Maintaining Orderly Market Conditions for the Dollar...

It's not clear to me that decision-making inside the Bush White House is as rational as Bob Reich thinks it is--that Paulson was brought in for one reason, or indeed for any combination of reasons at all. But I think Reich is right in assessing what Paulson's most important task is: to maintain "orderly market conditions" and to talk the value of the dollar down gradually so that the world economy has time to rebalance itself.

Robert Reich's Blog: Paulson's Real Job: Paulson was brought in to accomplish one big thing. That's to oversee an orderly decline in the value of the dollar. By "orderly" I mean gradual. The Chinese and Japanese central banks don't want a run on the dollar because they have too many of them right now, and would lose their shirts. But they understand, as does the Bush administration, that the huge global imbalances represented by their giant export surpluses and our giant debts are already causing global investors to diversify their currency holdings out of dollars and into euros and other denominations.

It's only a matter of time before the dollar ceases to be the only "reserve" currency in which global transactions are undertaken, and before investors move substantially out of dollars. So the Chinese and the Japanese would like the dollar decline to be gradual, so they can move out as well without suffering major losses. Paulson understands the Chinese economy and has good contacts with top-ranking Chinese policy makers. He's the ideal man for the job. But will global investors give him time? Or will they turn into speculators, and rush to the door too quickly for the Chinese, Japanese, and the U.S. to keep the dollar relatively strong in the interim? That's the big question.

The U.S. has a strong need for the dollar decline to be gradual as well. If $800 billion a year of financing for home-equity loan-fueled consumption spending suddenly vanishes, then 8 million workers lose their jobs in construction, consumer services, and related industries and have to find jobs in export-oriented and import-competing manufacturing. That can be done if it happens gradually over five years. It can't be done if it happens all at once.

Can the dollar be talked down gradually? Consensus economic models say no: once market expectations are that the dollar will be sharply lower in five years, speculators will make the dollar sharply lower tomorrow.

Nevertheless, there is hope: consensus economic models say the dollar crashed three years ago.

Comments

[Tom DC/VA]

The dollar will do whatever Hu Jintao wants it to do.

Somewhat more seriously, I really think that talking the dollar up or down is bad policy. During the Clinton administration the dollar was talked up, which kept inflation low but eviscerated America's industrial base and got America further addicted to cheap oil. Talking the dollar down now will plunge American into recession (though that may be inevitable given the consequences of talking the dollar up in the past). The TSoUS should let the dollar find its own level and really focus on jawboning other things, like good corporate governance, transparent trading markets, and - maybe, just maybe - tax avoidance by the CEO class/lucky sperm club.

[Matt]

Rumors were flying that Bernanke was appointed to start dollar devaluation, even before Paulson was appointed.

Even Tony Blair is talking about strengthening international security organizations as the US forwad defense retreats. A point he made while standing next to George.

The only way to get these dollars home is to support a small goverment libertarian economic policy. We need to nurture Hillary's libertarian self.

[Karlsfini]

Anne, I'm looking forward to your take on this.

If I've understood you correctly over the last months, you don't expect much of a devaluation.

If anything was said on the economic blogs two months ago when the government quit releasing the M3 figures I missed it. Do M3 figures really not mean anything?

Or is it like Harry the Horse throwing the dice in his hat and telling the other players what comes up?

If the game's on the level, why not let everyone see the dice?

Matt, if the health of the dollar depends on Sen. Clinton... well, this might be a good time to sell the house for pesos or ringgits.

[Michael @ hyip]

Dollar has been week lately, while euro seems to keep climbing, that might be good for cheaper export though.

[kharris]

Any chance Reich misunderstands Paulson's mandate in that he casts it too narrowly? The dollar is a financial risk, but not the only one. We have heard often enough lately that "every new Fed chairman faces a financial crisis," and Treasury has been without a risk-manager-in-chief throughout the Bush presidency. When the Fed tightens, markets get cranky, so it's time for a risk manager. We don't need to specify a market to explain the choice of Paulson. It may be that Paulson is also here to lower the value of the dollar, but that remains to be seen. He is an Easterner and from Wall Street, two qualities normally associated with support for the dollar.

[Cassius Chaerea]

"Brought in" by who? I can't think of even one Bushite that would even think about economic matters. Say "orderly decline of the dollar" to Bootsie and at best you'll get a deer-in-the headlights stare covering up his desire to stick his thumb in his mouth and burble.

[crack]

@Karlsfini

Big Picture mentioned M3 a lot.

[Ginger Yellow]

"Turn into" speculators? They already are.

[anne]

Robert Rubin always tells us pay attention to the bond market in looking to the relative health of the economy. The stock market is looked to for investment values, while the currency market is partly a reflection of the other markets, partly a speculative reflection. The dollar has recently declined in relative value so that it is almost 7% below where it was 10 years ago. But, long term bonds are reasonably priced and I find little reason for concern with another 7% move or another.

[Karlsfini]

Crack, thanks. I didn't know about Big Picture.

Anne, I see what you're saying, and your calmness is always refreshing.

Still the Euro's only been around 6 1/2 years, and while it's gone up and down, in the last six months it's gone from 119 to 129 to the dollar -- a return that's keeping pace with tuition rates at least, if not with the cost of fruits and vegetables.

I don't have any bonds, but somehow words like "long term bonds" have a soothing effect, a promise of a calm, orderly future, like walking into an old, marble-floored bank.

[anne]

Treasury interest rates, by the way are as flat as can be, with a 6 month bill and a 10 year note having virtually identical 5% yields. I am comforted that long term bond yields have not risen, but not the least sure I know why. Brad Delong noted a while ago that all the family investments were abroad, other than in real estate.

[jim]

"Consensus economic models say no: once market expectations are that the dollar will be sharply lower in five years, speculators will make the dollar sharply lower tomorrow."

Lower against what? The euro has already gone from $0.85 to $1.29 in the last four or five years. How much more upside is there? On a PPP basis (in Econ 101, we're told that exchange rates will tend to the PPP rate "in the long run") the euro should be at about $1.05. Does anyone really want to borrow dollars (at better than 6%!) to buy euros at this price?

The renmibi (sp?) will revalue against the dollar if and when the Chinese government decides revaluation is good for the Chinese government. Nothing Paulson says will affect them.

[s9]

So, let me see if I get this straight... the *good* news is that consensus economic models were All Wrong when they said that the dollar crash should have happened by now. I suppose the information is that the consensus economic models haven't changed as a result of being exposed as All Wrong.

The next time an economist complains to me that software isn't an engineering discipline, I'm going to reply that economics isn't a science. I have proof now.

[Ralph]

Ben Bernanke appears to be preparing another small hike in the Fed Funds rate. At the same time there is a fear for the housing market which has been slowing over the last few months so long term rates need to be kept from rising. Bernanke clearly has a high wire balancing act ahead of him.

[D]

s9: I used to be in software, now I'm in economics (for now, I am seriously considering going back... software was boring, but at least it was honest).

Believe me, being exposed as All Wrong will have no effect on theories that are taught in the economics classroom. Mathematical Elegance and Tractability are how theories are judged.... predictive power and relevance are not important, or even discussed.

[anne]

http://flagship2.vanguard.com/VGApp/hnw/FundsByName

Vanguard Fund Returns
12/31/05 to 6/6/06

S&P Index is 2.0
Large Cap Growth Index is -1.3
Large Cap Value Index is 5.2

Mid Cap Index is 3.3

Small Cap Index is 5.4
Small Cap Value Index is 6.0

Europe Index is 11.2
Pacific Index is 2.6
Emerging Markets Index is 4.9

Energy is 13.1
Health Care is 1.0
Precious Metals is 21.5
REIT Index is 10.4

High Yield Corporate Bond Fund is 1.6
Long Term Corporate Bond Fund is -4.3

[andres]

The probable reason why the dollar has not collapsed is that private speculators in this case face prisoners' dilemma/Nash equilibrium type of situation. Any individual bank or hedge fund which starts shorting the dollar (ie selling dollar reserves in order to profit when the value of the dollar does go down) will face concerted intervention (purchases of dollars at current exchange rate levels) not just by the Fed but also by the Bank of China, BOJ, and other central banks whose combined dollar reserves are far more than unlucky Mexico, Thailand, or Argentina ever had at their disposal. It is only if a large number of banks and hedge funds start shorting the dollar in a concerted manner that a hard-landing will ensue. But how such concerted action is to be enforced is another question.

Seen in this light, Paulson's job is to deter concerted action by stressing solidarity between the major country's central banks and finance ministers and therefore increasing the likelihod of negative consequences to would-be speculators who are "double-crossed" by fellow speculators who decide to stop selling dollars before substantial depreciation occurs.

[RN]

Andres is exactly right about the prisoner's dilemma.

It's a double-edged sword for China et. al. The longer they go on and don't permit the dollar's value to be market driven, the more dollars flow into their banks and the more they'll be hurt by a dollar crash.

But in the plus column, they destroy the US manufacturing base and build their own. That seems like a good long-term investment.

China, I suspect, will opt to extract every last drop of blood out of the US. I don't know why the US tolerates this almost warlike mercantilist policy.

Well, indeed I do really know why: because the US is a democracy full of stupid people who vote in crooks like Bushco and the like. These stupid people would prefer low cost goods and services now to a healthy economic base tomorrow. To tell an American he can't have his Escalade today because we need to create a better tomorrow just ain't gonna happen.

We elect leaders who tell us what we want to hear, not the truth. China is an ancient, wise, disciplined and very forward-looking culture. It is taking care of its tomorrow. America is not. For America to find its way out of this terrible trend, it needs to make some very hard choices and see that those choices find their way into prices. Americans respond only to prices.

Enforced saving is the best start, through raising taxes, particularly eliminating the absurd "rich just get richer" tax cuts of the Bush crooks. A gas tax woudn't hurt either. The revenue from those taxes needs to go more toward rebuilding our abandoned economic base, like schools, like worker training, like ridding the health care system of some of its terrible inefficiencies.

We have a very, very serious problem in America. But what is our congress debating? Gay marriage and a flag-burning amendment to the Constitution.

This is why America is a goner.

[Tom DC/VA]

"China, I suspect, will opt to extract every last drop of blood out of the US. I don't know why the US tolerates this almost warlike mercantilist policy."

Because economists and capitalists have convinced the sheeple to unilateraly disarm. "We may end up buying all our stuff from China but we'll sell them some services to be named later. And legal DVDs at 20x the price they can buy an illegal one." Oddly, it hasn't worked so well.

[RN]

Tom DC -

Very well said, imo.

[anne]

The stunning development of China is in every way hopeful for all emerging market countries and promising for and in no way exploitative of America.

[anne]

http://www.nytimes.com/2006/05/30/world/asia/30beijing.html?ex=1306641600&en=66cded5b0bcefc92&ei=5090&partner=rssuserland&emc=rss

May 30, 2006

Found in Translation: King's 'Dream' Plays in Beijing
By HOWARD W. FRENCH

BEIJING — For months now, Caitrin McKiernan has gone from place to place in this city to ask Chinese people an unlikely question: What does the life of the Rev. Dr. Martin Luther King Jr. mean to you?

The questions don't end there, either. In most of these gatherings, she gets far more specific, burrowing into the history and tactics of the American civil rights movement.

"Who knows what the Birmingham bus boycott was?" she asked a group of university students in May. "What is a sit-in?" "What's the meaning of separate but equal?" At the level of language, every one of those terms presents a formidable challenge, even to a woman who has spent years in this country and speaks fluent Chinese.

But language is not the half of it. How can one translate Dr. King's actions into the realm of ideas for an audience in a city notably hostile to protests? How does one convey to Chinese people the meaning of the life of a man who died fighting for civil rights nearly 40 years ago?

The answers may have begun to emerge since the production at the National Theater on Sunday of the play "Passages of Martin Luther King Jr." by the noted King scholar Clayborne Carson and based on the life and words of the American civil rights leader. Ms. McKiernan, who studied under Mr. Carson at Stanford and is the play's producer, was prepared for any kind of audience response, from deeply moved to completely stumped and anything in between.

But the responses of Ms. McKiernan's discussion groups and the reactions of her cast suggested that Dr. King's message would hit home here, that Chinese viewers would see parallels to divisions in their own society. That prospect poses a thorny problem for the government, which, on one hand, has endorsed Dr. King's work as a blow for the class struggle and against American imperialism, but on the other insists that racism and discrimination are purely problems of decadent Western societies.

The government, however, gave the production its imprimatur, and permission to play at the prestigious theater.

A distinct possibility was that the universality of Dr. King's message and the causes he fought for would completely escape Chinese viewers.

But the reactions Ms. McKiernan has heard so far suggest otherwise, and give her reason to hope that her dream of building a bridge between the societies by talking about peaceful struggle and universal rights has some hold on reality.

During one recent discussion at a Beijing university, after viewing excerpts from the PBS documentary "Eyes on the Prize," students explored their feelings on the discrimination they discern between migrant workers and more affluent residents of the country's eastern cities. Others spoke about the inferior position of women in their society or of being treated badly during visits overseas or the predominance of American power in the world.

"The significance of Martin Luther King for me is that we have to have the courage to stand up for our legitimate benefits," said a Chinese student who identified himself as Paul.

Ms. McKiernan has avoided lecturing her audiences, or even steering the discussions. "I don't want this to be about what happened in the U.S. in some past year," she said. "I want this to be about what discrimination is, and how it relates to your life."

The talks have usually begun with an explanation of how Dr. King's life came to mean so much to her, a Californian who first came to this city at 16 as an exchange student and had to struggle to overcome cultural differences with her host family. Then she studied Dr. King in college, and she has had him on her mind ever since.

"I realized that King was this great bridge between the United States and China," Ms. McKiernan said. "China is an emerging superpower, and the U.S. is the superpower, and King is someone that both sides believe in, and can be the starting point for a dialogue about how we wish the world to be."

Then she sighed, and said, "But it's the hardest thing I've ever done." ...

[RN]

anne -

You're dead wrong. China's refusal to apply minimal labor standards, to defend intellectual property rights, to do business with horrible regimes around the world, stifle free speech, and any number of other things, is not just exploitative of Americans, but of basic fundamental human rights the world around.

I wonder how Tibetans would feel about your heartless comment.

[Jennifer]

Brad DeLong has been to China and has always been sympathetic to China, and Anne is right. China is only struggling to develop from a base infinitely lower than that of the United States. China has labor standards including minimum wage laws and has been tightening the laws and raising minimum wages. There are also growing protections on intellectual property. Speech is growing freer in China. As for whom China deals with, China deals freely with nations as well as the United States does, but China is not at war.