Profit worries generated by the zigs and zags of the U.S. dollar were not always the case. In 1944, the Bretton Woods Agreement established a new global monetary system. Its hallmark was exchange‐rate stability. That stability was accompanied by a general acceleration of growth in the post‐war golden age. By 1973, the system had been swept into the dustbin by the broom of President Nixon. With that, the world entered an era of flexible, unstable exchange rates, or what my good friend, the great Jacques de Larosière, terms an anti‐system.
This exchange‐rate instability creates problems — big problems—for the economy as well as corporations. If we look back at the onset of the Great Recession, we should ask, were exchange rates stable back in the fall of 2008? As it turns out, one of the few who had a laser focus on what he deems the most important price in the world, the dollar‐euro exchange rate, was another good friend, Nobelist Robert “Bob” Mundell. A founding father of supply‐side economics, Bob is always focused on prices. That certainly separates Mundell from Ben Bernanke, who was Chairman of the Federal Reserve back in September of 2008. Bernanke saw fit to ignore fluctuations in the value of the dollar. Indeed, changes in the dollar’s exchange‐rate value did not appear as one of the six metrics on “Bernanke’s Dashboard” — the one the Chairman used to gauge the appropriateness of monetary policy.
Well, let’s take a look at what Mundell saw in the months surrounding the collapse of Lehman and the onset of the Great Recession. He observed a wild swing in the dollar‐euro exchange rate (see the table below). In the July‐November 2008 period, the greenback appreciated almost 24% against the euro. Accompanying that swing was an even sharper one in the price of oil. It plunged by 57%. Gold, too, had a sharp fall of almost 22%. And, consistent with Mundell’s supply‐side theories, changes in exchange rates transmit inflation (or deflation) into economies, and they can do so rapidly. Not surprisingly, then, the annual rate of inflation in the U.S. moved from an alarming rate of 5.6% in July 2008 to an outright deflation of 2.1% a year later. This 7.7 percentage‐point swing is truly stunning.