Money That Floats is Hard to Figure
Jude Wanniski
January 9, 2004


Memo To: Floyd Norris, New York Times chief financial correspondent
From: Jude Wanniski
Re: Currency Wars

Your “Business Day” column today from Paris, “Currency Wars: Europe Watches While Others Play by Different Rules,” tries to make some sense out of the senseless floating currencies. It would make more sense, Floyd, if you related the dollar/euro/yen ups and downs to the real world of commodities. Knowing me, you would guess I would say you should use gold as a reference point. It is, after all, the most monetary of all commodities. While you could use a basket of commodities to do the job – which in 1987 was a proposal of the Reagan Treasury, adding commodities that are “less monetary” in their uses only reduces the “reference” value of gold.

The heart of your piece is in the first graphs:

What happens if the world won't let the dollar fall? That question may sound odd given the run of headlines about the plunging dollar, but the reality is that the dollar is still strong where it counts.
And that is bad news for Europe.

Since the end of 2001, the dollar is down 30.4 percent against the euro. But against a basket of currencies - weighted by how much each country contributes to the American trade deficit - it is down just 6.7 percent.

The reason is that not all countries play by the same rules. Only a few are willing to allow their currencies to trade freely. China, which has the largest trade surplus, $123 billion in the latest 12 months reported, fixes its currency value against the dollar. It has turned away suggestions by the United States that it change that policy.

Japan, which ranks No. 2, with a trade surplus of $68 billion, spent about $200 billion last year trying to prop up the dollar, presumably slowing the yen's rise. The dollar is down 19 percent against the yen since the end of 2001.

The rise of the euro at first brought some joy to Europeans, who had been embarrassed by their new currency's initial slide. But now there is growing concern among companies and politicians that the euro will rise far enough to damage the nascent European recovery.

There are several problems with your commentary, Floyd, precisely because you are trying to analyze trade flows from jumbled currency gyrations, and it just doesn’t work. Once you bring gold into the picture, it becomes clear that the dollar has been a much weaker currency than you think, or than Fed Governor Ben Bernanke thinks. His quote in your column is what made me decide to write this missive, as he is in a position to affect the real “value of the dollar,” where no other central bank can. In other words, only the Federal Reserve can alter the dollar price of gold. The Eurobank and the Bank of Japan are powerless to do so. Yet here is your Bernanke quote:

''Looking at movements of the dollar against a single currency can be misleading about overall trends,'' said Ben S. Bernanke, a Fed governor, in a speech this week. ''Broader measures of dollar strength show somewhat less of a decline.'' The way he sees it, that makes American inflation less likely, and therefore gives the Fed less reason to be concerned or to raise its own rates.

Bernanke is certainly right that looking at the dollar against a single currency can be misleading about overall trends, but he himself is misled by thinking there will be less dollar inflation than some people think because it is down only 6.7% on a “trade-weighted basis” on the countries the U.S. does business with. This was exactly the kind of argument that conventional wisdom was making in 1973 when the dollar had weakened a little bit against the yen and a little bit against the Deutschemark, so it was assumed another dollar devaluation would only add a smidgeon to the Consumer Price Index in the following 12 months – 0.25%. Alas, the wise-guy Nobel prizewinning economists at the time did not take into account the fact that since Richard Nixon floated the dollar on August 15, 1971, it climbed to $140 from $35, exactly fourfold. It would take more than a year for that change to ripple though the price universe by four times, but in the first year it went up not the smidgeon predicted but by almost 10%.

The reason, Floyd, is that the value of the dollar has nothing to do with trade flows or current account deficits. A country can have a “strong currency” relative to its trading partners and run a trade deficit and it can have a “weak currency” and run a trade surplus. Remember when the yen was at 360 to the dollar and Nixon was persuaded that if it got to 330 to the dollar we would run a trade surplus with Japan? Well, it is now 106 to the dollar and we still are not running a trade surplus with Japan. There ain't no connection.

Where Governor Bernanke makes his mistake is in not taking seriously the dollar’s decline relative to gold since April 2001, although in the speech you quote, he does mention the fact. When you go from $255 per ounce back then to $425 per ounce today, the dollar has lost more than a smidgeon of its value. Back in 2001, the euro was only worth 80 cents on the dollar and it is now worth $1.27. If you think about it, Floyd, the euro price of gold has been much steadier than the dollar/gold price. That is, the euro has not really gotten stronger in “real” terms. It has been the dollar that has weakened.

Because you believe trade flows are causing the currency fluctuations, you are led to argue:

For the dollar to hold steady, foreigners must be willing to buy enough American assets - stocks, bonds, companies, real estate or whatever - to offset the current account deficit, which is largely caused by the trade deficit. If they do not buy enough, then the dollar must fall.

In theory, a declining dollar would lead to higher import prices that would reduce demand and bring down the trade deficit. But the current reality is that with the dollar not being allowed to fall against the Chinese currency, the yuan, economic adjustment will require a bigger decline against other currencies, primarily the euro.

The question now is whether Europe will stand by and watch its own competitiveness erode while hoping that world growth will somehow solve all problems. Notwithstanding the Bush administration's empty ''strong dollar'' talk, there appears to be little likelihood of Washington's joining in a move to sell euros.

The ball is in the European Central Bank's court. Its inaction yesterday was no surprise, but it was regrettable.

Again, Floyd, you are using really, really obsolete theory here, which is regrettable for the chief financial correspondent of the most important newspaper in the world. It is not “regrettable” that the ECB took no action yesterday. It should do everything it can to keep the euro steady against the real world, with gold as its proxy. That’s how you rid your economy of debilitating inflations and deflations. What you would like the ECB to do is to join the United States in a new bout of inflation, keeping the euro from climbing against the inflating dollar by making the same mistakes our Fed is now making. It is the Fed that should be raising the overnight interest rate, the fed funds rate, from 1% to 2% or 3%. If it did so, it would not have to be shoveling paper dollar reserves into the banking system to keep the 1% rate from climbing on its own.

Again, Floyd, again: You need a reference point in your analytics or you will remain as confused as our Federal Reserve governors have been lately.

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