The “Strong Dollar Policy” Charade

Robert Rubin, widely regarded as the father of the strong-dollar policy, declared his aim of a strong dollar soon after his appointment to the Treasury in January 1995. Rubin understood that a capital account surplus is the answer for a current account deficit, based on economics worked out by Martin Fieldstein in the Ronald Reagan administration. A strong dollar is key to this capital account surplus/current account deficit strategy, which has come to be known as dollar hegemony, or the “strong dollar policy”.


But as Representative Bernard Sanders (Independent, Vermont) pointed out when he interrupted Alan Greenspan during a congressional hearing on July 16, "We have a $4 trillion national debt, 1.4 million Americans have lost their health insurance, millions of seniors can't afford prescription drugs, middle-class families can't send their kids to college because they don't have the money to do that, bankruptcy cases have increased by a record-breaking 23 percent, business investment is at its lowest level in more than 50 years, CEOs [chief executive officers] make more than 500 times of what their workers make, the middle class is shrinking, we have the greatest gap between the rich and the poor of any industrialized nation, and this is an economy that is improving. I'd hate to see what would happen if our economy was sinking.” "Forrester Research says that over the next 15 years, 3.3 million US service industry jobs and $136 billion in wages will move offshore to India, Russia, China and the Philippines.” Moreover, the US current deficit is now approaching US$600 billion with the federal deficit at US$450 billion. The US needs to attract US$5 billion of funding each day (5% of GDP).


In other words, wealth is created in the United States as long as it can print money with little penalty of inflation, with the rest of the world shipping products to the US they themselves could not afford to consume in exchange for papers of the US financial system that in turn feeds US consumer power with debt. For this to be possible, the US has to continue playing the “strong dollar policy” charade. With the charade, even with the US dollar at four-year lows against the euro and six-year lows against the Canadian dollar, overseas investors have chosen simply to hedge their currency risks instead of abandoning US assets.


Among the economic definitions of “money”, the main two functions are “store of value” and “medium of exchange”. Because the US dollar is the main component of the world’s money supply, it forces the central banks of US trading partners to hold their dollar trade surplus in US bonds and assets, and for most of the world’s traded goods to be settled in US dollars. This allows the United States to levy a tax on the rest of the world for using the dollar, a fiat currency, as the reserve currency for world trade. An because it is a major component of the world’s money supply, any significant shrinkage in dollar supply would work to squash any budding economic expansion.


This is why every Treasury Secretary since Robert Rubin has paid lip service to the “strong dollar policy”. If they have not, or let slip the true nature of the “strong dollar policy”, they became ex-Treasury Secretaries very fast. Just ask Paul O’Neill. In February 2001, O'Neill said publicly: "We are not pursuing, as often said, a policy of a strong dollar. In my opinion, a strong dollar is the result of a strong economy." Financial markets reacted with massive dollar selling, forcing the Treasury Department to issue this clarification a day later: "The secretary supports a strong dollar. There is no change in policy." Mr. O'Neill then went overboard backtracking on February 18: "I guess I made a mistake in thinking it was okay to talk beyond simplistic things. So I'll make it very clear: I believe in a strong dollar, and if I decide to shift that stance I will hire out the Yankee Stadium and some rousing brass bands, and announce that change in policy to the whole world." But the White House could not afford to have anyone suggesting the US “strong dollar policy” was an emperor with no clothes. Mr. Simon was told to resign on December 5.


This is why the recent statement of the G7 finance ministers, in concert with US Treasury Secretary John Snow, was such a faux paux for the “strong dollar” charade. That is was aimed at Japan and China was not as important as the implications it had for the US strong dollar policy. Mr. Snow and Mr. Greenspan in 2003 have less room to maneuver than Mr. Baker and Mr. Volcker did in 1985. Investors suspect that Mr. Snow and the US Treasury will still push down the dollar at least by another 10 percent and the Fed will keep Fed Funds rate target near zero to deflect growing political heat.


(TT's Take)
The credibility of the “strong dollar policy” remains key to the business sentiment outlook for Japan. Most companies had budgeted for yen-dollar exchange rates of JPY115 this year, while we are already through that and going higher. The BOJ's spending of a record JPY13.48 trillion--almost twice as large as the previous record in 1999--has only slowed the yen's rise. If currency markets openly challenge the strong dollar policy charade, we could well see much larger two-digit declines in the US dollar, and a spurt in the yen beyond JPY100/US$, toward the old high set in 1995 of JPY79/US$.


This is bound to cause consternation in Japan, as exporters such as Toyota are already grumbling about the strong yen.