10.06.09 11:04 PM ET
Obama's Secret Jobs Plan
The dollar’s value plunged Tuesday, while gold simultaneously hit a record high ($1,045 per ounce). You might think this would worry the administration and send the Treasury secretary to the microphones in an attempt to head off further collapse in the currency. Do the darkest days of the Carter administration loom again, with inflation and unemployment both rising, apparently without limit?
Far from it—the last few weeks of dollar depreciation is an amazing stroke of luck for the Obama administration, admittedly facilitated by their adroit maneuvering in the corridors of high international finance. If it lasts—and they need some more luck—this could save the midterm elections for the Democrats.
Japan, France, Germany, and Italy all worry about a weak dollar. The U.S. officials, at the highest stakes poker table in the world, faced them down.
The near-term causes of the latest round of dollar decline are obvious. Australia’s central bank raised interest rates slightly on Tuesday. By itself, this would not be an exciting development, but it comes fast on the heels of the G-20 Pittsburgh summit in which all participants (including Australia) seemed to imply that “tightening monetary policy” (i.e., raising rates) was some way off.
So if Australia begins to tighten—an implication that its economy is picking up—market participants reckon that more commodity producers and other parts of the Pacific Rim will soon feel the need to do likewise. At the same time, the U.S. has signaled—most recently on Monday, in the powerful form of William Dudley, president of the New York Fed—that interest rates here will remain low for the foreseeable future.
If you can borrow in dollars and buy Australian (or Korean or Chinese, etc) government debt, you are in what is known as a positive “carry trade”—because of low interest rates here, you pay close to zero to borrow the dollars (e.g., if you are Goldman Sachs and have unfettered access to the Fed’s discount window) and you can invest in Australia at more than 3 percent interest (or you can plunge into speculative Chinese automotive stocks, as Goldman is now doing).
And if you think interest rates will rise in the rest of the world before they do in the United States, because the dollar is on its way down, then this carry trade becomes a one-way bet: You make money on the carry, you hold foreign currency while the dollar falls, and then you pay back your loan in depreciated dollars.
If the U.S. were concerned about the dollar weakening—say, because of its impact on inflation—it could counteract all of this by making warning noises about potential intervention in the currency market: If you borrow heavily in dollars to lend in Chinese renminbi, you can be easily rattled by the prospect that G-7 industrialized nations will intervene in a coordinated manner to strengthen the dollar (as they have in the past).
But the G-7 met this weekend and made no statement about the dollar—despite what must have been considerable pressure from Japan, France, Germany, and Italy, all of which are always worried about a rapid weakening of the dollar because they are so dependent on exports. The U.S. officials, at the highest stakes poker table in the world, faced them down.
The key reason why the U.S. can do this is simple: We’re not currently afraid of inflation. In fact, the administration and the Fed are rather more worried about deflation (falling prices), so it doesn’t matter to them if a weaker dollar pushes up prices to some degree.
This may, of course, turn out to be a miscalculation, but think what a weaker dollar does for the industrial heartland, where so many congressional seats will be in play and where today it’s easier to export or compete against imports because the same dollar costs convert into fewer euros, yen, or renminbi (this is what a “weaker” dollar means—foreigners can more easily afford our goods and their stuff is more expensive to us). If the dollar stays weak or declines further, our car companies, machinery makers, and turbine blade manufacturers will soon be rehiring and we’ll finally get some job growth as part of our sputtering economic recovery.
A weak dollar traditionally bothers our financial sector and they have enough political clout to bring on exchange-rate intervention. But the remaining big Wall Street firms have made out like bandits over the past 12 months—and they are perfectly positioned to make another ton of money from the carry trade. In fact, they’ll happily drive the dollar down further.
Sure, inflation may come back sooner than the administration would like—and here the increase in the price of gold is flashing a potential orange warning sign. But, the official thinking likely goes: We’ll deal with that after the midterms.
Simon Johnson is a professor at MIT’s Sloan School of Management, and a senior fellow at the Peterson Institute for International Economics.