Manipulating the dollar so that it is worth less and buys less seems like a foolish way to manage a nation's currency or economy. Doing so today, at worst, could derail the fledgling bull-market recovery, just as an overly cheap dollar ended the 1980s boom. Yet recent actions by Treasury Secretary John Snow and the Group of Seven industrial nations suggest that global policymakers are moving in this misguided direction.
A communique released at the recent G-7 meeting in Dubai called for flexible exchange rates rather than stable ones. Snow followed that up with a trip to Japan and China, where he sought to jawbone for a revaluation of the yen and the yuan. Implied from these actions is Snow's desire for a cheaper dollar.
Since the September G-7 meeting, the U.S. greenback has fallen nearly 6 percent. Prior to that, the foreign exchange value of the dollar lost about 20 percent. In terms of domestic purchasing power, the dollar has lost about one-third of its value when measured against the rising price of gold, which is a useful barometer of the domestic buying power of consumers and businesses.
Much of this dollar slide was necessary to end deflationary conditions -- commodity and business prices had been declining from 2000 to 2002. But in the past year, raw material and producer prices have stemmed their downturn and begun to rise.
Remember, just as inflation is caused by too much money chasing too few goods, deflation is primarily caused by a shortage of money in relation to available goods. The Federal Reserve controls the basic money supply, so its stinginess three years ago -- in part through an overly high dollar -- contributed mightily to the deflation of stocks and the economy. But that problem has been corrected. A "stable" dollar is all the recovering economy and stock market need.
Spurred by lower tax-rates, both the dollar and stocks appreciated late this summer. The bull run even spilled over into September, which is normally a rocky month for share prices. This followed the huge 25 percent rally between March and June, thereby confounding pessimists who were positive that shares had risen too far and too fast.
But financial markets are now worried about an overly weak greenback. Since the G-7 declaration and Snow's Asian trip, the dollar has completely given back its summer gain. Stocks, meanwhile, have lost more than 4 percent of their value.
Dollar tinkering seldom works. Right now, Japan and China own hundreds of billions of dollars worth of U.S. Treasury securities produced by a rising U.S. budget deficit. A shrinking dollar makes their investments less valuable. This could induce major selling and a run-up of domestic interest rates.
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