turn to the Unitred States…and not as a “safe haven”?

The Federal Reserve's Report Card

The headline reads “Conservative Republicans Propose to Pare Back Federal Reserve’s Dual Role.” (See http://www.nytimes.com/2010/11/17/business/economy/17fed.html?_r=1&ref=todayspaper.)

The Federal Reserve has been given two policy goals in the last half of the 20th century. The first policy goal given the Fed, the goal of full employment, was enacted into law in 1946. This act was called “The Employment Act” and it mandated that the federal government do everything in its authority to achieve full employment, which was established as a right guaranteed to the American people. This was supplemented in 1978 by “The Full Employment and Balanced Growth Act” also called the Humphrey-Hawkins Full Employment Act which encouraged the federal government to pursue "maximum employment, production, and purchasing power".

The inclusion of “purchasing power” introduced into government legislation the goal of maintaining stable prices, the second policy goal for which the Federal Reserve is responsible for.

The concern of the Conservatives regarding the “Dual Role” can be expressed in thoughts coming from the economist Milton Friedman. First, monetary policy does not determine the level of employment in the economy in the longer run. Second, inflation is everywhere and at every time a monetary phenomenon. So, to these Conservatives, the Fed cannot achieve full employment and the attempt to achieve full employment by monetary means just results in inflation.

Is there any way we can measure the success of the Federal Reserve in achieving the goals connected with its “Dual Role”? Do the Conservatives have any case for the stance they are taking?

I believe there is a report card related to Federal Reserve actions and that report card is the foreign exchange market. This belief is expressed by Paul Volker, former Chairman of the Board of Governors of the Federal Reserve System. He has written, “a nation’s exchange rate is the single most important price in its economy…” This quote can be found on page 232 of the book co-authored by Volker and Toyoo Gyohten, formerly of the Japanese Ministry of Finance, titled “Changing Fortunes.”

Volker goes on to say that “what the Fed does in regulating U. S. money and credit inevitably affects exchange rates, and even the world money supply. Domestic and international (monetary policy), it’s a seamless web…”

And, what grade is given to the United States in the foreign exchange market?

The grade is derived from the chart below.

The value of the United States dollar against major currencies has declined by 33% from January 1973 to October 2010. It has declined by 35% at the low point in the chart attained in April 2008, just before the financial collapse which came in September 2008.


There are two breaks in the decline. The first begins in the late 1970s as President Carter was forced to bring Paul Volker in as the Chairman of the Fed which was followed by a very severe tightening of monetary policy. Market participants gave Volker high praise. Note, however, that the value of the dollar has declined by 51% from its peak, reached in March 1985, to its low point in September 2008.

The second break came in the 1990s as Secretary of the Treasury Robert Rubin, under President Clinton, moved the government’s fiscal budget into surplus range accompanied by a relatively benign monetary policy. The effect of the surplus caused the value of the dollar to peak in February 2002 as the Bush tax cuts and military expenditures became a reality. From this peak, the value of the dollar declined by 37% from the peak to the low point achieved in September 2008.

The two peaks after September 2008 came from the “flight to (credit) quality” accompaning the subsequent world wide financial crisis and in early 2010 by the European Union sovereign debt crisis. The downward trend in the value of the dollar always seems to continue after these “short-run” crises.

The best grade that I can give the Federal Reserve from this long-term behavior is a D!

World financial markets do not seem to support the execution of the Feds “Dual Role”!

One further note: the Federal Reserve is supposed to be independent of the administrative and legislative branches of government. However, the legislation of 1946 and 1978 took away that independence, if it ever existed. The first evidence of this is the fact that the United States floated the value of its currency in 1971 as a result of the inflation that was growing in its economy. This is why the chart only begins in 1973, because the value of the dollar was fixed internationally before this time.

One-Way Bets for Traders

Government interventions are taking place all over the world from the Federal Reserve’s quantitative easing program to the efforts to prevent debt write-downs in Europe to South Korea’s currency intervention.

Will governments ever learn?

Wise advice: “Today’s eager interventionists should take note. Far more than they realize, they are setting up one-way bets for traders.”

The reason: sooner or later, markets “revert to the mean”: markets ultimately adjust to their underlying economic value.

“Hedge funds know that South Korea’s won is being artificially held down by the government and is therefore more likely to rise than to depreciate, so they are hosing Seoul with capital and compounding the problem of hot inflows that Korea is desperate to alleviate.”

Both of these quotes come from “Currency Warriors Should Consider India” by Sebastian Mallaby in the Financial Times. (See http://www.ft.com/cms/s/0/0f26703c-f105-11df-bb17-00144feab49a.html#axzz15Rw49cE9)

In other words, international investors, like hedge funds, are pouncing on the opportunities governments set up for them.

The won situation is just the reverse side of the classic George Soros “bet” against the British Pound in 1992. The British government tried to keep the value of the pound above an agreed lower limit in agreement with the policies of the European Exchange Rate Mechanism. “Black Wednesday” refers to the events of September 16, 1992 when the value of the pound was allowed to drop toward its underlying economic value. Soros, who had been selling the pound short is reported to have made over one billion dollars on this effort of the government to intervene in the market. The government set up a “one-way bet” for traders.

But, this is happening all over. Karim Abdel-Motaal and Bart Turtelboom, portfolio managers at GLG Partners, write this morning: “…emerging markets are being flooded with freshly minted dollars. No matter how much sand is thrown in the wheel in the form of intervention, transaction taxes or capital controls, these capital inflows will get through.” (See http://www.ft.com/cms/s/0/81dd24ea-f0c9-11df-8cc5-00144feab49a.html#axzz15S17R06s)

Preparations to take advantage of these “one-way bets” are not limited to one part of the world. “Asia’s financial firms are on the prowl—for deals as well as for new investors. Even as they continue to strengthen their capital base through stock offerings, Asian banks, insurers and other financial firms are converting the floods of capital in the region into firepower for acquisitions.” (See http://professional.wsj.com/article/SB10001424052748703670004575616162768312620.html?mod=ITP_moneyandinvesting_2&mg=reno-wsj)

Financial capital is being built up around the world to take advantage of the incentives that exist within the current environment. And, governments are creating some of the most attractive incentives going!

With these huge amounts of capital available, governments can only maintain their interventions for a limited amount of time. Eventually, the markets win!

In trying to overcome the market, the “one-way bets” are created that make certain traders enormously wealthy, as in the case of George Soros. That is, these governments are underwriting Wall Street and not Main Street, just what they say they don’t want to do!

This seems to be what is happening to the debt markets in Europe. Earlier this year the European Union pulled together to avoid a collapse of the debt markets and save the Euro. It has become apparent that these efforts just provided a temporary escape from the underlying economic realities alive in Europe.

Europe, once again, seems to be approaching the edge of the abyss. Now, participants in the financial markets are calling for a debt re-structuring in many nations and not just a financial “safety net” to help support existing debt levels. Investors seem to be insisting that Ireland, Portugal, Spain, Greece, Italy, and even, possibly France, write down their debt and begin anew.

The earlier efforts did not produce the result desired. The earlier efforts did not achieve the path to the real underlying economic realities that exist.

Speaking of debt, let’s shift to the debt situation in the United States. I was taught that the Federal Reserve could only really control short-term interest rates because they had short-term maturities. The Fed could impact longer-term interest rates but only for a limited amount of time because these investments provided cash flows for a longer period of time than the Fed could dominate the markets. Thus, longer-term interest rates could be held below real economic values for the short-run, but the “bets” of the financial markets would come to dominate over time and the longer-term interest rates would either rise back to the levels market conditions warranted or could even rise above levels the market was once happy with because inflationary expectations would overcome and offset the efforts of the central bank to hold down long-term interest rates.

In other words, in attempting to artificially keep long-term interest rates low, the Fed will be creating a “one-way bet” that market participants can take advantage of and make lots and lots of money.

This is a “reversion to the mean” argument and is the basis for “Value Investing.” Over the longer run, markets adjust to economic realities. The risk associated with this conclusion is connected to the length of time it takes for the market adjustment to take place. This is the problem that Long Term Capital Management ran into. The “reversion to the mean” did not occur soon enough.

Eventually, the long-run is achieved and many investors make a lot of money!

Large amounts of cash have been accumulated to take advantage of these “one-way bets.” If it is observed that governments have set up “one-way bets” and will set up even more “one-way bets” in the future, capital will rush to take advantage of the free gift of the governments. The more the government’s attempt to maintain this intervention, the more money there is to make.

The underlying question concerns how much the government is willing to pay to maintain its intervention. In the Soros case described above, it has been revealed that the British government expended £3.3 billion in its attempt to keep the value of the pound above the lower limits. These are 1992 values and not 2010 values.

Who knows how much governments in Europe and the United States have spent in order to try and maintain their interventionists policies. The basic guess is in the trillions.

And how much have investors made taking advantage of these interventions? The Fed has kept its Federal Funds target close to zero for two years. This policy has put trillions of dollars into the hands of the already wealthy. So much for a more equal distribution of wealth in the world!

Governments never seem to learn.

Ben and Tim: Part 2

When is the last time you heard that an American President was lectured to?


Mr. Obama…it’s time to change teams.


If you want to have any chance of getting re-elected in 2012 then you better make some changes now, both in the team that you have surrounded yourself with and with the economic and financial philosophy that has been followed.


Just remember, however, that Bush nominated Mr. Bernanke for the position of Chairman of the Board of Governors of the Federal Reserve System and an appointee of Mr. Bush, that is Mr. Bernanke, oversaw the appointment of Tim Geithner as the President of the Federal Reserve Bank of New York.


Obviously, these two people, Ben and Tim, are holdovers from the presidency that caused the mess that Mr. Obama now finds himself in.


Mr. Summers is on the way out and Ms. Romer has departed. A large part of the economic team that was in place is leaving or has left.


Clean house. Start again.


The economic model your team has worked with is out-of-date and inappropriate for the current situation.


We have been told for at least two years now that the problems in the banking sector are liquidity problems. But, liquidity problems are of short-term nature and need to be resolved within a relatively short period of time. (See http://seekingalpha.com/article/235712-it-s-a-solvency-problem-not-a-liquidity-problem.)


The policies that are used to combat a liquidity crisis are also of a short-term nature. These policies are based upon the need to supply the market with liquidity so that asset prices will stop dropping.


Given this interpretation, the Federal Reserve, under Ben’s leadership, has supplied liquidity…and more liquidity…and more liquidity to resolve the issue.


This is a sign that the model being used by Ben and the Fed is inappropriate for the particular situation that they face.


In terms of fiscal policy, the situation is similar. The “experts” in the Obama administration, led by Tim, have called for more spending…and more spending…and more spending.


In both cases, the reason given why the policy prescription is not working is that the particular stimulus package tried has not been large enough. The solution Ben and Tim have given is to make the policy package larger. More spending…and more liquidity!


This is a sign that something is wrong!


The model and the analysis being used are not appropriate. It is time to change policy advisors and the model being used to develop economic policy.

In the financial markets, the problems that exist are solvency problems. Households are declaring bankruptcy in record numbers and foreclosures on homes continue to run at very high rates. Small businesses are also declaring bankruptcy and loan demand coming from small businesses is dropping as of the last Federal Reserve survey. Thousands of small banks are on the verge of insolvency. (See http://seekingalpha.com/article/235712-it-s-a-solvency-problem-not-a-liquidity-problem.)


And, guess what? The monetary policy that the Federal Reserve is following has successfully resulted in the accumulation of massive amounts of cash in the hands of large banks and large corporations. I am just waiting for the acquisition binge to begin once the economy stabilizes a little more. So much for "Main Street"!


In the economy, the “consensus” economic model that has been used over the past fifty years is still contributing to the “more-of-the-same” policies that are being followed by the Federal Reserve and the Treasury Department.


Yet, over these past fifty years the application of this model has produced the following results: the United States has moved from an “under”-employment rate of around 8% of the working population to about 25% in the current environment; these policies have also resulted in the capacity utilization in industry moving from about 93% in the 1960s to about 75% at the present time, constantly eroding throughout the whole time period; and, the distribution of income in the United States over this fifty years has moved dramatically toward the end of the most wealthy.


The foreign exchange markets have signaled to the United States that something is wrong! Over the past fifty years, the value of the dollar has declined by more than 40% in foreign exchange markets. After a recovery in the latter part of the 1990s, the value of the dollar once again tanked until we hit the financial crisis of 2008 and there was a “stampede to quality.” Once this “stampede” was over and markets and economies stabilized, the value of the dollar declined once again. And, after Ben made his remarks in Jackson Hole concerning the forthcoming quantitative easing, the value of the dollar plunged 7% in a matter of weeks.


Paul Volker has written that the most important price in a country is the price of its currency in terms of other currencies. If the value of your currency declines, this is a sign of weakness…weakness in your economy and in your economic policies.


And, here we are. Thursday November 11, 2010, the President of the United States was lectured to by Hu Jintao, the Chinese President, over the United States currency. Other world leaders, from Germany, Great Britain, and Brazil, have also reprimanded the President over the United States currency situation. (http://seekingalpha.com/article/236430-release-from-the-g20-what-more-needs-to-be-said)


Furthermore, given the election results in the mid-term elections held last week, the American people seem to have a problem with United States economic policies.


The President needs different advice. The President needs different advisors. Ben and Tim need to go!

Release from the G-20: What More Needs to be Said?

Released at 4:04 PM EST by the Wall Street Journal: “China's Hu Rebuffs Weakened Obama at Summit” by Jonathan Weisman and Damian Paletta. (http://professional.wsj.com/article/SB10001424052748703848204575608024073731214.html?mod=WSJ_hpp_LEFTTopStories)

“That China was emboldened to lecture the U.S. on its currency, a notable reversal of recent meetings, underscores how it and other countries, including Brazil and Germany, have emerged from the global economic crisis faster and more strongly than the U.S. Mr. Obama found himself in the odd position of having to defend the U.S.'s independent central bank. He was also unable to quell concerns that the U.S. government is deliberately trying to weaken the dollar to boost exports.”

When are the leaders of the United States going to recognize that they are out-of-step with the world and that the economic model they are using is out-of-date and inappropriate?

China better not get too aggressive, however, because they continue to benefit from the short-sightedness of the United States leadership. Ah, but it feels good to lecture someone else after one has been down so long!

International Capital Mobility: the United States Dilemma

In this globalized world, international capital mobility must be taken as a given.

According to modern international economic theory, if international capital mobility is a given, then there are only two other policy choices left a nation, but that nation can only choose one of the two. The first is a fixed exchange rate and the second is the ability to run an independent government economic policy. By independent is meant that a nation’s economic policy can be run according to the internal goals and objectives of that nation without regard to the economic policy of any other nation in the world.

The assumption has been that a nation can follow an independent path internally so as to achieve high levels of employment as well as other social goals like attempting to put every family in the country in its own home.

The United States began following a fully independent economic path in the 1960s and with the growing mobility of capital globally following World War II, the Nixon administration found it could not continue keeping the value of the dollar tied to a gold standard. In August 1971, President Nixon released the dollar and allowed its value to float.

The basic assumption of this move was that the value of the dollar would adjust in international markets so that the United States government could inflate the economy so as to achieve full employment of its labor force. As credit inflation took place within the country, the value of the dollar would decline causing exports to increase which would keep the labor market fully engaged.

One problem: this assumed that the United States economy would stay competitive with other nations. Unfortunately, this assumption did not hold as the credit inflation within the United States resulted in a deterioration of the competitive base of American industry.

A consequence of this deterioration is that American exports could not keep up with the competition in world markets. As the value of the dollar declined, exports did not expand as the economic model predicted. Charles Kadlec reported in the Wall Street Journal that as the value of the dollar declined dramatically over the 42 years following 1967 “net exports have fallen from a modest surplus in 1967 to a $390 billion deficit equivalent to 2.7% of GDP today.” (http://professional.wsj.com/article/SB10001424052748703440004575548451304697496.html?mod=WSJ_Opinion_LEFTTopOpinion&mg=reno-wsj)

Hello?

Is the market trying to tell us something?

In my post yesterday, I presented information cited by Tom Freidman in the New York Times who focused on a report from the National Academies listing how the United States has declined from being a leader in innovation and technology. The conclusion from this report is that the United States just is not as competitive in the world as it was fifty years ago.

Bloomberg adds further evidence that the world is shifting in terms of competitive action. How do you like this headline? “IPOs in Asia Grab Record Share of Funds as U. S. Offers Dry Up.” (http://www.bloomberg.com/news/2010-10-27/ipos-in-asia-grab-record-share-of-global-funds-as-u-s-offerings-dry-up.html)

“‘What the market needs and wants is a lot more IPOs coming out of China,’ said Jeff Urbina, who oversees emerging-market strategy at Chicago-based William Blair, which manages more than $41 billion. ‘That’s where the growth is.’”

The article states that “Record demand for initial public offerings in Asia is reducing the share of U. S. IPOs to an all-time low as companies from China to Malaysia and India flood the market with more equity than ever.”

Who says the world is not shifting?

And, then, in another blow to American pride, we learn that the Chinese have built a supercomputer that has 1.4 times the horsepower of the fastest computer that exists in the United States. (http://www.nytimes.com/2010/10/28/technology/28compute.html?hp)

Maybe, just maybe, the United States needs to take a hard look at the economic philosophy it has based economic policy on over the past fifty years. Maybe an economic policy based upon credit inflation is not productive in the longer run after all.

There is substantial information being produced by the market place to indicate that maybe the predominant economic model in the United States, the “Keynesian” model, does not produce the results that we want. In fact, the information is pointing to the fact that, in the long run, the results that are produced by this model are exactly the opposite of what people were trying to achieve.

However, the real Keynes argued that when the facts seemed to point away from the models currently in use, one should change the models that are being used.

Maybe, just maybe, we should listen to this Keynes and not to the “Keynesian” true-believers that preach the fundamentalist gospel that has dominated economic policy making over the past fifty years.

The Basics of Turnarounds: the United States Situation

A part of my life has been connected with company turnarounds, bank turnarounds to be more precise. I would suggest that the United States is in a turnaround situation right now but its leaders claim that the economic model it is using is still relevant and that all that is needed is a little more time and a little more co-operation from others and everything will turn out alright.

My experience has led me to some conclusions about what is needed in a turnaround situation. (By-the-way, all my turnarounds were successful and I can say that now because I am not doing turnarounds any more.) We don’t have much space to discuss these things so let me just summarize what I believe to be the four most important factors in achieving a turnaround: the business model; information coming from the market place; the need for transparency and openness; and the existing business culture.

Although these factors relate to a business situation, I believe that they can be applied to any “turnaround” situation, including the “turnaround” of a government.

First, and foremost, an organization gets into trouble because its business model, or economic model, is not working. But, because a leader or a management team believes that the organization has gotten where it is because of that business model, they tend to stick with the model and apply the model even more forcefully.

In some cases, the success of the model has come because of the timing of the model’s use and not because of any inherent characteristics of the model are correct. To justify this statement I refer the reader to the book “Fooled By Randomness,” by Nassim Nicholas Taleb.

In terms of the economic model that the United States government is applying, and has been applying for a very long time, there is no real evidence that it works. I am, of course, speaking of the Keynesian macro-economic model.

Ever since the 1930s when the model was first presented, all I have ever heard in times of difficulty is that the reason the Keynesian model falls short is that not enough stimulus has been forthcoming. Keynesian economists contend that the Great Depression continued on for as long as it did because governments did not create sufficient budget deficits. Only the war effort, World War II, got the US out.

This criticism has been applied over and over again during the last fifty years. All we have been hearing from the fundamentalist preacher Paul Krugman is that the Obama stimulus package must be greater. He has been consistent in applying this remedy since early on in the Great Recession. More spending, more, more!

Maybe the economic model the government is using is wrong!
The application of this model over the past fifty years has produced falling capacity utilization, rising under-employment, and greater income inequality.

Maybe the economic model has not been applied correctly!

Defensive comments like these are heard over and over again within a company that is in decline.

Second, it seems that others recognize the decline in the company even though the leaders and management of the organization do not. That is, the market recognizes that the model of the organization is not working and that the organization is in decline.

And, what is the response of the leaders or managements of the targeted organization. The response is “The market doesn’t understand us!” I don’t know how many CEOs I have heard express this sentiment in the face of a falling stock price.

The thing is, the market does understand the company and the fact that the company is applying an inappropriate business model.

The market response to the economic policy of the United States? Well, the behavior of the United States government in the 1960s resulted in the need for the United States to go off the gold standard. Since the United States has been off the gold standard, the value of the United States dollar has declined almost constantly (with the two exceptions, when Paul Volcker was the Chairman of the Board of Governors of the Federal Reserve system and during the 1990s when Robert Rubin was the Secretary of the Treasury).

Obviously, for the value of the United States dollar to substantially fall, almost continuously, over a fifty year period, indicates that something must be wrong with the economic model the government is using. During the past fifty years, the government has relied on a credit inflation whose foundation is a federal deficit that has resulted in the federal debt increasing at an annual compound rate of growth of more than 9% over this time period. The government has created other avenues of credit inflation through programs like those built for housing and home ownership. The whole economic model was based upon inflating the economy causing people to constantly “leverage up” and take on more and more risk.

Third, transparency and openness goes by the wayside as organizations experience decline. Cover ups abound! President Obama came into office declaring that he was going to change the way things are done in Washington. Yet, his administration is now charged with opaqueness and obfuscation like every other presidential administration. Even little bits of information, like the recent report by the special inspector of the TARP program, only adds to the accusation that this administration is hiding things. This was in all the papers this morning. (See “Treasury Hid A. I. G. Loss, Report Says,” http://www.nytimes.com/2010/10/26/business/26tarp.html?ref=business.) This does not help!

Fourth, the culture of an organization begins at the top. In a turnaround situation, a new culture
must be implemented and that culture must begin with Number One. The new leader that takes on a turnaround situation must change the way things are done and introduce a new business or economic model into the organization.

However, this new business model cannot be introduced or implemented if the (new) leader assumes that little or nothing needs to be changed. And, this implementation cannot be carried off unless the members of his or her team are all on board.

In my view, things need to be changed in Washington, D. C. The evidence in the market place is hard to ignore, although Washington has done its best to shift attention to others. But, the weakness of the United States position has been observed and others (China, Brazil, and India, and others) have moved into the void to take advantage of it. (See my post http://seekingalpha.com/article/229112-the-imf-bowl-u-s-vs-china.)

Even if the philosophy of economic policy used by the United States government was appropriate forty or fifty years ago, things have changed since then. (See my post http://seekingalpha.com/article/232044-maybe-things-have-changed.) The United States needs to be “turned around”. But, to do a turnaround, those that are in leadership positions must accept the fact that a turnaround is necessary. I don’t see this happening any time soon.

Ben and Tim: Part I

We have been living with the team of Ben Bernanke and Tim Geithner since 2006, Bernanke as Chairman of the Board of Governors of the Federal Reserve System and Geithner as the President of the Federal Reserve Bank of New York. The only person now missing from this team is Hank Paulson, who was Secretary of the Treasury until Geithner moved into that position.

During their partnership, there has been a failure to recognize the clouds that were forming in the 2006-2007 period. We have the flooding of the banking system which took place beginning in the fall of 2008. And, now, we have the sinking of the United States dollar.

It was very disingenuous of Treasury Secretary Geithner to claim yesterday that he…and the United States government stood for a “strong dollar” and “will not engage” in currency devaluation.

This stance has been taken by the United States government and every Treasury Secretary since the dollar was floated in August 1971.

Yet, the value of the dollar has fallen by around 30% on a trade-weighted basis against major trading countries since this index began in early 1973. The value of the dollar on the same basis has fallen by about 11% since March 2009.

And, where do we stand policy wise? The deficit of the United States government has fallen to $1.3 trillion in fiscal year 2010, down from $1.4 trillion in fiscal year 2009. My estimate of the cumulative fiscal deficit for the next ten years, assuming the current philosophy of government (which is the same philosophy of government that has been around since the early 1960s), is at least $15 trillion.

Monetary policy? Well, the Ben and Tim team gave us a Federal Reserve balance sheet that more than doubled to over $2 trillion from about $0.9 trillion in August 2008. Now, Chairman Ben is making noises that could lead to an increase in this balance sheet to over $3 trillion in the next year. And, with federal deficits over the next ten years that could total $15 trillion or more, it is hard to see how this balance sheet could decline by much.

The basic crisis philosophy of the Treasury and the Federal Reserve since the fall of 2008 has been to throw as much “spaghetti” as they can against the wall to see what sticks. That policy still seems to be alive and well within the halls of the Federal Reserve and the Treasury.

This approach to policy making is what international investors are concerned about at the present time.

A complicating fact relating to this picture is that the world is splitting into two camps. There is the dollar/Euro camp that is composed of the developed countries in the world who are still battling to get their economies moving again. (Note that the dollar/Euro camp is split as well. See “Fed’s Strategy Will Bring Euro Victory Over the Dollar,” http://www.ft.com/cms/s/0/239b1134-db85-11df-ae99-00144feabdc0.html.)

And, there is the camp that includes the rapidly emerging nations (including some others) that are experiencing relatively high rates of economic growth.

This bifurcation into the two camps is causing and will continue to cause world trade and finance pressures going forward. There may not be any change for some time about the place of the United States dollar as the world’s reserve currency. But, if the scenario presented above actually occurs, the pressure on the dollar will just continue to grow with time.

At this point I won’t get further into this discussion for the focus today is on Ben and Tim.

Why is it that I have so little confidence in the future of the economic policy of the United States government at the present time. Bernanke has been in a leadership role around Washington since 2002. Everything he has been connected with has not turned out particularly well with the exception of his ability to throw “spaghetti” against the wall. Geithner is the only senior economic advisor of the Obama administration that was with the administration at the beginning and still remains. What interpretation can be put on this survival?

Who knows, maybe Ben and Tim will go down in history as the team that saved the economy but sank the dollar.

I don’t know when in my professional career that I have been so nervous about the economic leadership in this country. My impression is that many others feel the same way I do and much of this feeling is getting reflected in the value of the United States dollar. Thus, although the value of the United States dollar will vary from time-to-time, I see no reason to believe that this value will not continue to trend downwards over the longer term.