Friday, November 24, 2006

Fear For The Dollar: A Different Kind of Trade Deficit

It may be true that the trade deficit and current account deficit are not "deficits" in the accounting sense of the word, as I have tried to explain in an earlier post and more at length in this article over at Prudentbear.com.

However, as I also pointed out in those pieces, there is a factor propping up these deficits that America must guard carefully, and it is the world's faith in our dollar and in our management of its role in global monetary policy.

stilts
[Thanks to sevenseven.com for the photo.]

When it comes to the dollar's worldwide status, we're pretty cocky. You just have to listen to one of our Fed governers crowing about it in Germany the other day. I especially liked the passage where he says something like, "... and I note in passing that we're speaking English at this reunion, aren't we?" As though that were somehow proof of America's fiscal leadership.

But we must be humble and vigilant. Faith can move mountains, but it can also be a delicate thing. Goodness knows that confidence in our judgment is waning on a number of fronts, and that our hubris has gotten us into trouble more than once.

In our defense, the dollar is so dispersed around the world today, that every holder of them has an interest in propping it up. But this interest is a double-edged sword. There could come a time when they can no longer afford to sustain it. Uncertainty is a catchy virus. (See previous posts here and here.)

And it continues:

"People's Bank of China Vice-Governor Wu Xiaoling said East Asia needs to reduce its reliance on dollar inflows because of the risk of a further slump in the currency. China's foreign- exchange reserves exceed $1 trillion, the world's largest." (Source)

Yup, as I've said many a time, the Fed is between a rock and a hard place. If they lower rates, the dollar holders and speculators may panic and take it and themselves down for a ride, with repercussions for the economy. If the Fed raises rates, the US stockholders and speculators may panic and take workers, their pensions, and the short-term dollar down for the ride. Which will it be? Maybe neither; maybe everyone can hold steady indefinitely. But that doesn't seem to describe today's touchy market dynamics.

On the other hand, maybe a good panic would force central banks out of the monetary policy business. Now that would be good news.

2 Comments:

Blogger Gem Hudson said...

But at last print money still makes the money more paper. Because the money is exchanged for trade more of somethan for next to nothing. Unearned money buys mot much these days and even the supply side of the foreign exchange rate will drop the price of the dollar down.

10:09 AM  
Blogger Katy said...

Gem, if I understand you correctly, you are saying that it's okay to print paper dollars, because (1) they buy something anyway, and (2) eventually the supply of extra dollars on the foreign exchange will drop the price of the dollar down.

In spite of this facade of truth, I don't agree that it's okay. Maybe you think it's okay for us to print dollars to pay for our imports and then inflate those dollars' value away, but I think it is immoral, number one, and dangerous, number two. (And "Everybody is doing it" is never a proper retort, all the more so because we are the trendsetters here.)

I think you are forgetting that our trading partners have a choice of spending those paper dollars or holding them, and out of improper logic they are choosing to hold them as reserve investments. (They've essentially bought our budget deficit, among other things.)

I say "improper logic" because they think they are boosting their manufacturing sector by supporting the dollar's value by these investments, but I think this maneuver will backfire, because they have gone beyond the point of no return, i.e. they have accumulated so many dollars that they can no longer get rid of them without hurting both their overbooming manufacturing sector and their own reserve portfolio. (See my later post above for a discussion of their pegging procedures.)

Who will get burnt in these operations? You might respond it is they and not us, but you will be mistaken, because we all will ultimately pay the price for this bilaterally disengenuous behavior.

I tend to want to think about the long term.

10:43 AM  

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