Dollar Talkers
A recent headline in The Washington Times: "Snow's words boost dollar, interest rates." A few days earlier, Treasury Secretary John Snow's words were being criticized for sinking the dollar. It sometimes seems as if a treasury secretary can't even sneeze without someone seeing it as an invitation to speculate on the dollar.
Still, silence is often the best policy. As the Wall Street Journal's wise veteran George Melloan wrote, "Giving monetary lectures to trading partners just makes the markets nervous." Trying to influence exchange rates is sometimes dangerous and never successful. Just take a look at the sorry efforts of previous treasury secretaries.
Nearly every treasury secretary since George Shultz (1972-'74), with the notable exception of Robert Rubin, has made some effort to negotiate or talk the dollar down. This was always due to misplaced anxiety about trade deficits and misplaced confidence on a weaker dollar as a means of fixing that phony problem.
I propose looking at what was happening at the time of major turning points in the dollar, using the Federal Reserve Board's broad index of the dollar's value against 26 other currencies. The broad index is needed to include such major trading partners as Mexico, China, South Korea and Singapore. Even if pushing the dollar down against one currency reduced imports from that country (say, Japan), the United States would just import more from another (South Korea).
To digress into complex economics, the overall current account deficit is equal to the gap between domestic investment and savings. That means a weaker dollar could only reduce the deficit by raising U.S. savings (which makes no sense at all) or reducing U.S. investment (which is an odd definition of improvement).
Economics aside, the first political push to devalue the dollar began with President Nixon closing the gold window and imposing tariffs and price controls in August 1971, with the explicit goal of pushing the dollar down. All that atrocious federal intrusion left us with double-digit inflation in 1973, followed by a nasty inflationary recession. Yet the dollar index merely dropped from 31.9 in January 1973 to 28.7 in July, before starting back up again.
Michael Blumenthal was treasury secretary from 1977 to 1979 under President Carter. He soon began preaching that a weak dollar was good for America. Exchange traders obliged by dumping the dollar by nearly 14 percent against major currencies. But the dollar's drop against our broad mix of currencies was less dramatic: The dollar peaked at 34.9 in September 1977, sliding to 31.7 13 months later and then edging up. Efforts to unload dollars before they shrunk did indeed "stimulate demand" -- inflation jumped to 9 percent from December 1997 to December 1998, and to 13.3 percent over the following 12 months. But imports rose and their prices rose, too, and the trade deficit did not "improve" until the recession of early 1980.
The Fed kept interest rates below the rising inflation rate, so it paid to borrow cheap and speculate in tangible assets like gold. That game ended in 1981, as Ronald Reagan let Fed Chairman Paul Volcker push the fed funds rate to between 16 percent and 19 percent. The high real return on cash attracted hot money, so the broad dollar soared -- from 35.1 in January 1981 to 47.3 by November 1982. As the U.S. economy and stocks exploded with the tax cuts of 1983-'84, so did the greenback, which peaked at 65.8 in March 1985.
Enter James Baker III, treasury secretary from 1985 to 1988, who revived Group of Seven meetings to bring the dollar down. The Fed did all the heavy lifting, bringing the funds rate down to 6.7 percent in 1987 from 10.2 percent in 1984. Even so, by October 1987, the broad index was just down to 58.9 from the 65.8 peak of 2½ years earlier.
The weekend before Black Monday, Oct. 19, 1987, Mr. Baker went on TV and threatened to devalue the dollar if the Germans did not do as he ordered on trade. Foreigners holding stocks or bonds denominated in dollars naturally ran for the doors. You had to sell fast before everything measured in dollars was suddenly marked down in marks or yen. Americans likewise rushed to buy foreign securities for the exchange rate windfall.
After that rout was over, however, U.S. stocks and bonds were much cheaper to foreigners, and their prices went back up.
The broad index was barely affected by the G-7 feud, falling from 58.95 in October to 56.7 in December, and then rising once again to 72.1 by April 1990. Iraq's invasion of Kuwait and the simultaneous U.S. recession briefly pushed the dollar down to 68.4 by October 1990. Then the dollar started back up again.
By January 1993, when Lloyd Bentsen became President Clinton's first treasury secretary, the dollar was up to 81.1. Mr Bentsen tried talking the dollar down at first, rattling the bond market but only tipping the dollar index to a low of 80.6 in April. Stung by criticism, Mr. Bentsen began saying a strong dollar was good for America -- a statement often repeated by successor Robert Rubin. But the main reason the dollar started rising after 1995 was the U.S. stock market, including the investment hopes and dreams connected to the Internet and related equipment.
This March, when U.S. stock prices were very low and bond prices very high, the Financial Times wrote: "About 42 percent of U.S. Treasuries are owned by foreigners, along with 26 percent of corporate bonds and 13 percent of equities. If these investors get the impression that the U.S. administration is abandoning the dollar, they may step up their hedging activity or, at worst, scale back their U.S. holdings."
For foreigners to "scale back" total foreign holdings of U.S. stocks and bonds, however, they have to sell them to Americans. Any foreigners who sold U.S. stocks to Americans at the March lows must be kicking themselves today. At last look, our broad dollar index was at 116.9 in October -- almost identical to the level of 117.4 in March 2000, before stocks began a three-year slide.
The dollar apparently rose even as the market crashed because the Fed held interest rates too high for too long. In any event, the dollar's current level is no more problematic today than it was in March 2000. Nor would it matter much if the dollar went up or down a bit, so long as it wasn't being driven by the wind from Washington.
Two lessons of postwar history are that (1) most of us should rarely worry much about the dollar and that (2) treasury secretaries and presidents should never talk too much about the dollar.