Understanding the Debate on the Dollar
A strong dollar seems patriotic. It is also meaningful to long-term purchasing power. Weaker dollars mean a higher cost for foreign products, and that is inflationary for the US consumer.
This natural impulse is at odds with current equity trading. A friend asked why the market had 200+ rally in the DJIA on Monday. My answer — dollar weakness– was counter-intuitive and unsatisfying, but accurate.
Dollar's Drop Helps Dow Hit New 2009 High, explained Briefing.com.
Today the Dow declined 100 points. Why? Many cited dollar strength.
Investors and traders alike need to pay attention to the dollar.
The Prescriptive Viewpoint
Some commentators who choose to advise the government on preferred policy are outspoken on both the need for dollar strength and the policies required. David Merkel calls for the Fed to raise interest rates and the Obama Administration to balance the budget. The prescription embraces a willingness, perhaps even a necessity, for the recession to become much deeper. The resulting unemployment and business failures are part of a needed cleansing process that will avert an inevitable deeper economic decline. This viewpoint is based upon economic theory, not a political viewpoint.
Others seem to advocate similar views with politics in mind. You can watch any nightly Kudlow show to get this argument about "king dollar."
A third viewpoint, represented by Bob McTeer, suggests an alternative. McTeer is a free-market Republican, but he has a pragmatic approach. He recognizes the need for dollar strength in the long run, but notes a short-term problem.
So, my conclusion is there is a strong argument to be made for a
strong currency. It just doesn’t apply in the midst of a deep recession
when the main problem is inadequate aggregate demand. Many people who
don’t acknowledge that are, in my opinion, trying to avoid sounding
I’ve said this many times before. My position on a strong dollar is
similar to St.Augustine’s position on chastity in his famous prayer:
“Lord, make me chaste, but not just yet.” My prayer is, “Lord give us a
strong dollar, but not just yet.”
His reason? No individual country can control the currency. All act in accord with internal political mandates.
The positive jolt to domestic GDP caused by a depreciating home
currency is well known all over the world. That is why during a global
slump such as we are in today we have to guard against competitive
devaluations where each country tries to boost its economy through
depreciation or devaluation which has the opposite effect on its
trading partners. The term of art is “beggar thy neighbor” policies,
sometimes called “beggar my neighbor” policies.
The Descriptive Perspective.
David Merkel and other observers are quite correct in noting the divergence between stated and actual public policy. Investors need to understand this.
There is an inverse relationship between the dollar and equity strength. There are several hypotheses (and little evidence) to explain the daily trading.
There is more here than I can cover in a single piece, so I will take a deeper look. We need to investigate the dollar carry trade, the alternative causal models in the relationships, and the time frames for the various arguments. There may not be enough data for an objective answer, but I will give it a shot.
Meanwhile, investors should realize that actual policy is aimed at improving economic performance, even if the dollar declines. If you are an investor, put aside your opinion about whether the policy is correct.