Wednesday, October 21, 2009

Straight talk on the dollar

A good supply-side friend, Don Luskin, yesterday wrote a very nice article in NRO and on his website that speaks to Treasury's apparent lack of concern for the weak dollar.

The fact is that the Obama Treasury is playing a very difficult hand of poker here. Its failure to wave a magic wand and restore the prestige of the U.S. dollar does not originate in a willingness to acquiesce in American decline. Secretary Geithner told me that he rejects what he called the “existential narrative” so popular among global economic elites — the declinist doctrine of so-called “global imbalances” that envisions a lazy America being overrun by hard-working Asians. No, what’s holding the Treasury back from delivering a stronger dollar is, more than anything else, the absence of magic wands in the real world.

The closest thing we’ve got is the Fed’s magic checkbook, and that’s been wide open for more than a year now. So if you’re worried about our currency, you can spend your time more wisely than hoping for a “strong dollar” speech from Tim Geithner, or even trying to get him to lay off the Chinese for a while. Instead, hope for Ben Bernanke to start closing the Fed’s checkbook — before runaway inflation depreciates the dollar both on foreign exchange markets and in every American’s wallet.

Despite popular perceptions to the contrary, the fate of the dollar rests entirely in the hands of the Fed. Since the Fed has been willing to over-supply dollars to the world at a time when the demand for dollars has been falling, the dollar is losing value against other currencies. This is just basic econ 101: supply more of something than the market wants, and its price will fall.

4 comments:

Public Library said...

Good post. Thank you.

brodero said...

Will the recent flatness in growth
of M2 lead to future strength in the dollar???

Scott Grannis said...

I think that flat M2 growth is due to a decline in the demand for money. The growth of dollar currency in circulation has also slowed down significantly. Both point to the same decline in money demand. Since the demand for dollars is declining at the same time that the Fed continues to be extremely willing to supply dollars to the world, we end up with too many dollars. This in turn explains why the dollar is falling in value relative to other currencies and relative to gold and commodities.

Until demand changes or the Fed starts tightening policy, the declining dollar trend is likely to continue.

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