Wednesday, April 27, 2011

Bernanke and the dollar

In his first-ever press conference today following the FOMC meeting, Fed Chairman Bernanke mentioned the dollar quite a few times. You might think that would be a natural, coming from the head of the institution that has direct control over the supply of dollars to the world, and by extension the dollar's value. But in fact, the Fed rarely addresses the issue of the dollar's value in the context of the things it watches or tries to target.

So it was somewhat refreshing that today Bernanke joined with Geithner and Treasury Secretaries of the past in saying that a strong and stable dollar was in the interests of both the U.S. and the global economy. Unfortunately, he qualified that by adding that he thought the dollar's recent weakness was another one of those transitory things (like rising headline inflation and weak first quarter growth) that should reverse in the medium term. He's not targeting the dollar directly, in other words, believing instead that the dollar will find support and prove strong and stable over the long run if the Fed is successful at containing inflation and boosting the economy.

It's all too tautological for me, and for the markets, I suspect. Yes, if the Fed is successful in defending the dollar's purchasing power over time, then the dollar should find market support and its value should be relatively strong and stable. But just how are we going to get a stronger dollar tomorrow by weakening the dollar today?

As I've pointed out, the Fed has yet to commit any gross monetary error, since there is no sign of any unusual growth in the M2 money supply. But even though M2 is only growing at a a 6% rate, the decline in the dollar's value against other currencies and gold is prima facie evidence that the Fed is supplying more dollars to the world than the world is demanding. It's clear that monetary policy is accommodative, and that means the Fed is setting interest rates artificially low in order to create an over-supply of dollars, and an over-supply of dollars means the dollar's value has to decline.

This is what is troubling the world. How can we be sure that the Fed will be able to pull off the trick of weakening the dollar today in order to strengthen it tomorrow? A weaker dollar risks letting the inflation genie out of the bottle, and we know it's very hard to put back in once that happens. There is little or no theoretical or logical support for the idea that a weaker currency creates a stronger economy. Bernanke is saying the right things, but he is also asking us to trust him an awful lot. The world would feel much better if he were more specific. Holding press conferences is a good way to make the Fed more transparent, but unless there is substance (i.e., rules and/or objective measures that guide policy) behind the words, then fear, uncertainty and doubt will erode confidence in the dollar and that will exacerbate inflationary pressures. Less demand for dollars contributes to an over-supply of dollars the same way an increased supply does. In the end it's a negative feedback loop that threatens us all.

So it was not surprising to see the dollar decline in the wake of today's FOMC meeting (9:30 am Pacific Time on the chart above) and throughout Bernanke's testimony, and it was not surprising to see gold prices rise (see below). In nominal and real terms against a broad basket of currencies, the dollar is now at a new all-time low. In nominal terms gold is at a new all-time high, but in real terms it is still about one-third below the highs it (very) briefly reached in early 1980.

Ben "Trust Me" Bernanke may well pull off the greatest balancing act in history when all is said and done, but I have to believe there is an easier and more direct way to achieve a strong and stable dollar, which is ultimately the only way to enjoy low and stable inflation and a strong economy.


Benjamin Cole said...

First some good news:

"The Nasdaq Composite index hit its highest level in more than 10 years Wednesday as US stocks pushed upward after the Federal Reserve left ..."

A 10-year high!

I guess I am the only man in America who believes in Bernanke. I think he is deeply learned, and a dedicated public servant. If anything, I think he is a little bit too cautious, sober, circumspect.

Bernanke inherited a train wreck into a sewage treatment facility. He negotiated his way though the worst of it. We will not see a Great Depression. If we are lucky, we will see a secular bull market from here, and I think we will.

That ain't half-bad work, Jack.

William said...

I think that we shouldn't give too much credit to Mr. Bernacke for the decline of the US Dollar.

What is dismaying foreign investors is the real results of last year's mid-term elections: 1) the December compromise in which the Democrats got more spending and the Republicans got low tax rates and 2) the shameful Budget Shutdown sham which claimed to save $38 Billion but cut this years spending by only $1 Billion. The net effect of all this "politics as usual" is to increase the projected 2011 Budget Deficit from $1.3 Trillion to $1.5 Trillion.

Large global investors had confirmed to them that the US government is NOT serious about controlling its spending or lowering its massive debt. Compare the US government's actions to those taken by Great Britain, Germany and France - not to mention what Ireland, Greece, Portugal and Spain are attempting to do.

Our government is "fiddling while Rome burns" so to speak. It is clear that the US government was dysfunctional for more than two decades. Here are other areas where our elected officials have been ineffectual: Medicare, Social Security, Medicaid, Immigration, Infrastructure, Energy Independence, State Budget Deficits, Government Pensions, etc.

I might also mention how the US so blithely entered military mis-adventures which squandered our nation's wealth.

Conclusion: large global investors are losing faith in the ability of the US to manage it's future. There is plenty of credit to go around for these errors.

Public Library said...

Ben "Trust Me" Bernanke has to be a new coined phrase. I love it but I will take the under on his eventual success.

Cabodog said...

Scott, the scary thing about gold right now is that, yes, in 1980 it was higher (in real terms), but that was in response to REAL inflation.

Gold right now is high due to the FEAR of the return of inflation.

What will gold be when inflation actually returns?

Benjamin Cole said...


I share your sentiments, and admire your balanced point of view.

The problem is entitlements, the number of federal employees, military spending and rural subsidies.

Aside from that, it is pretty easy to fix.

William said...

8;30 PM EUR-USD 1.482

This AM it was down to 1.472 from the previous day.

When states obviously can't pay their debt, the adjustment occurs primarily through their currency which falls dramatically. This is the point which major investors overseas and also in the U.S. understand. Unfortunately for Greece, Ireland and Portugal, they don't have this option.

The U.S. fortunately or not does.

Lori said...


Have you ever heard the term buy the rumor sell the fact?

In the words of Maury Finkle, founder of Finkle Fixtures, Biggest Lighting Fixture Chain in the Southland,

Do it.

John said...

"A weaker dollar risks letting the inflation genie out of the bottle, and we know it's very hard to put back in once that happens."

Huh? Hard to "put back?" Volker didn't have any trouble 30 years ago. Probably the easiest thing to fix and you guys talk about it like it was an incurable disease.

brodero said...

Does anybody realize how close to
a depression we got in 2008 plus
does anybody realize how close to
a depression we will have if Dr.
Ron Paul M.D. gets real power???

Scott Grannis said...

Re: putting the inflation genie back in the bottle. It is indeed difficult. I note that every recession in the past 60 years has been precipitated by a tightening of monetary policy in response to rising inflation. Volcker's tightening triggered a very painful recession in the early 1980s. Interest rates had to climb well into double digit territory. Plus, it took a good 3-4 years before inflation and inflation expectations settled back down. The Fed cannot micro-manage inflation. The lags are long and unpredictable, and the impact of policy changes on the economy can be significant.

TradingStrategyLetter - Weekly Summary said...

We will soon discover if Uncle Ben and the USA will be the first country to inflate it's way to prosperity.
Many have tried - none have succeeded.

Stone Glasgow said...

"I have to believe there is an easier and more direct way to achieve a strong and stable dollar, which is ultimately the only way to enjoy low and stable inflation and a strong economy."

What is the easier and more direct way?

Scott Grannis said...

Re a better way to a strong and stable dollar: simply tell the world that a strong and stable dollar is the Fed's primary objective. (As it is today their primary objective is low inflation and low unemployment, with the hope that that will then lead to a strong and stable dollar) I believe that if the Fed's primary objective were a strong and stable dollar, then low inflation and low unemployment would naturally follow.

Stone Glasgow said...

I don't think their stated (public) goals are tremendously important. As a private company, their goal is to make money, which requires keeping inflation low and predictable and avoiding deflation. They have been relatively good at this since the gold standard was removed, which freed them to adjust the value of the dollar more easily. There has not been a deflationary year since the 70's, and inflation has been relatively low and consistent.

I believe the main problem is not that the Fed is bad at its job, per se, but that it has no (domestic) competition. If we really want a stable currency, we would do well to take Hayek's advice, described in his 1977 book "The Denationalization of Money."

Unknown said...


Last PIMCO article (Skunked) brings that:
"As others, such as Pete Peterson of the Blackstone Group and Mary Meeker, have shown much better and for far longer than I, the true but unrecorded debt of the U.S. Treasury is not $9.1 trillion or even $11-12 trillion when Agency and Student Loan liabilities are thrown in, but $65 trillion more! This country appears to have an off-balance-sheet, unrecorded debt burden of close to 500% of GDP! We are out-Greeking the Greeks, dear reader"

What are your takes on that, plse?

Scott Grannis said...

I don't disagree that the U.S. has a big debt problem, but don't see how it is possible that debt amounts to $65 trillion or anything even close to that. There are indeed trillions of unfunded liabilities of social security and medicare, etc., but these liabilities are not debt. No one has a legal entitlement to his social security promises, for example. Plus, the unfunded liabilities can only be calculated by assuming all sorts of things that are impossible to know today (e.g., will the retirement age remain the same, or be raised).

acrossthecurve said...

The velocity of the decline the in the dollar is the real concern. Bernanke's disdain for defending the dollar has created a major momentum behind its decline it will be very hard to stop. DXY is down almost 15% since September, one of the strongest corrections of the previous decade. Now, we embark into uncharted territory as we float at historic weakness for the dollar. Central Bankers, Multinationals and other large holders of US dollars are very nervous at the moment. Should the dollar continue to fall many will start to waive the white flag and just hit whatever bid is out there(note: there wont be many). I hope it does not come to this but, being a technical trader and studying the trends it looks possible. The risks are HUGE and the upside at this point seems marginal at best. I believe Bernanke has our best interests in mind but, its hard to stand behind a guy who defended housing from 2005 to late 2008.

hadn't watched this in awhile and it now seems awfully similar to how he is defending his weak dollar policy.

bernanke 2006 - "we've never seen national housing prices decline on a nationwide basis"

bernanke 2011 - "we've never seen a falling dollar as an inflation risk"