Here's an interesting take from Stumbling and Mumbling. In part:
Did I learn nothing at all at university? I’m prompted to ask by the increasing tendency – of which the BBC is part – to blame the falling dollar on the US’s budget deficit.
This view not only flatly contradicts efficient market theory – we’ve known about the federal government’s red ink for ages – it also contradicts the standard exchange rate models we learnt in the 1980s. These are the Mundell-Fleming-Dornbusch models. In these, a fiscal expansion strengthens the currency, because it boosts economic activity and raises the demand for money.
And later...
More respectably, some people are using the weak dollar to draw attention to the fact that Americans will have to increase their savings sometime.
And herein lies the problem. If or when Americans do start to save more, the resulting slowdown in demand could weaken the dollar still further, and cause even more trouble for people exporting to the US.
Read the whole thing. The part about savings is something that I haven't heard anyone else say out loud. I wrote about personal savings a few days ago, but from the perspective of explaining why it is so low. The author of the quote above is saying that it would get worse if people saved more. I say people save less because it's a rational equilibrium response (consumption smoothing, etc.) that keeps the situation from getting worse. We're on the same page, really. (It goes without saying that I think the author has little to worry about on that score--at least for the forseeable future.)
The real question here is whether or not it is the US budget deficit that is driving the dollar down. I too, would have to say "no," although in the grand scheme of things it is far from irrelevant. Here's another quote from the same post (listing potential problems with the standard models and the relationship between dollar and deficits):
2) Deteriorating creditworthiness. If foreign investors take fright at rising government debt, they’ll sell bonds and trigger a fall in the currency. Again, though, this hasn’t happened, at least not yet. These figures show that foreign private investors (never mind central banks) bought $167.3bn of US government debt in the 12 months to September.
One word. China. And that may change, but it's really unclear if and when. So are speculators overestimating the chances of this? I'd say it's a distinct possibility. (Reference here, particularly my quoting of DeLong's advice to the Secretary of the Treasury.) If so, is there a correction coming? Yes, but not until interest rates come back up in the U.S. That's the real reason. Speculators might be rationally expecting all that monetary stimulus (as well as the fiscal stimulus of deficit spending) that has been in place for 3 years now might finally start to result in inflation. If for some reason the economy stalls at that point, the result could be low real rates and high nominal rates which would essentially confirm the speculators' worst fears. That hasn't happened yet.
And that's why I think the death of the dollar is being exaggerated.
Oh, and by the way, the dollar isn't that much lower (according to the major currency index) than it was in the early 90's. See for yourself. The late '90s were the abberation, methinks. (I know, I know, try telling that to students wanting to spend January in London.)
Hat tip to Newmark's Door.
Leave a comment