Five Reasons To Save The Dollar

Financial firms have so far announced losses totaling around $160 billion, and UBS feels there could be a total of $600 billion in losses triggered by the subprime collapse. There is more bad news to come and central bankers know it. If UBS is correct we've only seen the tip of the subprime iceberg, and central bankers will have to remain flexibile to effectively deal with upcoming challenges. I don't doubt that the dollar's long term trend is down, but coordinated intervention to give the U.S. dollar a short-term (2-5 years) lift may be an interesting idea for central banks to consider.

"The already undervalued dollar won't stop falling until it is stopped via coordinated intervention," said Morgan Stanley's Stephen Jen in a note published in December. "While the preconditions for such an action have not yet been met, uncoordinated verbal intervention has clearly commenced, validating the notion that the costs of a weaker dollar are quickly catching up to the benefits for most countries in the world."

Coordinated central bank intervention to save the dollar might sound like a crazy idea, but it's worth pointing out that in the past 30 years, coordinated intervention caused all but one of the changes to the dollar's long-term trend. Morgan Stanley said in November that the Fed, European Central Bank (ECB) and the Bank of Japan (BoJ) may coordinate efforts and intervene once the Euro hits $1.50, or if the Yen goes to 100. The analysts suggested that coordinated intervention would become more likely once the Fed ends cutting rates and the ECB ends hiking rates, and it's probably fair to say that we are fast approaching such a condition.

The Morgan Stanley report points out that trade and investment flows rarely offset large currency moves, which implies that the "natural economic mechanisms that should, in theory, have helped halt the greenback sell-off were not, in fact, usually strong enough. This is why multilateral interventions were usually required to facilitate the re-alignments of exchange rates."

Central bank credibility can go down the tubes if it fails to boost the dollar in a coordinated intervention attempt. How long will the Fed's $67 billion of reserves (including $42 billion in foreign currency) last before it's absorbed by a forex market that trades $3,000 billion a day? The Fed will need the help of other central banks to take on the massive foreign exchange market. Assuming central banks can successfully pull off a coordinated intervention, here follows five reasons why saving the dollar makes sense:

1) Record oil prices pose a major risk to the industrialized world, and a higher dollar will probably knock down oil prices and reduce inflation

OPEC is refusing to boost production when the rest of the global economy is faltering, and it's time for central banks to get creative. Lower oil prices, as a result of coordinated intervention to save the dollar, will help to cool inflationary pressures, giving central banks some room to adjust monetary policy. For example, many analysts believe the ECB is behind the curve, especially after recent economic releases that disappointed. Lower oil prices may reduce inflation expectations in Europe, which may allow the ECB to cut interest rates and deal with the economic slowdown and credit troubles.

2) A stronger dollar will boost the buying power of the weakening U.S. consumer

The U.S. remains a consumer nation, and central bankers need to find ways to resuscitate the U.S. consumer. After all, the U.S. consumer has been the driver of growth in many parts of the world. By boosting the value of the dollar through coordinated intervention, U.S. consumers remain protected from inflationary pressures by increasing their buying power.

3) Japanese exporters need to remain competitive

"Recession is a clear and present danger in Japan," said Tetsufumi Yamakawa, chief Japan economist for Goldman Sachs. "The leading indicators are deteriorating very sharply. Inventory is piling up at a rapid pace. There are clear signs of deceleration in exports of steel and semi-conductors to China," he said. Japanese exporters will have to remain competitive if Japan is going to recover from the current slowdown. Coordinated intervention to lift the dollar will push down the yen, helping Japanese exporters.

4) Coordinated solutions will be more effective than isolated solutions

If countries act in isolation, I doubt they can produce meaningful solutions. A perfect example of this idea is the Fed's recently announced rescue package that will probably benefit the Chinese more than the United States. "Americans will use the rebates to buy Chinese imports offered at Wal-Mart and the $150 billion will then wind its way inevitably back to Asian coffers," says PIMCO's Bill Gross in a recent note. Some might say this is far-fetched, but it illustrates an important point: Global economies are tightly connected, and contagion effects are likely to undermine the impact of domestic policy action. This is a global problem, and it has to be solved by global, coordinated solutions. "Preventing a global downturn is too big a job to be left just to American policymakers," says the headline in a recent article published by The Economist.

5) The timing of the U.S. elections

The world can't always rely on America to save the day, so other nations will have to come to the table and offer solutions. Due to the political transition in the U.S., it might take time to implement policies that will be effective. After all, the $150 billion rescue package has been labeled a "temporary" solution to avoid widespread damage to the economy in an election year, and much work still has to be done to arrive at a permanent solution. Quoting PIMCO's Bill Gross again: "When private demand falters, it becomes the responsibility of the government to fill the breach. Because it likely will not do so effectively until after a new Administration is elected in late 2008, the U.S. economy and its somewhat coupled global companion will sleep walk for some time and a resumption of prosperity as we knew it will be dependent on reforms of monetary and fiscal policy resembling the 1930s more than our past decade."

There are numerous arguments against intervention to save the dollar. Exports have turned into the main driver of US growth, offsetting the housing slowdown and credit crisis. It doesn't make sense to disturb an area of growth, especially when we don't know if U.S. consumption will continue to hold up. A weakening dollar is also helping the adjustment of the U.S. trade deficit, a process that U.S. officials wouldn't want to disturb. Politics may also delay coordinated central bank intervention. The G7 demands currency flexibility in the emerging world, and for that reason any coordinated intervention from G7 central banks will contradict those demands. Some analysts suggest that a more realistic scenario would involve Europeans undertaking some sort of coordinated intervention that would spread the burden of adjustment more evenly between the euro and some Asian currencies.

Coordinated intervention to boost the dollar is not an ideal solution, but the foundation of the idea is simple: we need coordinated solutions. "If the world leaves the Fed to provide risk insurance for everyone, America's interest rates will almost certainly be too loose for too long-just as they were in 2001-04," says The Economist. "Excessively low American rates would raise the odds of new asset bubbles and impede the rebalancing of the global economy."

Comments

[joebhed]

Ummmmm, let's see.
Where to start?
Did you say the price of oil needs fixing, or the dollar? Which?
Well, how about doing away with futures speculation in the marketing of oil?
I happen to agree with those, even OPEC, who say that market speculation is the major cause of oil price increases - beyond, of course that caused indirectly by the falling value of the curency on which its price is based.
So, basically, what I would call for at the moment is more market "discipline", i.e., the antithesis of the free market, known as price regulation.
Then, looking at the benefits of a soft-landing for the American economy and dollar, I would say this.
WHO, or whom, is responsible for the underlying factors of the impending(as in, not here yet) slide of both the economy and the dollar?
Please stand up. Please raise your hands if you have acted against the interests of this country and its citizens by supercharging the growth of currency and debt?
Please, all those raising their hands, over here on this side of the aisle.
Right!
Nobody raised their hands.
Rather, everyone points to the "invisible" hand of the free market.
The market made me do it.
"I just played along as a market player should."
Interestingly, your "coordinated intervention" approach makes sense were it not for one thing.
That sounds like a cooperative framework for currency valuation.
What are you, a communist, or socialist?
Where have you been?
Haven't you heard about the free market?
A cooperative framework is more like, well, you know, it must be socialism, because that's all there really is in this world.
There's capitalism, and there's socialism.
Did I say cooperativism?
What am I thinking?
Cooperative curency management?
Coordinated intervention?
Cooperative?
Cooperate?
What's this world coming to?

[Henry]

Eben:
There is a simple solution for you, and us, and everyone.
1) Declare the OPEC countries in violation of WTO principles that prohibit cartels that manipulate price. What's good for the goose has to be good for the gander, eh? (and...this by the way, is where General Patreus should be pointing his troops)
2) Permit the noncartel group oil exporting countries (NOPEC anyone?) or demand if necessary to price oil in a range of currencies e.g. Yen, Euro, Dollar, Yuan.

When we have a 100 yard dash, we expect that each competitor should have 100 yards in the race. Why should the U.S. have had 60 yards in this race dating since post WWII?
The dollar needs to be deThroned as the world currency. Also you should look at the central bank rates of countries competing in the world market. You'll notice Japan at one/half of one percent. You'll notice the U.S. at 600 percent of that rate. Then you'll look at the damage done by the so-called carry trade. Perplexing and bewildering. We all learned in college about the market place, the "domestic" market place. We have no comprehension of the global market place with vastly different central bank policies that make what we have learned passe. (for example...do you think that supply and demand are setting interest rates??)

[kikomnipotent]

I need an information source that explains in plain English how the dollar works, & stacks up against other money. I also would like to understand exactly how inflation becomes this ever growing monster that affects evryone exept the people who control all of the money. Why is it that every time we face a financial crisis, the move is to "Save the banks"? Why is our notion of a good economy based on how giaint entities like the airlines (who get bailed out when they overpay themselves & cry to the Fed), or the banks? I know a lot of folks who could use some "bail-out" type help, yet when it comes to the citizens, the innability to keep up with inflation is seen as a failure on their part, & that they should pick up their boot straps & get to work again? The Fed has let inflation squash the dreams of the American worker, while allowing their fat-cat friends @ the oil, shipping, & engineering companies make record profits that are measured quarterly. And every time a scandal like Enron hits, when it is actually proven that arich folks are stealing from their workers, the Fed puts a diaper on the CEO & holds his hand to console him. People like that should be hanged in public. This country is in the toilet because the people who make the laws are competely blind to the plight of average people. The rich need to be shown that their money comes from the abuse of others (minimum wage is an INSULT). When it goes bad I'm going to eat them.

[Henry]

Kiko:
You might start by typing into your web search Nixon, floating exchange rates. Then you might type in Bretton Woods for a search. Then you could type in Purchasing Power Parity.
The formal textbook answer to the question of how the dollar works vis-a-vis is "supply and demand". For example: There is big demand for the U.S. Dollar because everyone who purchases oil from OPEC has to purchase in dollars. This makes the dollar more dear than it otherwise would be.
Republicans like to state that they are market disciplinarians, yet their actions avoid or preempt market discipline. For example: Japan and the PRC manipulate their currencies to keep them low so they can depend on exports to the industrialied west. And we do nothing about this manipulation. Why? Cheaper prices for America, lower inflation, and therefore lower rates permitted by Central Bank (economy boooms). It's all a scam. And somebody should call them on this. Snow, the Sec of Treas for Bush said there was no "evidence" the PRC was manipulating their currency (ho ho). And devious George stated just the other day that he (Little George) had a strong dollar policy! And... he gets away with it!!!

[Sundialsvc4]

Eben, I soberly submit to you that your well-phrased arguments do not have any hope whatever of success, because these ills face not "the Dollar," but "the Country" that issues them. When a country dismantles its own internal industrial infrastructure in a mad quest to become "a consumer nation," the strength that enabled its currency to be a "Reserve Currency" is likewise removed. When, on top of that, said nation now "borrows from itself" more than $1 million a minute, 24/7/365, it takes very little time for that currency's status as a "Reserve" to become utterly unsustainable.

There is no amount of "magic banker-mojo" that can be applied in this case, because one of the most populous nations on this planet cannot, by definition, be "a consumer nation." (Most especially when it seems bound-and-­determined to bring about World War III.)

Because we do everything now with computers, we do not conjure-up images of German citizens shoveling wheelbarrow-loads of currency into their stoves, but the present situation is very much the same and for the same reasons. Our coffers are filled with Leprechaun gold, and the morning sun is rising upon ... straw.

[Sundialsvc4]

Footnote: Lest anyone imagine I am suggesting some kind of conspiracy, think just like a true businessman ... someone who does not have a magic-money-machine in their garage.

"I'm a fuel broker, and my customer is airlines. Airlines need to buy millions of gallons of fuel at a predictable price, through futures contracts, so they know how much they'll pay for the fuel six months from now and therefore how to price the tickets. But I have to take the money now and deliver the fuel six months from now ... when the American Dollar is going to be worth far less than it is today because by that time there will be 6 x 30 x 24 x 60 = $259,200 MILLION more in "magical money" in circulation than there is today. I'm losing my shirt on the exchange-rate, and so is the producer that I buy from.

"Therefore, I -have to- buy and sell in Euros, or in a basket of currencies of my choosing, just so that I can stay in business. Trouble is, the 'magical money machine' only works because people have to trade their currency for Dollars in order to buy oil. If people instead had to trade their Dollars for any other currency, the 'magic money machine with unlimited borrowing power' would stop. But that's not my problem, you know... That's not my problem."

[mightbesane]

It is interesting that debt is the theme of these commentss while it does not appear central to the blog - although the blog does begin with a discussion of the sub prime mess.

The fact that so much of our national debt is held off shore should be central to any discussion of the dollar. Perhaps the belief is that these holders of American debt instruments can't afford to let the dollar collapse. I don't know. I do know that we would be in deep trouble if the euro instead of the dollar becomes the benchmark for international banking and trade.

In the emerging world economy, where financial rather than military might will decide the weight of a nation's power, a smart dollar will be more important than a smart bomb.

[kikomnipotent]

I heard almost the same language used today in the media, twice, referring to the dollar-euro fight. Some countries are now turning away the American dollar? Uh-Oh, what is coming?

[January]

Thank you for laying out the complexities so concisely. Our global house of cards economy is easier to tear down than build up. The suggestions of coordinated monetary policies sounds a bit wishful, but I confess to status as a blithering idiot on the subject.

Yet I'd like to add one more feature, and that is some evidence acknowledging that patches are not enough. Would the US, as the world's primary arms merchant, subscribe to arms reductions? Allowing all to keep their costs down? That would be a drop in the bucket, but it would show goodwill. The longest journey begins with one step, the Chinese tell us. It's time to listen.

[mmckinl]

The only relief for the dollar is to reign in the trade deficit ...

Two steps must be taken , first we need tariffs to slow imports and boost reserves, second we need to declare an energy emergency. The tariffs will counteract the currency manipulation, product dumping and trade barriers that are currently being practiced. The energy emergency would lower all speed limits and empower electric vehicles to be manufactured while beefing up the electric grid.

We also need to get out of Iraq and cut our military spending by at least 40% , place progressive taxes on all income including capital gains and dividends, and abolish all tax loopholes including off shore advantages.

No amount of 'intervention' will cure this problem. Serious solutions are the only answer to this devaluation, all else is doomed to fail.

[dadw5boys]

THE TAXPAYERS PAID MORE IN INTEREST ON THE NATION DEBT THAN WAS SPEND FOR THE WAR!

THE USA NEEDS TO PRINT IT'S OWN MONEY AND BACK IT WITH SLIVER LIKE JFK DID!!!!!!!!

THEN PAY OFF THE NATIONAL DEBT AND STOP PAYUING INTEREST TO THE FEDERAL RESERVE!