The Dollar: Weak or Strong?

I gave the following brief (lightly edited) commentary on the dollar March 19 on BBC World Service. See the link in the previous posting. Also see my Wall Street Journal op-ed on the dollar on March 8, also reproduced in a previous blog posting.

Lord, give us a strong dollar, but not just yet.

When rock and roller Buddy Holly was four years old, he insisted on playing his toy fiddle in his uncle's band. It made a terrible sound; so his uncle waxed Buddy's bow. He could still fiddle, but he made no sound.

Alan Greenspan waxed my bow when, as president of the Federal Reserve Bank of Dallas, I served with him on the Fed's Federal Open Market Committee for almost 14 years. He wouldn't let me or other committee members, including himself, talk about the dollar. That delicate task was reserved for the Secretary of the Treasury, who also tried to avoid it, for good reason. The market always reacted badly.

Now that my bow is no longer waxed, I feel a perverse urge to talk about the dollar. Unfortunately, my viewpoint currently differs from that of other "talking heads" on financial TV and Radio. They want a strong dollar, by jingo, as if they could just order it off a menu with everything else they want, no matter their compatibility. They worry, especially, about the dollar's recent decline against the Euro and the implications for U.S. inflation and prestige abroad.

I think the strong Euro will do more damage to Europe than our weak dollar will do to us. The cheerleaders for a strong Euro may soon feel like the dog that finally caught the car. What now?

Normally, I prefer the advantages of a strong currency, but, by definition, all currencies can't be stronger than average. Strong currencies help consumers hold down prices and keep the pressure on producers to remain competitive in the world market. But, under current circumstances, I feel about the dollar what St. Augustine felt about chastity. To paraphrase his famous prayer, "Lord, make our dollar strong, but not just yet."

For now, our weaker dollar serves us well in two principal ways. First, by boosting our exports and discouraging imports, it provides a shot in the arm for our weak economy. A smaller trade deficit will boost economic growth, and help us avoid or, at least, moderate a recession. Second, we need to shrink our trade deficit in goods and services to slow the relentless flow of dollars abroad.

Each year's deficit adds that much more to the huge dollar holdings of foreign central banks and others and means greater foreign indebtedness for the United States. The persistence and size of our trade deficit also lead to calls for protectionism, a cure worse than the disease.

Normally, a trade deficit would adjust automatically through a decline in the dollar. That hasn't happened yet because the U.S. has been such a magnet for foreign investment. Foreign capital inflows have kept the dollar too high for trade to adjust. Only recently has the capital inflow diminished enough to allow the dollar to depreciate, and depreciation's positive impact on our trade is just now beginning. We shouldn't interrupt that correction prematurely by trying to talk the dollar up, or by intervening in foreign exchange markets, neither of which helps for long anyway, if at all.

The dollar won't fall forever. The lower it goes, the sooner foreign importers, and, especially, investors will return to take advantage of the bargains. At that point, the dollar will rebound, but hopefully from a sounder basis of more balanced trade. So, I repeat my prayer: "Lord, give us a strong dollar, but not just yet."

This entry was posted on Friday, March 21st, 2008 at 9:31 am . You can