As the US$ turns

The dangers of a weak dollar

A prolonged, uncontrolled decline in the dollar could reignite inflation in the U.S. and cripple the efforts of America’s trading partners to rev up their own economies

It’s not every day that Federal Reserve Chairman Ben Bernanke offers “an unusually strident defense of the dollar,” said Emily Kaiser in Reuters. Ordinarily, Fed chairmen “avoid the subject altogether,” letting the Treasury secretary handle currency issues. But these aren’t ordinary times. Over the past three years, the dollar has fallen 30 percent to 50 percent against most of the world’s major currencies, and it could fall even further, because trillions of greenbacks are sloshing around the globe as a result of the Fed’s efforts to fight the recession by putting a lot of money into circulation. A prolonged, uncontrolled decline in the dollar could reignite inflation in the U.S. and cripple the efforts of America’s trading partners to rev up their own economies. Bernanke’s comment during a speech this week that the Fed is “attentive to the implications of changes in the value of the dollar” was an attempt to reassure our trading partners that he understands their worries and won’t let the dollar fall too far.

Bernanke timed his comments to coincide with the beginning of President Obama’s first visit to China, said Benn Steil in Realclearmarkets.com. He sought to smooth over a major source of friction between Washington and Beijing—the value of the dollar versus the renminbi. Both countries are trying to keep their exchange rates low in order to make their exports more attractive to foreigners. But there’s a complicating factor: China, with two trillion U.S. dollars in its vaults, has a lot of incentive to root for the dollar to stop its slide. Bernanke’s remarks were a signal that he takes that concern seriously. But one speech won’t arrest the dollar’s fall. Unless the two countries reach an accommodation on their currencies, “financial crises, protectionism, and political conflict are inevitable.”

It’s not just China that’s alarmed by the cheap dollar, said The Wall Street Journal in an editorial. Other Asian countries are angry “about what all those greenbacks are doing to their economies.” With short-term U.S. interest rates near zero, financial speculators are borrowing U.S. dollars cheaply and investing them in higher-yielding Asian stocks and bonds. The influx of dollars pushes up the value of those stocks and bonds to unrealistic heights, creating an asset bubble. Bernanke so far has acted as if those bubbles are Asia’s problem, not America’s. But “asset bubbles that build and burst in Asia will eventually cause trouble here.” Obama and Bernanke should heed Asia’s call “to run a more cautious monetary policy,” by draining excess dollars from the financial system before they trigger another worldwide financial meltdown.

But China has to do its part, too, said Paul Krugman in The New York Times. By holding the value of the renminbi at artificially low levels, thus making its goods cheaper on world markets, China is boosting its own export-led economy at the expense of other exporting countries—including the U.S. Yet at the same time, Beijing is urging Bernanke to raise interest rates to stop the dollar’s slide. Don’t the Chinese realize that raising U.S. rates would stall the economic recovery and “make our unemployment problem even worse?” That’s no way for the Chinese to treat their biggest market. Before “lecturing the United States” about the dollar, China should set a more realistic value for its own currency.