Hyperbole in the Media on the Dollar Decline

Last week we saw the fictional cabal planning the demise of the dollar with Russians, Chinese, Brazilians and the Gulf States planning to move out of dollars. We've got more stories today about the dollar at the "breaking point" here via Bloomberg.

People I think have forgotten the dollar was significantly up in the prior period due to the "fear trade". As the fear trade has unwound, the dollar has fallen back. The media (a story in the independent by a nut that got carried in drudge) likes to become hysterical though. If one wants to become hysterical, A 40% imbalance with our largest source of imports is more important to fix than a 10% down turn of return to risk.

The dollar decline is a function of a moderate decline in economic competitiveness, an over reliance on services industries such as banking as well as excessive spending at the Federal and State level. I'm not saying that we don't need to focus on making are economy more competitive or curtailing excessive spending.

However, the decline in the dollar, as long as remains orderly is helpful to this process. Specifically, a few facts to keep in mind:

• While the dollar may be a bit undervalued against some currencies, it's perhaps 30-40% against the Chinese currency. The Chinese use cheap exports to the US to keep a restive population employed and flowing with cash. US policy makers have allowed this to continue because of the downward
• Our largest source of Imports is not the US or Mexico, it's China at $184 Billion from January to August 2009. Germany, the largest exporter in the EU was $59 billion during the same period.
• Free trade does not work when the third largest economy in the world is not using a free floating exchange rate and uses subsidies and competitive barriers to keep out foreign trade. It causes disruptions in financial markets and imbalances throughout the system especially as those flows have grown so large. Commodity markets are nowhere near large enough to absorb the flows.
• People talk about the US fiscal imbalance and China as if they are to unrelated problems. They are entirely symbiotic.
• As the US currency drops it makes the Chinese fixed rates more difficult. While we gain in many ways by having cheap imports, we lose much elsewhere.
• Much of this is directly as a result of an increased tolerance for risk. The dollar was way up before this period.

While the drop is alarming, we need to encourage a gradual drop in the dollar vs. the Chinese currency and more market access. While this won't solve all our problems, a gradual effort to address the imbalance will be helpful in lowering US consumption and raising investment.