Benson's Economic & Market Trends
The Currency War
January 18, 2004
The U.S. is running a "silent currency war" against the rest of the world by not only trying to devalue the dollar until the economy begins to grow on a sustained basis, but until employment starts to grow as well. As long as the U.S. is dedicated to 5% budget and trade deficits and 1% short-term interest rates, the fall of the dollar is guaranteed.
Our government's policies are extraordinarily self-indulgent and profligate. The Treasury and Federal Reserve want to punish savers by continuing to reward financial speculation, credit creation and spending. Indeed, there is no better way to punish savers than to offer a 1% interest rate and a 20% annual drop in the value of the dollar. Moreover, be assured the Federal Reserve will not raise interest rates and will continue the limitless flow of credit until there is enough growth in employment to ensure both the Fed Chairman's re-appointment, and the President's re-election. Stabilizing the dollar will be our trading partners' problem.
If any countries wish to bring sanity and stability to the world currency markets, it will not be the U.S. It will be up to our trading partners to "act like adults and say no" to the indulgent child. A falling dollar looks good and is a stimulant to our economy in the short run. Foreign cars and other goods become more expensive and less competitive, helping our domestic industry. U.S. corporations can bring profits back from overseas (profits in Euros look 30% better when they are brought home to the US in dollars.)
At present, some of the countries being smashed by the currency war are Europe, the United Kingdom, Canada, Australia, and South Africa. The countries targeted for "dollar bombing" have a few things in common: they have generally sound economic policies, no major trade imbalances, and a desire to fight inflation. They have not yet "capitulated to the dollar bombing campaign" and started to buy dollars to prevent their currencies from rising. While their central banks already own too many dollar assets and are losing their taxpayers tens of billions of dollars, they have not signed on to buy additional endless amounts of dollar assets to hold their currencies down.
On the other hand, the Japanese and Chinese appear to have capitulated. They will buy any and all dollar assets necessary for America to live beyond its means, but they will do this only as long as we send them our jobs. In buying dollar assets, foreign central banks help hold interest rates in the U.S. at artificially low levels. With the size of our trade and budget deficits and no savings, this country could not keep its housing, stock market, and consumption bubbles afloat, if interest rates went up. In this currency war, the Japanese, Chinese, and the rest of Asia, are "killing us with kindness".
The currency war is being waged with two alternative goals: Foreign countries should either let their currencies rise and suffer the loss of jobs to America, or they should buy U.S. government debt without limit. As long as Foreign Central banks buy dollars, they are the ones paying for our war in Iraq, and they are the ones paying for an American buying a Hummer with a second mortgage.
However, it is becoming clear that anyone buying U.S. debt is making a horrible investment. For those foreign countries holding and buying this debt, it is a major tax on their citizens as the dollar tumbles. America's profligate spending and currency war is painful for the rest of the world, particularly for those countries that wish to have responsible and prudent fiscal and monetary policies.
There is a way out for foreign countries, but it is not what the U.S. expects or would want in an election year. Our Federal Reserve is throwing a great party with easy money and a weak dollar while asking responsible governments and central banks to suffer our "hangover" for us. There is no natural law that says that the only thing foreign central banks can do to take the pressure off their rising currencies is to create money and buy dollars.
Under the Clinton Presidency, the genius of Larry Summers was to sell gold to make the dollar look strong. This policy worked. The reverse will also work. Responsible central banks that want to help the United States establish responsible budget, trade and interest rate policies, should "buy gold not dollars" to make their currencies "look weak". Moreover, there are any number of things that foreign central banks and governments can buy with new local currency that will help hold their currencies down, give the country something of value, and stop enabling the Federal Reserve to run a monetary policy fit for a drunken sailor. Countries should "manage their currencies down against the dollar" by buying gold and silver, oil and more oil, tin, copper, zinc, etc. Countries with sounder monetary and economic policies, such as England, Australia, and Europe, are major oil importers. Now would be a wonderful time to fight back against the U.S. currency war by printing up some money to fund a strategic oil reserve. Countries such as South Africa, Canada, and Australia, should buy gold, silver and other commodities they produce to manage their currencies down. This policy is in their clear national interest because it will build up central bank reserves that will hold their value and give their miners jobs!
Most countries do not have as their clear national policy to "steal American jobs". Therefore, their monetary policy should be one that builds real financial reserves and gives their citizens something of value for their money. Only Japan and China have to play America's dirty currency war and hold the value of their currencies down by buying dollar assets. Holding dollar assets will cost their taxpayers a king's ransom because they are the ones who are ending up with the factories and jobs. All that Americans will be left with are massive debts and an almost worthless dollar for a currency.
Indeed, the only way foreign central banks can really help America is to treat the United States the way friends treat their friends who drink by not letting them drive drunk. The motto for central bankers should be "Central Banks Don't Accommodate Financial Suicide".
The problem for the world's central banks is that irresponsible U.S. budget, trade and monetary policies threaten the entire monetary system. It will be very interesting to see what foreign central banks do. World inflation remains highly likely.