Too many (currency) cooks

Larry Kudlow
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Posted: Oct 02, 2003 12:00 AM

Manipulating the dollar so that it is worth less and buys less seems like a foolish way to manage a nation's currency or economy. Doing so today, at worst, could derail the fledgling bull-market recovery, just as an overly cheap dollar ended the 1980s boom. Yet recent actions by Treasury Secretary John Snow and the Group of Seven industrial nations suggest that global policymakers are moving in this misguided direction.

A communique released at the recent G-7 meeting in Dubai called for flexible exchange rates rather than stable ones. Snow followed that up with a trip to Japan and China, where he sought to jawbone for a revaluation of the yen and the yuan. Implied from these actions is Snow's desire for a cheaper dollar.

Since the September G-7 meeting, the U.S. greenback has fallen nearly 6 percent. Prior to that, the foreign exchange value of the dollar lost about 20 percent. In terms of domestic purchasing power, the dollar has lost about one-third of its value when measured against the rising price of gold, which is a useful barometer of the domestic buying power of consumers and businesses.

Much of this dollar slide was necessary to end deflationary conditions -- commodity and business prices had been declining from 2000 to 2002. But in the past year, raw material and producer prices have stemmed their downturn and begun to rise.

Remember, just as inflation is caused by too much money chasing too few goods, deflation is primarily caused by a shortage of money in relation to available goods. The Federal Reserve controls the basic money supply, so its stinginess three years ago -- in part through an overly high dollar -- contributed mightily to the deflation of stocks and the economy. But that problem has been corrected. A "stable" dollar is all the recovering economy and stock market need.

Spurred by lower tax-rates, both the dollar and stocks appreciated late this summer. The bull run even spilled over into September, which is normally a rocky month for share prices. This followed the huge 25 percent rally between March and June, thereby confounding pessimists who were positive that shares had risen too far and too fast.

But financial markets are now worried about an overly weak greenback. Since the G-7 declaration and Snow's Asian trip, the dollar has completely given back its summer gain. Stocks, meanwhile, have lost more than 4 percent of their value.

Dollar tinkering seldom works. Right now, Japan and China own hundreds of billions of dollars worth of U.S. Treasury securities produced by a rising U.S. budget deficit. A shrinking dollar makes their investments less valuable. This could induce major selling and a run-up of domestic interest rates.

Meanwhile, as the dollar buys less at home, businesses and consumers who purchase foreign goods are disadvantaged. They now face the equivalent of a tax increase, as the cost of their purchases have gone up.

Manufacturing companies and their unions in Washington want a lower dollar because they erroneously believe it will increase exports of hard goods and create new jobs at home. But there is scant evidence that currency manipulation will remedy a 40-year decline in U.S. manufacturing jobs.

The per capita cost of a manufacturing job in China is $1,200. It's $26,000 in America. Beating down the dollar will not solve this imbalance. In addition, American producers can now maintain a constant share of gross domestic product with far fewer workers, largely due to big productivity gains.

Consider this as well: There are 14.6 million manufacturing workers in the United States, compared to 100 million Wal-Mart shoppers. A continuously weaker dollar could conceivably help manufacturing exports (slightly) in the short run, but at great cost to the purchasing power of the consumer army that is so important to domestic economic growth. The economic potency of Wal-Mart shoppers is far greater than the dwindling rolls of the AFL-CIO or the National Association of Manufacturers. But they don't have powerful union reps in Washington.

The good news is that neither core inflation nor interest rates on U.S. Treasury debt are rising much so far. But if the Treasury Department is targeting a cheaper dollar and the Fed accommodates this with excess money creation, spiking interest rates and inflation could short-circuit the bull-market recovery.

The Bush administration has already lowered tax rates to provide a positive jolt for new capital formation. The policy is working. But the recently shaky stock market is telling us that a sinking dollar -- aimed at spreading some kind of misbegotten policy icing on the recovery cake -- will hinder job creation and hurt President Bush's re-election bid next year.