Everyone is talking about dollar devaluation and deflation, which is certainly an odd couple. If there was any reason to worry about the dollar going down (devaluation), it might be that a weaker dollar makes it easier for prices to go up. If there was any reason to worry about prices going down (deflation), that anxiety should have vanished long before the dollar had fallen for 15 months. Yet New York Times columnist Paul Krugman is still worrying about a Japan-style deflationary "quagmire."
The only reason the 1997-2002 deflation scare still sells papers is that the word was dropped by the Fed in early May and the IMF more recently. Given the forecasting record of the IMF, Fed and Krugman, when they start worrying about deflation, investors start betting on inflation. An executive at TIAA-CREF tells me their most popular fund is inflation-protected bonds, and gold is up about 16 percent over the past year. Deflation scares for the United States are quagmire quackery, as I explained with greater patience in a column last November.
There are also those who worry about the dollar. A lady on PBS with a classy British accent was recently pontificating about the dangers of a falling dollar. If we let the dollar fall too quickly, she warned, foreigners will stop investing in the United States, making it impossible to finance our current account (trade) deficit. She said the Fed will then be forced to push interest rates up to defend the dollar (crashing U.S. stock and bond markets is supposed to make the dollar more valuable), and that could create recession.
This is the old "hard landing" hoax that Keynesians recycle each time the dollar momentarily stops rising. That doesn't happen often. The Fed's trade-weighted index for the dollar has been about 118 lately, which is where it was from July 1998 through July 2000. Pundits say Treasury Secretary Snow has abandoned the "strong dollar" policy, yet the dollar is just as strong as it was when we supposedly had a strong dollar policy. The dollar rose before and during the last recession, but that does not constitute a persuasive case for a rising dollar. Strong means stable, not rising. For perspective, the Fed's dollar index was 35 in early 1981, when President Reagan took office.
Why should a drop of the dollar against the euro make Europeans stop investing in the United States? Suppose the dollar drops by 20 percent against the euro. That does not just make U.S. goods look 20 percent cheaper to Europeans, it also makes U.S. stocks, bonds and real estate look 20 percent cheaper.
Why should a bargain like that make Europeans stop investing in the United States? The lady on PBS suggested that the fact the dollar has fallen in the past makes foreigners fear it will fall more in the future. That makes as much sense as saying tech stocks were a terrific bargain in March 2000 because they had gone up so far and so fast. In reality, smart European investors have probably been helping to bid U.S. stock prices up.
Foreigners could stop investing in the United States only if they were wiling to either buy more U.S. goods and services or sell us fewer of theirs. So long as any country runs a trade surplus with the United States, that country's exporters are going to end up accumulating more dollars. Those dollars can only be used to buy U.S. goods or assets. A journalist recently said there's a third choice -- to trade spare dollars for foreign currencies. But whoever buys dollars for euros still has only two choices, to spend or invest the dollars in the United States. Sellers of euros may offer more of them for fewer dollars, but the buyer and seller in a foreign exchange deal cannot both gain from that trade.
So forget about deflation and hard landings. There are real things to worry about, like the endless East Coast rain.
The positive spin on the dollar's modest reversion to the pre-recession level is that a cheaper dollar means cheaper exports and more costly imports. But that depends on what happens to prices, including prices (costs) of imported materials. Continued... |