A week or so ago, Intelligence Squared offered a live debate in New York City, which put forward the notion that “America Doesn’t Need a Strong Dollar Policy.” Ahead of the debate, 24% of the audience agreed that this was true, 29% disagreed and maintained that the U.S. does need a strong dollar policy , whilst 47% were undecided. After the debate, 54% were swayed to believe that the U.S. does not need a strong dollar policy, 37% maintained that it does and 9% were left undecided.
While we lean towards thinking that the U.S. is better off with a strong dollar policy, the argument put forward by the other side was more persuasive and so we also wanted to vote with the crowd that was not in favour of having a strong dollar policy.
The argument that a weak dollar sparks higher commodity prices, makes commerce more difficult, leads to financial bubbles and helped to create to the housing crisis missed the point in many ways – at least for those who remember when and why Treasury Secretary Robert Rubin coined the phrase “strong dollar policy” in the first place.
First, here is a bit of the landscape of the time. In February 1994, after keeping the fed funds rate at 3.0% for over a year, the Federal Reserve raised rates by 25 basis points. The tightening moves that followed in the coming year grew incrementally, and by February 1995, fed funds stood at 6.0%. It was only in July 1995 that the FOMC decided that inflation had come down enough to allow a small 25 basis point cut to 5.75%.
From February 1994 to February 1994, the German Bundesbank was continuing the process of lowering the discount rate. The discount rate had peaked at 8.75% in July/August 1992 and was slowly lowered month by month. In February 1994, the discount rate stood at 5.25%, and a year-later at 4.50%.
On February 4, 1994, when the Fed began to tighten, dollar-Deutsche Mark (using New York Federal Reserve Fixing data) was around DM 1.7515; when fund funds hit 6.0% on 1st February 1995 , dollar-mark was DM 1.5235 . And on 6th July 1995, the pair was DM1.3822.
To see the greenback fall so hard while the Fed was in hyper-tightening mode and the Bundesbank was easing was disconcerting, not just to FX traders, but to the powers that be.
In April 1995, G7 Finance Ministers and Central Bankers met in Washington and noted in their communique: “The ministers and governors expressed concerns about recent developments in exchange rates. They agreed that recent movements have gone beyond the levels justified by underlying economic conditions in the major countries. They also agreed that orderly reversal of those movements is desirable, would provide a better basis for a continued expansion of international trade and investment, and would contribute to our common objectives of sustained noninflationary growth. They further agreed to strengthen their efforts in reducing internal and external imbalances and to continue to cooperate closely in exchange markets.”
Before Robert Rubin took office in January 1995, then Treasury Secretary Lloyd Bensen was already doing his best to talk the dollar up, and used every opportunity to do so as the U.S. intervened in the currency market. But Bensen was perceived by the market as somewhat wishy-washy and there was a lack of confidence in him and the Treasury Department.
Newcomer Robert Rubin breathed new life into the phrase, “a strong dollar is in the interest of the United States.” His verbal intervention, combined with concerted intervention with other major central banks, helped to turn dollar sentiment around. By 15th January 1999, the last day of the dollar-Mark fixing before the euro took its place, and six months before Rubin would leave office, dollar-Mark stood at DM1.6874.
Obviously, there were other factors at work, but the market players believed that the U.S. would back up what Rubin said, and were fearful of intervention. By the end of his term, the Asian Crisis was in full flux and the dollar was in hot demand as a safe-haven.
The point is that what the U.S. Treasury says about the dollar is important and the market listens. Consider that in February 2001, then Treasury Secretary Paul O’Neill decided not to toe the line. The market didn’t bother to listen to his whole phrase, and instead homed in on only the first part, i.e. “We are not pursuing as often said, a policy of strong dollar. In my opinion, a strong dollar is the result of a strong economy.” Oops! After the dollar tanked, the Treasury Department had to issue a clarification a day later, saying “The Secretary supports a strong dollar. There is no change in policy.”
Fast forward to 2013 and imagine what would happen if the market believed that U.S. officials were actively trying to weaken the dollar. Imagine the chaos if current Treasury Secretary Jack Lew voiced the opinion that while a strong dollar is nice to have in good times, it is not always the best thing for the economy and the current recovery. While this may be true, U.S. officials don’t dare open their mouths to say so. Of course, some can argue that if near zero U.S. interest rates haven’t brought the dollar down, then what will? It may be easier than you think.
A loss of confidence in the dollar, as seen back in the mid 1990s when Treasury Secretary Rubin was arguing that the U.S. defaulting on its debt was “absolutely unthinkable” (sound familiar?), is not easily reversed and hard to combat. The market currently is clinging to the greenback because of the size and perceived safety of the U.S. bond market and because there is no viable FX alternative.
If the Congress does not fix our fiscal mess, and another U.S. rating agency downgrades the country, the exodus out of U.S. markets may at first be only a trickle. But, if Europe gets its act together and if China opens its markets further, global investors will have other alternatives.
Naysayers may argue, “Oh that will take many, many years”, and that may be true. But ultimately, once that global investor flow has left, it will not be easy to get back.
So for now, strong dollar policy – you betcha!