Declining dollar

Steve Forbes has a plan for America: end mark-to-market accounting, and strengthen the dollar. As so often, Mr Forbes seems to have confused what is good for him, personally, with what is good for the nation at large.

The dollar decline is not the cause of our problems; it is a symptom. To be sure, most of us professional prognosticators thought that it would be a cause of our problems. We expected that eventually the trade deficit would cause a decline in the dollar, and capital would start to flow outward again, tanking the markets. Instead what happened is that the market tanked and (presumably) foreign investors have started to withdraw their funds.

This is, to be sure, not making things any better. But the things that the government could do to prop up the dollar would make things worse. It could, say, ratchet up interest rates to make US assets more attractive. This would be fantastic for a market desperately trying to unwind its excess short-term leverage. It would also do delightful things to homeowners with resetting ARMs.

Also the way the Fed targets the money supply is to sell bonds. And what a market with to few buyers really needs right now is more product. Meanwhile, of course, business investment would fall even further. Hello, recession. And did I mention that our exports would tank even further?

There's an alternative: the Treasury could sell a lot of foreign currency. This would probably be pointless; because the US doesn't intervene in the value of the dollar, we have very little in the way of foreign reserves. The Treasury and the Fed together have about $70 billion in euros, yen, and Swiss francs. They have another $20 billion in foreign securities. Meanwhile, other countries have well over a trillion US dollars in cash and US securities.

Foreign central banks might try to help us, but with such a pitiful supply of foreign currency, we'd never stand up against the foreign investors trying to get out of our broken market, much less the fx speculators. George Soros alone bet 6.5 billion pounds sterling against the Bank of England nearly twenty years ago. There's a lot more money floating around out there today. Successful defenses of overvalued currencies are few and far between, and tend to involve measures a lot stronger than buying a few dollars.

The other proposal is even more daft. There's nothing to reassure markets in a liquidity crisis like reducing transparency.

The good news is, the weak dollar isn't the catastrophe that some people seem to think it is. While it is falling, it will trigger capital outflow, but when it bottoms, US capital markets will become attractive to foreigners. Meanwhile, our export industries will get more competitive. And while it will mean fewer cheap electronics (buy that flat panel now!), trade just isn't that big a component of the US economy. The really big problem is that it will make oil even more expensive. But the effect on gas prices will be relatively small compared to the Asian demand, terror worries, and supply-side restraints that have pushed it to $100 a barrel.

Psychologically, a weak dollar is a blow to our pride. But practically, it was going to have to happen, because Americans have been buying more than they sell for much too long. Among the various financial problems the world has today, this should be about the last one you worry about.