Send Hank Home

Under the law, the foreign exchange value of the US dollar is the responsibility of the Treasury Department. In the Clinton years a succession of Treasury Secretaries from Lloyd Bentsen to Bob Rubin and Larry Summers maintained a strong dollar policy, ultimately taking the dollar as high as 0.82 cents per euro.

The "industrial heartland" disagreed violently with this policy because it lowered the international pricing advantage of US industries such as steel, aluminum, autos and chemicals that faced stiff international competition. But the Clinton administration had a post-industrial view of the US economy, one that was based on the "software" produced by Hollywood, Silicon Valley and Wall Street, rather than the "hardware" coming out of the industrial Midwest.

There was another reason for the strong US dollar policy: the inception of the euro posed a very real threat to the dollar's global reserve status and had to be defended against, right from the start. Some US economists even went so far as to suggest that the euro would precipitate severe global tensions, ultimately leading to war! Marty Feldstein wrote a highly biased polemic article in the November/December 1997 issue of Foreign Affairs titled "EMU and International Conflict". The summary is below:

Jean Monnet's dream that European integration would eliminate conflict may have been a delusion. France and other countries do not share Germany's fixation on sound money -- or its hegemonic vision. A European central bank would be unresponsive to local unemployment, while political union would remove competitive pressures within Europe for structural reform, prompting protectionism and conflict with the United States. A Europe of 300 million people and an independent military might be a force for world peace, but war is also a distinct possibility.

I clearly recall the howls of protest coming out of the EU at that time and later, that the US was trashing the euro just as it was starting out - and they weren't without justification. For a while, Bob Rubin and Larry Summers included "a strong dollar is in the best interest of the United States" to each and every speech and comment they made.

When George W. Bush took over all of this was changed in the blink of an eye. The new administration appointed Paul O'Neill as Secretary of the Treasury and we all looked at each other across our screens and asked.."Paul Who?" Clearly, he was not "one of us", i.e. not a member of the global finance "club". As soon as we found out he was the CEO of Alcoa we knew the strong dollar game was up. The euro immediately rallied from 0.82 to 0.95, went back to 0.85 to test its lows a couple of times in 2001 and then embarked on the massive rally that has brought it to its current 1.46-1.48.

I won't go into why the Bush administration decided to trash the dollar; I have my theories, but suffice it to say that, as with several other major policy moves, it was astonishingly short-sighted and stubbornly defended even in failure.

This brings us to the present: in the past few days Hank Paulson has been attempting to verbally shore up the dollar in various comments, in a clear shift from previous remarks. The sharp rise of commodity prices and the real, or threatened, actions of various dollar-block countries (UAE, Qatar, Kuwait, China, KSA, et. al.) to move their reserves away from the dollar, is finally starting to raise red flags even for the otherwise color-blind Bush administration. But it is way too late for mere talk; if the US is really determined to halt the slide of the dollar it has to send some serious and tangible messages to the global financial community. All talk, no action simply won't cut it.

The very first thing to do is "Thank Hank for his excellent work done at the Treasury"... and send him home (unfortunately - or fortunately, depending on your viewpoint - this is how things are done). All other things equal, it doesn't much matter who replaces him so long as he is known to the "club" and the very first thing he says publicly after "I thank the President for the honor.." is "The United States Government is fully committed to a strong dollar as a store of value and global purchasing power...". Bang, that's good for 10 cents against the euro right there.

Naturally, such a statement will have to be followed by tangible policy shifts to restore balance to the global standing of the US economy, but this is a subject for another post. Suffice it to say that Empires with debased currencies do not last long.