Who Controls the Dollar?

By Daniel O'Connor of Integral Ventures, LLC

Thomas Friedman attempts to rattle President Bush's cage about the fate of the dollar in this recent op-ed piece. 

The dollar is falling! The dollar is falling! But the Bush team has basically told the world that unless the markets make the falling dollar into a full-blown New York Stock Exchange crisis and trade war, it is not going to raise taxes, cut spending or reduce oil consumption in ways that could really shrink our budget and trade deficits and reverse the dollar's slide.

This administration is content to let the dollar fall and bet that the global markets will glide the greenback lower in an "orderly" manner.

While I share Friedman's concern about the dollar's orderly devaluation, I do not share his apparent belief that the White House can engineer a reversal in the dollar's devaluation through fiscal policy. 

In my opinion, the dollar's fate is tied more directly to the Fed's monetary policy by virtue of the fact that it is the Fed that influences the rate of growth in the supply of dollars in relation to the rate of growth in the demand for dollars.  Therefore, if we want to understand why the dollar has been falling for these past several years, we might begin by examining the growth in the supply of dollars since, maybe 1995, in relation to the growth in supply of the other major currencies.

And second only to the Fed's responsibility for the dollar's value would have to be the other central banks that have been gobbling up dollars in an unsustainable effort to stem the rise in their own currencies and support their export sectors.  If we want to understand why the dollar has not fallen farther, faster, then we need only look at the monetary policies of America's trading partners.  And if we want to understand the downside potential for the dollar in the years ahead, we should try to look at the world through the eyes of one of these developing economy central bankers currently sitting on a pile of depreciating dollar reserves.

That said, the fiscal policies coming out of Washington are a disgrace.  Any sober assessment of the depth and tenacity of the fiscal corruption infecting Washington will in time, if it has not already, be fully incorporated into the valuation of the dollar.  This can only hurt its prospects for stabilization, let alone appreciation.

Friedman concludes:

When a country lives on borrowed time, borrowed money and borrowed energy, it is just begging the markets to discipline it in their own way at their own time.  As I said, usually the markets do it in an orderly way - except when they don't.

Indeed.  And if the dollar's devaluation becomes disorderly, this is certain to be blamed on currency markets and their inherent volatility rather than the central bankers and politicians who created the disequilibrium in the first place.  Following such blame will be urgent demands to get these volatile markets back under control using the same political forces that, unbeknownst to most citizens, created the imbalances in the first place.  And so the cycle will continue...

© 2005 by Daniel J. O'Connor.  All Rights Reserved.

Comments

[george may]

What ought to be the forces we should be demanding to bring this dollar back into some kind of equilibrium on the world market?