Friday, November 16, 2007

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.

23 comments:

  1. Hellasious,
    Surely, Hank IS a member of the global finance club...are you saying he is just a muppet of the administration and would otherwise prefer a strong dollar?

    Secondly, are you positive that Paul O'Neill was a dollar trasher? I realize his resume allows you to make those assumptions but he was very much a victim of the Bush tax cut program--something he was openly opposed to--and this, with its consequent deficits, weakened the dollar. No?

    Is PH part of the global finance club now that he works for Blackstone? :)

    ReplyDelete
  2. Your bibliography is quite eclectic! I will get a few for my Christmas reading. May I volunteer the following: [Caution: the opinions expressed may alter you perspectives!!]

    Greider, William.

    Secrets of the Temple: how the Federal Reserve runs the country.
    1987: ISBN(10) 0-671-47989-X

    Who Will Tell the People: the betrayal of American Democracy.

    1992: ISBN(10) 0-681-86740-7

    also;

    Soddy, Frederick.

    Wealth, Virtual Wealth and Debt: a solution to the economic paradox.

    Reprint of 1933 2nd ed: Omni Publications, Hawthorn, CA.

    Lib Cong Cat Card No: 60-53331


    Mention of the Global Finance Club. Seems these guys and gals are on an ocean cruise ship, which is leaking below the water-line - and some stupid person forgot to install the watertight bulkheads. Will the salvage tugs get the ship to dry-dock before it founders?

    Brian Woods

    ReplyDelete
  3. I do not wish to imply that the dollar policies, past and present, were the sole personal choices of the Treasury Secretaries. What I am saying is that the dollar is the responsibility of each Administration as a whole.

    On a personal basis Paul O'Neill was a very likeable guy, a straight shooter. He was not a "trasher" by any stretch - but the policy shift WAS signalled by his appointment as Secretary and then the two subsequent Secretary appointments.

    Regards

    ReplyDelete
  4. Certainly a weaker dollar appeals to the export set, but there is a point where the dollar can't be defended effectively simply because the real world consequences are too catastrophic to swallow. The club was quick to lecture the Asians on allowing their 1990s mess to clear itself out of the system without intervention, yet the club now can't fathom choking down its own advice.

    Defend the dollar? With what? Asset backed paper that the club does not dare to mark to market? $ 4.2 trillion of annual unfunded / off-balance-sheet entitlement promises about which the Fed itself questions (in a paper also titled) "Is the United States Going Bankrupt", concluding absent politically untenable changes, yes?

    In the end the dollar is backed by a big promise that at the moment does not seem terribly reliable. Being between a rock and a hard place is not the most easily defended position.

    Restoring balance in this environment will not come without a hefty payment for decades of free lunch policy.

    Just my two cents.

    ReplyDelete
  5. Hellascious,

    You claim that the Bush Administration is responsible for an intentional "Trash The Dollar" strategy but are you also implying that the U.S. could have weathered the strengthening recession (started in the last year of the Clinton presidency) as well as the aftershock of 9-11 WITHOUT doing something about lowering taxes and making money easier to borrow?
    Clinton ended his show with some rather substantial blockages to "easier" money that was needed to at least get the economy going again - I'd much rather have a strong dollar myself but an escape from a full blown Recession is not exactly a better choice.
    I will, however, most definitely agree that things got too far. It is disgraceful how U.S. companies, for the last two years or so, have been gloating about record profits but then whine incessantly that they cannot add to this mile-high-pile-of-dough because the Dollar is "too strong" - for the capitulation to occur under a Republican Administration (who inherited such a long-term budget mess) is .... pathetic to say the least! But the Dem's vows for Universal Health Care? Clinton and his/her bunch ain't exactly Strong Dollar types themselves (unless it falls in their laps) - it is not even in their nature.

    Thanks again for your blog Hellasious - enjoy your weekend.

    ReplyDelete
  6. WHERE THE VALUE LIES

    When you recall the instrument
    Is functional, not permanent,
    Then you may understand the sin
    When it comes time to cash it in.

    The financing of war by debt
    Were none too brilliant--you can bet
    That when that value drainward aims
    One finds self-worth not as one claims.

    A bridge is the example pure
    Of positive expenditure,
    For it adds but to wealth´s increase,
    But war´s remorseless in its lease.

    Save plunder, war does not return
    A benefit, spent money earn
    Sweet recompense, for all one´s loss
    Just meant to show the world "who´s boss."

    The world is wider than your patch
    Of neighbors--debt comes with a catch,
    While bombs exploded, holes in earth
    Do not contribute any worth.

    ReplyDelete
  7. imsmall -

    Very well put.

    But flush consumer-benefitting economies do not keep the bad guys away - it is easy to think about what the money COULD be doing but keeping the bad guys busy in other areas of the world enables us the luxury to complain about the weak Dollar.

    ReplyDelete
  8. Hel, the credit problems seem to be worse today than back in Sept. when you posted "The real reason"... will you revisit the problems within the overnight lending markets and discuss the implications over the next few weeks and months?

    ReplyDelete
  9. a Republican Administration (who inherited such a long-term budget mess)

    Inherited from Reagan/Bush I, you might add. Bush II inherited a surplus, don't you know.

    ReplyDelete
  10. Well, Hell, you must have known that given the state of the U.S. economy, the day would arrive when either the dollar or the economy would be sacrificed. Some of us had a pretty good idea it was going to be the dollar that was thrown under the bus, and so it has been and will continue to be.

    Pity is, it won't do the trick, not by a damn sight, so hold onto your gold and silver-if you own any. The de rigeur beat downs on PMs have become something of a tedious joke by now, and in the meantime I look forward to gold priced in dollars to reach well into the five figures.

    ReplyDelete
  11. Contradiction 1 - National policies vs. International.

    Contradiction 2 - Postwar dollar hegemony vs.
    Relative, to some extent absolute, decline of U.S. economic and military power since more or less early 1970s.

    Contradiction 3 - Growth in power of private traders vs. National & international institutions.

    Take us all 'back to the future' of the inter-war years and economic nationalisms, a 'rebalancing' based in crisis?

    ReplyDelete
  12. I won't go into why the Bush administration decided to trash the dollar;...

    Do you really think dollar devaluation was a deliberate policy goal? Or more a side-effect of other variables the administration decided to do little or nothing about, e.g. deficit spending?

    ...I have my theories,...

    Still it would be interesting to hear what you think. Because in the popular financial press you hear the dollar's woes blamed mostly on low interest rates, which are the Fed's doing, and the government/Treasury has, nominally (wink wink) little or no influence on Fed policy.

    eh

    ReplyDelete
  13. The devaluation of the dollar was Bush administration policy, no question about it.

    I don't think they meant for it to get as out of hand as it has currently, but they definitely wanted a lower dollar when they took over in 2001. The oil and industrial commodity connection was the paramount reason at the time.

    The rest came from a combination of choices made along the way (eg Iraq war, bubble blowing, the asset economy, lower taxes and deficit spending, the China Syndrome...)

    To me it looks like they want to stop the slide now. But for that to happen they must make some very painful choices. And with less than a year to go in the current presidency it's difficult. But they'll try to TALK the dollar up, anyway.

    Regards

    ReplyDelete
  14. 1. Nothing will tank the market like the Fed failing to cut rates as the housing situation gets worse, regardless of whether a cut would actually help or not.
    2. 2008 is election year.
    3. Voters vote their wallets.
    4. A choice of higher inflation which can be lied about and a devalued dollar OR a major drop in the stock market which will be covered on the front page of every newspaper(even if people don't read anymore)
    5. Rate cuts and devaluation.

    ReplyDelete
  15. Dear Brian Woods,

    Thank you for the book recommendations. The Soddy book is tough to get...i.e. pricey. I will keep trying tho.

    ReplyDelete
  16. Hel,

    I second the recommendation of Greider's book "Secrets of the Temple". It's excellent.

    I also recommend Peter Warburton's "Debt and Delusion", published in 1999. Warburton was one of the first to warn that global central banks were goosing the financial markets and inflating financial assets to levels way out of proportion with income growth of countries.

    For anyone with a broader historical interest, I also recommend "A History of Interest Rates" by Homer and Sylla. I was surprised to learn that the highest, most sustained increase in interest rates worldwide came not in the Middle Ages but in the post-Vietnam era when Volcker put an end to a decade of insanity at the Fed.

    ReplyDelete
  17. The Soddy book is tough to get...i.e. pricey.

    You can get it here for $6.95 -- just search for "Soddy".

    eh

    ReplyDelete
  18. This is OT to some degree, but I thought you might want to render an opinion. Someone on another site offered the following:

    "But, exports have more than made up for the drop in consumer spending."

    To that I said:

    Show me some credible source that says so. In the meantime I say that's pure bunk.

    Any thoughts, Hell?

    ReplyDelete
  19. This is OT to some degree, but I thought you might want to render an opinion. Someone on another site offered the following:

    "But, exports have more than made up for the drop in consumer spending."

    To that I said:

    Show me some credible source that says so. In the meantime I say that's pure bunk.

    Any thoughts, Hell?

    ReplyDelete
  20. Thanks for the book source. Makes a huge difference - about $90 worth!

    About exports..

    Total retail spending comes to 35% of GDP. Exports of goods and services are ~11% of GDP, so exports would have to increase more than three times faster to make a difference. But we are importing even more, of course...

    It is true that exports have been rising fast since the dollar tanked, but not so fast as to make much of a dent in the large trade deficit.

    Regards

    ReplyDelete
  21. You know I read that new Merrill CEO John Thain was also educated as an engineer...an EE to be exact at MIT. Never spent much time looking into engineering, but it seems to produce interesting people.

    ReplyDelete
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