September 24, 2003

Talking Down the Dollar

A correspondent asks why I am so annoyed with Treasury Secretary John Snow's attempts to talk down the dollar:

...a weaker dollar [is] a good idea... you soft-pedal the fact that we need a big real exchange rate adjustment eventually, so why not get started now?

The answer is that there are good ways and bad ways to talk down the dollar, and Snow chose a bad way. A good way convinces foreign investors that future monetary policy is likely to be accomodative and interest rates low as a way of inducing them to try to sell their dollar-denominated portfolio assets for less. This way promises to boost exports eventually (because the value of the dollar falls) and to boost investment (because it adds further credibility to the Federal Reserve's promises to keep interest rates low for quite a while). It so boosts aggregate demand, reducing unemployment. And it reduces the magnitude of the dollar's overvaluation, thus diminishing the chance that we will have to face a severe dollar-driven financial crisis a few years down the road.

A bad way to talk down the dollar convinces foreign investors that their investments in dollar-denominated securities are riskier than they thought they would be because the Treasury Department does not care. In this case, the value of the dollar falls (promising to boost exports eventually) but interest rates rise (as bond traders sense that there will be less in the way of foreign money flowing into the bond market in a couple of years). The rise in interest rates depresses investment spending, and the net effect is probably a minus for aggregate demand. Moreover, the increase in the perceived riskiness of dollar-denominated assets both reduces the value of the dollar today and reduces foreign investors' long-term willingness to hold dollar assets. To a first approximation, the magnitude of overvaluation does not change as the fall in the current value of the dollar is matched by a fall in the long-run "fundamental" value.

Guess which way John Snow chose?

And, of course, there are other reasons for being annoyed with John Snow: his unwillingness to take on the White House political apparatus, his craven total surrender of all of his deficit-hawk convictions, et cetera, et cetera.

Posted by DeLong at September 24, 2003 08:07 AM | TrackBack

Comments

Maybe the administration wants high unemployment?

Everything they do increases unemployment, so the logical conclusion is that they want people to be unemployed.

I can't imagine why.

Posted by: J.Goodwin on September 24, 2003 09:02 AM

The joys of the Bush administration. They balance bad policy with incompetent execution.

Posted by: richard on September 24, 2003 09:53 AM

Heh,
honesty from a Bush official should be encouraged rather than stomped on because you don't like what it implies.

Posted by: Patrick (G) on September 24, 2003 09:58 AM

Maybe the administration wants high unemployment?

Everything they do increases unemployment, so the logical conclusion is that they want people to be unemployed.

I can't imagine why.

Posted by: J.Goodwin on September 24, 2003 10:02 AM

"And the winner is:Mr. J. Good-win"=> Bingo

Why?
Ask some people!

Posted by: Drake Ramore on September 24, 2003 10:28 AM

High unemployment depresses wages, and, especially in service sectors, increases productivity (many unpaid hours of overtime by salaried people) and profits

Posted by: bob mcmanus on September 24, 2003 11:04 AM

Is such a policy at the end a "wise" one?
If not, what could be the consequences?

Posted by: Drake Ramore on September 24, 2003 11:35 AM

Is such a policy at the end a "wise" one?
If not, what could be the consequences?

Posted by: Drake Ramore on September 24, 2003 11:40 AM

I was wondering too, weak dollar good, then bad!? Brad explains it well in this post, I think. Still no one except Edward Hugh has even tried to point out what the fundamentals are that implies a weaker dollar. And I have still not been able to find IMF claiming a 40% dollar overvaluation in their April 2002 "World Outlook". And the dollar is still much weaker against both Yen and Euro than it was a couple of years ago.

What am I missing?

Posted by: Mats on September 24, 2003 11:40 AM

A sort of "whirlwind"?

Posted by: Drake Ramore on September 24, 2003 11:50 AM

A sort of "whirlwind"?

Posted by: Drake Ramore on September 24, 2003 11:55 AM

No matter what the supposed agreement to allow market forces to determine the value of currencies, I do not believe Japan will allow a significant further rise in the value of the Yen. Now are the Asian "tigers" going to welcome or allow a significant rise in the value of their currencies. China and Hong Kong will surely not give up their dollar pegs. So, I would be surprised if there is much dollar value change other than against the Euro.

Posted by: anne on September 24, 2003 12:18 PM

My guess is that the "agreement" at Doha was simply appearing to give the Bush Administration some cover on weak American employment. Encourage a decline in the value of the dollar, and American exports can gorw and imports will be limited. I doubt it. Growth is too weak in Asia to allow a substantial decline in the value of the dollar just now. Imagine what that will mean as Asians watch the value of China's currency fall with the dollar. Europe also would not wish a decline in the value of China's currency along with the dollar.

My guess is much ado about nothing for the present.

Posted by: anne on September 24, 2003 12:24 PM

I'm still searching for fundamental exchange rate arguments. Too simple, but a first try at it, the PPP: US comparative prices were 2001 1.09 of OECD average. Should be higher (in a Balassa-Samuelsson world) as I guess productivity in the US is above average. Has declined since, so no argument there.

Basically, I agree much with anne here - but:
"I would be surprised if there is much dollar value change other than against the Euro" - wanna buy Euros, what for? To pay them to unemployed europeans as unemployment benefits?

Posted by: Mats on September 24, 2003 12:40 PM

More effect than just the Euro. Japanese Yen is already up and Canadian dollar is expected to go up to 0.80/$

Time to check out those overseas bond funds.

Posted by: bakho on September 24, 2003 12:58 PM

Again, I'm mystified. Which is wrong:
(1) BDL does not support the Fed's easy-money policy. (Heck, didn't he just say he would have cut another quarter point at the last meeting?)
(2) The Fed's easy-money policy mechanically weakens the dollar against other currencies. More dollars => dollars less valuable.

Posted by: Andrew Boucher on September 24, 2003 01:55 PM

Currencies & Crises by Paul Krugman

FED's interest rate is indirectly proportional to investments = new machines = less jobs = higher productivity = cheaper goods

Posted by: Drake Ramore on September 24, 2003 02:11 PM

Currencies & Crises by Paul Krugman

FED's interest rate is indirectly proportional to investments = new machines = less jobs = higher productivity = cheaper goods

Posted by: Drake Ramore on September 24, 2003 02:16 PM

Currencies & Crises by Paul Krugman

FED's interest rate is indirectly proportional to investments = new machines = less jobs = higher productivity = cheaper goods

Posted by: Drake Ramore on September 24, 2003 02:22 PM

Currencies & Crises by Paul Krugman

FED's interest rate is indirectly proportional to investments = new machines = less jobs = higher productivity = cheaper goods

Posted by: Drake Ramore on September 24, 2003 02:27 PM

Currencies & Crises by Paul Krugman

FED's interest rate is indirectly proportional to investments = new machines = less jobs = higher productivity = cheaper goods

Posted by: Drake Ramore on September 24, 2003 02:32 PM

>Time to check out those overseas bond funds.
To late, trade-weighted dollar has declined 20% already in two years, how much further do you really expect it to go? This time looks quite different from 1985:

http://blogofpandora.blogspot.com/2003_09_01_blogofpandora_archive.html#106448679397622194

Posted by: Mats on September 25, 2003 04:16 AM

Sorry for the last post - must have got confused with the thread.

I think you are confusing short-term and medium-(and long-) term movements. In the short-term traders do indeed care about what the Treasury thinks and what the Treasury does. No one wants to leave early for the week-end with a short dollar position, to have the Fed intervene. But for the medium-term, no one gives a hoot about the Treasury. Interventions may smooth out declines, they can effectively stop panics, but they can't stop the waves from crashing, and they can't buck the fundamentals.

The fundamentals depend not on the Treasury Dept., but on the Fed, the balance of trade, and the U.S. budget deficit among others (for the deficit the Treasury Dept. has only a small responsibility). Given the Fed's policy stance of easy money, in the medium-term the dollar will go lower. It is not Snow, but the Fed backed by the economists (like yourself and Krugman), who are responsible for this decline. It is inevitable.

To suppose that interest-rates will be effected differently in your two cases, is to suppose the markets are irrational. Now maybe they are, but that is crucial to your argument, and you should make it explicitly. In both cases the medium-term is the same - the dollar is lower and the Fed acts the same. But in one case traders are supposed to be blinded and confident; in the other pessimists and sellers.

I insist on this, because it hits on another point where we have a strong disagreement, which is (for the lack of a better word, and excuse me if you find it inflammatory) Rubinomics. Rubins, bond trader that he was, thought the key to prosperity was to give people confidence in the U.S. The problem is, overconfidence is just as dangerous as underconfidence. Overconfidence leads to overinvestment and share-price bubbles. And overconfidence is what we got.

An economic policy built on the idea of confidence without worrying about the fundamentals behind it, is doomed. Advocating an easy-money policy and expecting traders and others to remain confident in the dollar, is doomed. Maybe it will work in the short-term; but in the medium- it will unravel.

Posted by: Andrew Boucher on September 25, 2003 04:34 AM

Sorry for the last post - must have got confused with the thread.

I think you are confusing short-term and medium-(and long-) term movements. In the short-term traders do indeed care about what the Treasury thinks and what the Treasury does. No one wants to leave early for the week-end with a short dollar position, to have the Fed intervene. But for the medium-term, no one gives a hoot about the Treasury. Interventions may smooth out declines, they can effectively stop panics, but they can't stop the waves from crashing, and they can't buck the fundamentals.

The fundamentals depend not on the Treasury Dept., but on the Fed, the balance of trade, and the U.S. budget deficit among others (for the deficit the Treasury Dept. has only a small responsibility). Given the Fed's policy stance of easy money, in the medium-term the dollar will go lower. It is not Snow, but the Fed backed by the economists (like yourself and Krugman), who are responsible for this decline. It is inevitable.

To suppose that interest-rates will be effected differently in your two cases, is to suppose the markets are irrational. Now maybe they are, but that is crucial to your argument, and you should make it explicitly. In both cases the medium-term is the same - the dollar is lower and the Fed acts the same. But in one case traders are supposed to be blinded and confident; in the other pessimists and sellers.

I insist on this, because it hits on another point where we have a strong disagreement, which is (for the lack of a better word, and excuse me if you find it inflammatory) Rubinomics. Rubins, bond trader that he was, thought the key to prosperity was to give people confidence in the U.S. The problem is, overconfidence is just as dangerous as underconfidence. Overconfidence leads to overinvestment and share-price bubbles. And overconfidence is what we got.

An economic policy built on the idea of confidence without worrying about the fundamentals behind it, is doomed. Advocating an easy-money policy and expecting traders and others to remain confident in the dollar, is doomed. Maybe it will work in the short-term; but in the medium- it will unravel.

Posted by: Andrew Boucher on September 25, 2003 05:11 AM
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