The Fall in the Dollar and the 2008 Election

Robert Reich on the implications of the fall in the dollar for the 2008 election:

How the Dropping Dollar Affects 2008, by Robert Reich: The dollar is weakening and Hank Paulson couldn’t be happier. Remember, Paulson was hired as Treasury Secretary essentially to do one thing – convince the Chinese to revalue the yuan, in order to increase American exports, revive American manufacturing, and save the industrial heartland ... for the Republicans. Paulson had worked with the Chinese for years as an investment banker ..., but as Treasury Secretary he has had no luck getting China to cooperate because he has had absolutely nothing to offer them.

Yet with interest rates relatively low in America relative to Europe, and the American economy slowing ..., global investors are taking their money out of dollars and putting them into euros, British pounds, and Japanese yen. Presto: The dollar is dropping. As a result, the Chinese – who hold more dollars than almost anyone else – are losing lots of money. Hence, it will make more and more sense for them to stop buying dollars, start selling them, and allow their currency to rise relative to the dollar.

In other words, international currency markets are doing for Paulson what Paulson was supposed to do for the American economy and for Republicans in 2008. That’s okay so long as global investors, as well as China and OPEC ..., don’t get carried away... [I]f the dollar drops too far too fast, everything America buys from the rest of the world begins costing a lot more... That pushes inflation. Meanwhile, the only way we can continue to finance our budget deficit and consumer buying spree is by yanking up our own interest rates. Result: stagflation – inflation combined with no or negative growth. Wall Street goes into a tailspin. Paulson leaves office as the Treasury Secretary who caused the crisis. And Republicans are unceremoniously kicked out of the White House in 2008.

It's starting to become a familiar story: Even though the global economy is taking decisions out of the hands of American officials, the public still credits or blames them for what happens.

There's a lot of time between now and the election. Seeing Republicans "unceremoniously kicked out of the White House" has its attractions, but let's hope Democrats can take the White House in 2008 through good politics and good policy rather than from a crash on Wall Street and a stagnating economy. But if economic difficulties are unavoidable, a Democrat in the White House would be a positive externality.

Comments

[evagrius]

"It's starting to become a familiar story: Even though the global economy is taking decisions out of the hands of American officials, the public still credits or blames them for what happens."

Sounds like the war.

Isn't it about time that the U.S. wake up and realizes that the world doesn't follow them?

[Elvis]

let's hope Democrats can take the White House in 2008 through good politics and good policy

Well, that's a tall order, but there's a first time for everything. ;-)

Let's hope anyone who takes the highest office of the land does so through good politics and policy. It would be so refreshing.

[JamesG]

"Yet with interest rates relatively low in America relative to Europe, and the American economy slowing ..., global investors are taking their money out of dollars and putting them into euros, British pounds, and Japanese yen. Presto: The dollar is dropping. As a result, the Chinese – who hold more dollars than almost anyone else – are losing lots of money. Hence, it will make more and more sense for them to stop buying dollars, start selling them, and allow their currency to rise relative to the dollar."

Since the euro interest rates have been lower than the US for some time and the dollar is most likely dropping because the Chinese came out and said the dollar was worth shit* (ok real quote below) and they were already moving into Euros, Reich's analysis is worthless. As for Poulson being hired to convince the Chinese to devalue the yuan, phooey, I can think of a few other reasons.

*"The U.S. dollar is no longer a stable anchor in the global financial system, nor is it likely to become one," said Fan Gang, a member of the Monetary Policy Committee of the Chinese central bank and director of the National Economic Research Institute. "Thus it is time to look for alternatives."

[JamesG]

whoops meant to say revalue.

[save_the_rustbelt]

"...Remember, Paulson was hired as Treasury Secretary essentially to do one thing – convince the Chinese to revalue the yuan, in order to increase American exports, revive American manufacturing, and save the industrial heartland ... "

Paulson and Bush could care less about the industrial heartland, they care about Wall Street and their corporate cronies.

The next recession will destroy another 20 or 30% of heartland manufacturing, and I think that will be in the second half of 2007 (and that will make 2008 really tough for the GOP).

The Democrats are busy forming their circular firing squad, so it will be interesting.

[save_the_rustbelt]

According to the Washington Times, the first likely success of the new Congress will be providing amnesty for 12 million illegal aliens.

The Democrats are already forming the circular firing squad.

[callahan]

Yup, time for a third party president, even time for an economist/journalist. I give you Lou Dobbs. We've had an actor, a monkey, and others, why not Lou?

[Ken]

*"The U.S. dollar is no longer a stable anchor in the global financial system, nor is it likely to become one," said Fan Gang, a member of the Monetary Policy Committee of the Chinese central bank and director of the National Economic Research Institute. "Thus it is time to look for alternatives."

If this is the case, wouldnt we expect to see market rates rise (Discounting) to attract foreign capital? Call me dense but this inversion is confusing to me. It seems there is more than enough demand for this debt.

[Peter Schaeffer]

“Paulson had worked with the Chinese for years as an investment banker ..., but as Treasury Secretary he has had no luck getting China to cooperate because he has had absolutely nothing to offer them.”

This has to be one of the more astounding examples of the myopia of the “free trade” radicals who dominate Washington. How about offering them (the Chinese) access to the US market if they revalue and restricting access if they don’t?

If the Chinese thought there was even the slightest chance we would close the door, they would be negotiating Yuan revaluation 24 x 7. However, given the hysterical cries of “protectionism” that accompany any hint that the US might act in its national interest, our trade policies amount to unilateral disarmament. Any wonder that the Chinese don’t take us seriously?

[calmo]

Just reading...and hootingPaulson had worked with the Chinese for years [ shovel in hand, apprentice laborer on the Great Dam ] as an investment banker [but not for long]...but as Treasury Secretary he has had no luck [and piss poor astrological signs ] getting China to cooperate because he has had absolutely nothing to offer them [ and so he is at the mercy of his craving for Won Ton soup! unlike his more disciplined cheeseburger President]

Ok would you say Robert needs a relatively better proof reader here:relatively low in America relative to Europeor just an absolutely better proof reader? [ok, you relative dummies, the answer is: Absolutely!]

Ok maestro prestoPresto: The dollar is droppingI'm going to give you Robert another paragraph before I head for greener pastures that provide me with real information, commentary, and less slop (who are there 'global investors'? what role do they play against the cbs? what portion of fx markets is dominated by HFs? what is the historical trend of this Financial component on global GDP?...and other less presto observations/questions.)
Just sayin... a reader is about to abandon ship...
As a result, the Chinese – who hold more dollars than almost anyone else – are losing lots of money. Robert, please just tell us that the Japanese hold more dollars and puzzle over this fact that recent fx issues never include Japan. [Paulson does not go for his sushi fix, but his won ton soup.] Recall Japan's massive intervention up to 2003 to keep the dollar high.
I'm at the end of my tether with thisHence, it will make more and more sense for them to stop buying dollars, start selling them, and allow their currency to rise relative to the dollar Could be that as the US consumer regains consciousness (garage full of cordless drills will do it) [surrendering garage to presto apartment to help pay mortgage even more so] trade patterns shift to other global consumers and China just naturally (hence-like) acquires euros. Those watching this spectacle (Setser is my window) have noticed that ASEAN countries are not actually dumping their dollars --undermining their relative (ok there's that gem again!) worth. It is hardly presto! and saying so does not help your cause here.
No, it B self-inflicting Presto Bad.

[anne]

Calmo is clever:

"Robert, please just tell us that the Japanese hold more dollars and puzzle over this fact that recent fx issues never include Japan. [Paulson does not go for his sushi fix, but his won ton soup.] Recall Japan's massive intervention up to 2003 to keep the dollar high."

The dollar is falling moderately against the Euro and related currencies, falling slightly against the Yen and is stable against the Yuan. The long term Treasury yield is a remarkable low 4.43%, and there is no reason to think the rate will climb from here. The decline is value of the dollar could have a moderate stimulus effect on the economy if the decline is sustained through the coming months, but I cannot imagine China or Japan are concerned. Investors have been preparing for a decline in the value of the dollar for quite a while, and international stock markets are just fine, actually better than fine.

[anne]

Repeatedly the Federal Reserve has made it clear interest rates will not be adjusted to defend the dollar, and long term rates are low as can be. Though we are told how much money the Chinese (why not the Japanese?) will lose by holding dollar reserves, I do not think Chinese bankers worry in the least and do not think they should worry.

Every developed market internationally is positive in domestic currencies and dollars, with almost all especially robust again this year. Japan is always the market of death, but what do I know for those who are always hopeful. The Europe index is up about 30%, Canada and Australia are up 20% and 30% respectively, emerging markets up about 24%.

So, as for the "yanking" of interest rates, please....

[calmo]

calmo is not clever. (Tall, dark and handsome, yes.)[Cute too]
calmo is mighty cheesed off, looking for real guidance from the usual sources (RR among them) who are currently in short supply.
Peter's queryHow about offering them (the Chinese) access to the US market if they revalue and restricting access if they don’t?restores me somewhat. Do you have that aborted Chinese purchase of an energy company in mind? Are there less blatant ways around these asquisitions in any case (see Setser on tbill acquisitions through 3rd parties masking/delaying the accounting of China's actual purchasing habits)? If you were China would you be buying tbills or bls of oil and creating a reserve that would skip this currency uncertainty?

Ok, back to being tall dark and handsome...

[lonesome moderate]

Anne - while I find your measured response to calmo reassuring, I have to ask--just how are going to climb down from our $60 billion/month trade deficit? It seems to me that pretty much anything that happens is going to mean sharply higher prices for imports, which implies a few years of stagflation or something like it (at best). Are we going to be able to grow ourselves out of this?

[anne]

Important question. Now I do not know what will happen to the dollar, though I expect a continued loss a value in time. The dollar had only lost 3% to 4% in relative value to developed markets over the last decade through Thanksgiving. The loss has grown beyond 10% since then. But in the 1980s, the dollar lost 40% to 50% in value against developed markets and there was no noticeable inflation or long term interest rate effect. Alan Greenspan always insisted the Federal Reserve would not be driven to change short term rates according to dollar movements.

My guess is that there can be a fairly smooth adjustment to a weaker dollar, as long as the domestic economy is healthy. A reasonably healthy domestic economy, as in the 1980s, should bring all the foreign capital flows needed to keep long term interest rates low. As for the Chinese and Japanese, there have been fearful comments about turning from the dollar for years and years. I just do not think so. Japan would not want to repeat of the late 1980s strong yen, and China knows of the Japanese experience.

[john c. halasz]

Dear Anne, gentle souland eternal optimist:

But all those dollars flying out into the world on the winds of trade must "correspond" to real production of goods and services somewhere, right? And whatever the RoW's appetite for Fx reserves and the reasons for it, the "value" of a currency must "ultimately" be backed by and reflective of the real production of the economy that issues the currency, is that right? And all the slicing, dicing, and exchanging of securities and risk factors in the financial system can not insure against the absence of real production, right?

Yes, it's true that none of this is exactly new and has been going one for quite some time. IIRC, when Reagan took office the U.S. was a net creditor to RoW to the tune of $350 billion, which would presumably be slightly north a $1 trillion in current $, when these capital promoting, "pro-business" policies of deficit spending were first enacted, admittedly in response to the stagflation crisis of the '70's when real returns to interest-bearing assets were negative and the stock market was flat, rendering life difficult for the well-to-do, (and in response to a renewed ideological offensive by corporate interests and the "far" right). And since then an additional 7 trillion in accumulated federal debt and perennial trade deficits. I tried to find on google the current figure of net U.S. external debt, but couldn't find the official figure. The best I could find for my limited effort was a slightly old post of Brian Setzer estimating, against the official number, that the actual external debt was $4.6 trillion or 34% of GDP and that assuming the trade deficit gap between imports and exports were to be reduced at .5% of GDP for the next 14 years the external debt might stabilize at between 60% and 70% of GDP. So what is it that distinguishes this set-up from a dollar-kiting scheme? Can the immense growth of the global financial economy since the end of the Bretton Woods pseudo-gold/dollar standard adjustable peg Fx system, which then stood at about a 1 to 1 ratio to real output, compared to something like a 4 or 5 to 1 ration nowadays really insure against the risks of an absence of balancing in real production and the potential for disrupting of real aggregate demand?

(You might recall a post here a couple of weeks ago about the "carry trade", in which the fact that, according to the logical idealization of economic theory, it is impossible to derive a steady profit from fx/interest rate differentials, but hedge funds routinely do make a steady ROI could perhaps only be accounted for by speculators driving fx rates further off their "true" equilibrium values, further increasing imbalances at the margin and thus eventual difficulties in rebalancing adjustment. According to Prof. DeLong today, hedge funds are currently capitalized at $1.5 trillion.)

Now I would guess that neither you nor I were exactly pleased with the Bush tax cut policies. The simplest interpretation of the tax cuts for corporations and wealthy investors was that it exchanged a financial obligation to the federal government for a financial obligation from the federal government. A bit more realistically, it exchanged a financial obligation to the federal government for funds to be invested abroad by corporations and wealthy investors to be exchanged, in turn, for a financial obligation to foreign central banks from the federal government. And those dividend and capital gains cuts apply to foreign investment income too, right? And if the latter were intended to refloat the domestic economy by encouraging consumer demand from the well-to-do via the "wealth effect" and thereby stimulate domestic employment, well, the "wealth effect" would perhaps better be termed the "domestic dissavings effect". And, of course, those immense injections of liquidity into the economy though miniscule interest rates, due to the fear of deflation, almost automatically imply and inflation of asset "values", especially since those low interest costs make corporate balance sheets look healthy, inspite of lackluster employment, demand and investment.

Now it's not, all told, exactly surprising that those returns on foreign markets that you keep on posting are robust. Among other things, the growth of the RoW has been rather robust, especially due to the boom in commodities prices. And, of course, there is that peculiar real irony that declines in the U.S. $, due to declining economic "fundamentals", produce increased valuations in U.S. held foreign assets, for those corporations and investors that hold them, and thereby, in aggregate, help to offset deteriorating CA deficits, though perhaps not so much as to offset the effect of the roll-over on external debt at increased interest rates. Still, you are aware of the old Ricardian saw that returns to capital are inversely proportional to returns to labor, right? That, plus the excess liquidity sloshing around in global financial markets might give one pause in considering that booming foreign financial indexes are perhaps not the best indicators of the underlying condition in the real productive economy. How long the required adjustments in the real productive economy can be "smoothed" by financial means is a question that remains up in the air.

Perhaps it would be best for all of us, if your, er, Leibnizian economic theodicy were to prove true. But perhaps I might ask my economic betters for a more complex and convincing logic than that afforded by the aggregations of financial markets. Perhaps I could direct you to a comment at Maxspeak, by one "Juan" who apparently takes a Latin American and neo-Marxist perspective, from Nov. 30 entitled "Outside the Edgeworth Box" at 12/02/06 4:08 PM. He details statistics from the remarkable U.S. boom of 1921-1929 based on an sudden extraordinary increase in productivity having to do with the increased electrification of industry, the consolidation of automobile production, the development of business bureaucracy and office machines, etc. Productivity boomed, together with financial markets, the work force grew well in excess of population growth, but wages grew much less. You know the story no doubt better than I do. No doubt we have learned much since then about automatic stabilizers, regulation of financial markets, the uses of monetary and fiscal policy, etc. But then we also all learned the lessons of the Vietnam War, right?

[calmo]

I can just see Ben and the boys doubled over in the basement with their fresh batch of $100 bills replying John's question: But all those dollars flying out into the world on the winds of trade must "correspond" to real production of goods and services somewhere, right?"Absolutely! A miracluous 1 to 1 correspondence".

Ok, I'm not sure it's Brian Setser [Buzz? Bobby? Bart? Bo? Bison?...whatizit about names? I believe you may be confusing Setser with a movie of the same title: The Life of Brian.]

Now if you'll excuse me, I need to change my shorts.

[john c. halasz]

Right. It's Brad. I was worrying about spelling the surmane from memory, so I slipped. Brian Setser was the leader of a bad retro-swing band, right? (Have you seen the movie "The Life of John" though? It's about a quadraplegic who thinks he's an acrobat.)

You did rather reverse my meaning though; I certainly didn't mean to innovate with a "corespondance", nor a quantity theory of money. The point about the long-run grow of the financial economy compared to the real economy, since the end of Bretton Woods' relatively fixed fx regime could be put this way: obviously, all sorts of financial "instruments" are being sliced and diced and traded of against each other such that they largely sum each other out, but, at the same time, the tremendous growth of the sector implies an increased investment of capital and labor in financial activities, which implies that there must be some real underlying reason for it: an increase in demand, an increase in profitability, an increase in efficiency or productivity of investment through decreasing risks and search costs, or all three. But then there are the "fundamentalistic" suspiscions that the growth of the financial economy vis-a-vis the real economy might represent an increase in opportunities for extractions "up front", as opposed to the longer-run uncertainties of realizing real capital investments, an increase in the rates of extraction of profits from labor, a counterpart to the increase in the upward distribution of income to the very top echelons, and/or an increase in the complexity/opacity of the information-processing intermediation function of financial markets, which amounts to an increase of rather than a diminishment of systemic risk.

Calmo, if you didn't respond to everything with such gleeful enthusiasm, you might be less wont to wet yourself. Just some friendly advice.

[Cassandra]

meester halasz...Bravo! Sizzling Posts!! Encore! Encore!

[calmo]

I need to tell you just how stumpable I can get john, wanting to believe that not only had Setser changed his name (without telling me!) but luckily also making an improved choice (Brad is just so tacky; I could accept Bret or even Brot, but Brian was just so right, so chunky --like the soup)...anyhow in your overture to Anne I needed to make the same adjustment with the unfamiliar "souland" which sounds like that old French word for "under the bridge" or...something entirely seductive. My 'tall, dark and handsome' had nothing on this.
It is on my lips now, "souland, souland" and the cats are on me as if I were concealing mice, birds, fish? something. [Don't try this at home you catlovers]
I shall recover, I must.
I just need some settling time to regain some composure...my reply to your post has been postponed...tomorrow hopefully.

[JamesG]

Ken
"Call me dense but this inversion is confusing to me. It seems there is more than enough demand for this debt."

Just assume that central bankers worldwide are dense, rather than you, and it makes perfect sense.