Friday, October 09, 2009

David Malpas On The Weak US Dollar

Former Bear Stearns economist David Malpass wrote a great editorial in yesterday's Wall Street Journal concerning the coming effects of a continued weak US dollar policy.

In brief, Mr. Malpass notes that while a country temporarily gains trading volume from a weak or weakening, depreciating currency, those illusory profits are more than offset by a global flight from the currency.

Thus, while the US goes about its merry way flooding its trading partners and global investors with dollars and liabilities which are steadily declining in value, fewer investors will continue to want to either hold US dollars or dollar-denominated assets. In time, there will be a shortage of capital inflows to the US, and, quite possibly, a net outflow, as sophisticated investors flee the dollar for hard assets or other currencies.

Malpass gives a very good, clear account of the fall of the British pound and the accompanying hollowing out of their economy.

He writes,

"At the end of empire, the giant sucking sound was from British capital and jobs moving offshore as the pound sank."

Sound familiar?

He continues by observing,

"Some weak-dollar advocates believe that American workers will eventually get cheap enough in foreign-currency terms to win manufacturing jobs back. In practice, however, capital outflows overwhelm the trade flows, causing more job losses than cheap real wages create.

No countries have devalued their way into prosperity, while many- Hong Kong, China, Australia today- have used stable money to invite capital and jobs.

There's been a clear demonstration this decade. The S&P nearly doubled from 2003 through 2007. Those who borrowed to buy won big-time. At the same time, the dollar's value was cut nearly in half versus the euro and other stable measures. Capital fled, undercutting job growth. Rent, gasoline and food prices rose more than wages.

Equity gains provide cold comfort when currencies crash. From the euro perspective, the S&P peaked at 1700 in 2000, finally reattained 1100 in the 2007 bubble, fell below 600 in March and now stands at 700. With most of the market capitalization of U.S. stocks held by Americans, the dollar devaluation has caused a massive decline in the U.S. share of global wealth."

Malpass doesn't explicitly address the reserve currency issue, as I did in this recent post. But he really doesn't have to. Everything he writes points to an implicit move away from the dollar as a stable, globally-preferred store of value and safety.

His recommendations for how to fix this problem are fuzzy and lack the ability to actually be implemented. Just calling for "jobs and wealth" policies isn't enough.

What Malpass avoids saying is the obvious, i.e., that the U.S. must rein in deficit spending, stop monetizing its own borrowings with Fed purchases, and begin to behave like a world leader in commerce and economics again. Something not done since, oh, the Reagan administration, and perhaps the Clinton years, as well.

American politicians may fool the country's residents into believing that simply running the printing presses overtime and issuing excessive debt, too, won't affect America's global economic standing or hamstring monetary policy in years to come.

But global investors and trading partners understand reality, and won't be so fooled.


Steve Merrell said...

I believe you and David have summed up the long-term case against a weak dollar policy. Of course there are short-term benefits which, if handled correctly, could help us retool the economy for a return to long-term prosperity. But you are right--unless we make some fundamental changes, even the short-term benefits will evaporate and we will be in worse shape than ever. Given this administration's apparent determination to ignore the economics of the long-term, I am skeptical about our current course.

C Neul said...


Thanks for your comment.

I agree with your sentiments, obviously. Except for your belief that, somehow, a weak dollar could be used for long term economic benefit.

I know the old standard argument about US goods being disadvantaged by a strong dollar. But I don't see how a weak dollar helps us "retool the economy for a return to long-term prosperity."