National customs certainly differ. In monasteries high in the Himalayas, monks rhythmically intone “Om, om, om” to achieve inner peace and serenity. In the U.S. Treasury in Washington, D.C., economists ceaselessly intone “strong dollar, strong dollar, strong dollar” to maintain serenity in the media and on Wall Street. The only difference is that Buddhist chanting may be a valuable use of time.
No one would blink if Secretary of State Colin Powell said that Belgium is in Europe, Interior Secretary Gail Norton observed that pines are coniferous trees or Attorney General John Ashcroft commented that murder is a crime. But national hysteria nearly ensued when Treasury Secretary Paul O’Neill’s recently remarked that “we are not pursuing, as is often said, a policy of a strong dollar. In my opinion a strong dollar is the result of a strong economy.”
O’Neill was just stating the obvious. While government policies do have some effect on exchange rates, there is little any government can do in the long run to control the value of its currency relative to those of other nations. There is no lever in the basement of the Treasury that some functionary can pull to make the dollar stronger or weaker.
Moreover, a strong currency is not necessarily good. Nor is a weak one necessarily bad. Throughout four decades of dramatic growth beginning in 1950, Japanese policy was to keep the yen as weak as possible. And during Latin America’s “lost decade” of stagnation in the 1980s, many governments in that region tried to keep their currencies stronger than market forces would dictate, even as their economies floundered.
Here in the U.S. in the 1980s, the combined actions of Republican President Reagan, a Democratic majority in the House and Senate, and a Federal Reserve led by Paul Volcker turned historic budget deficits into the highest real interest rates in the nation’s history. High interest rates attracted investment by foreigners, which drove up the value of the dollar. A strong dollar made our exports expensive and our imports cheap.
By 1985, Reagan, who had studied economics in college, could triumphantly crow that the U.S. dollar was stronger than it had been for a decade. Yes, Mr. President, it was, and that strong dollar took about 300,000 jobs out of the U.S. steel industry and another 400,000 or so out of the auto industry. It also put a quarter-million U.S. farms into liquidation.
Despite all this history, it somehow has become a requirement that government officials pledge their undying support of an expensive dollar. Nicolas Brady, treasury secretary under George H.W. Bush, intoned the strong dollar mantra frequently, as did Lloyd Bentsen, Robert Rubin and Larry Summers in the Clinton years.
However, I challenge anyone to demonstrate exactly what these gentlemen did to keep the dollar strong. That is because a treasury secretary can do virtually nothing to offset the fundamental market forces that ultimately determine exchange rates.
Central banks, on the other hand, can and do “intervene” in foreign exchange markets. In the short run, they can strengthen a currency by buying it up, or weaken it by selling it. But three decades of experience since the demise of the Bretton Woods system demonstrates that such action is usually futile except in the very short run.
The Clinton administration occasionally did participate, with the Federal Reserve, in a few such interventions relative to the yen and the euro. The most recent such adventure took place last summer as the United States cooperated with several other nations in trying to drive up the value of the euro.
Few seemed to notice that “driving up the value of the euro” is the same as “driving down the value of the dollar.” All the while, Summers piously reiterated the administration’s commitment to a strong dollar. In any event, the effort did nothing to change the euro’s value for more than a few days.
The importance of a strong dollar has become something of a national fetish even though 99.5 percent of the public apparently is unable to articulate any reason for that. Exchange rates, like interest rates, fluctuate in response to numerous forces. A stronger dollar makes imports cheaper, favoring consumers. A weaker dollar would favor producers, including hard-pressed farmers and steel makers.
Over time, the effects of such fluctuations tend to average out. As a society, we would be better off if we accepted exchange rate variability as a fact of life. If we pretend that a given exchange rate is unequivocally good or bad, and that the government can do anything substantive to set that rate, we both delude ourselves and set ourselves up for bad policy decisions some time in the future.
© 2001 Edward Lotterman
Chanarambie Consulting, Inc.