The Fall of the Dollar (and Rise of the Amero?)

Harvard professor Larry Summers frames the issue of the weak US dollar simply enough:

The falling dollar generates anxiety almost everywhere. Americans and those dependent on American growth worry about the proverbial “hard landing” as inflation and interest rates rise with a weakening dollar, causing asset prices and output to fall. Europeans and others with currencies that float freely against the dollar worry that their currencies will bear a disproportionate share of the dollar’s decline and appreciate too far, leading to competitiveness problems. The falling dollar risks rising inflation, asset bubbles and the loss of macroeconomic control in countries that have tied their currencies to the dollar’s sagging mast.

The dollar’s decline may provoke anxiety but it should not be a surprise to anyone who has followed the global economy in recent years. History suggests that periods when a country’s economy turns down, short-term interest rates are declining and financial strains are increasing are likely to be periods when a nation’s currency depreciates. Moreover the US current account has for years now been financing consumption rather than investment, with the financing coming increasingly from debt rather than equity and shorter rather than longer-term debt.

He then points out some inadequacies in the current manner of exchange rate management (or lack thereof):

There is nothing very new about a decline in currency of a country running a large current account deficit and whose economy is softening. But in important respects the situation of the dollar is almost without precedent.

The vast majority of the US current account deficit is now being funded by central banks accumulating reserves as they seek to avoid appreciation of their home currencies. While the US dollar is usually viewed as a floating rate currency, substantial and critical parts of the world economy operate with currencies pegged to dollar parities or at least managed with them in mind.

Finally he advocates for change:

This suggests the need for rethinking traditional approaches to dollar policy at a time when the global economy is more vulnerable than it has been since 1998.

The Clinton administration approach of asserting the desirability of a strong dollar based on strong fundamentals while allowing its value to be set on foreign exchange markets was highly successful in its time and has largely been followed by the Bush Treasury. But it is insufficient in the current world, where the dollar’s trade-weighted exchange rate is to an important extent managed abroad. Some means of engagement must be found with those who have yolked their currencies and so their financial policies to that of the US.

The US has responded in an ad hoc way by carrying on a “strategic dialogue” with China – by far the largest economy with an exchange rate linked to the dollar – backed by congressional threats to address exchange rate issues using the tools of trade policy and references to communiqués from the Group of Seven leading industrial nations. In reality the dialogue is anything but strategic. Like so much of American international policy in recent years, it seems to confuse the firm statement of legitimate desire with the serious conduct of diplomacy.

I think a new currency strategy is a must, but I am definitely concerned about what the "next administration" might come up with. If you hear me advocating for the status quo it is likely from a position of concern about the new policy rather than an expression of satisfaction with the existing policy. (Out of left field: Does Larry remind anyone else of Nouriel Roubini in saying the global economy is the most vulnerable since 1998?)

US policymakers aren't the only ones concerned about the weak dollar being financed by China. I read that OPEC is likely to review pricing oil using a basket of currencies rather than just using the dollar. I also wouldn't be surprised to hear about Middle Eastern countries dropping their dollar pegs. Our firm is actually going through a similar evaluation of our firm's currency overlay policy to determine if we should hedge our currency exposure to a basket currencies rather than arbitrarily using the US dollar as our home currency.

In all of this I think that one fact is abundantly clear; any policy change is better than a move towards the North American Union (NAU) and the Amero. The NAU is a President Bush supported idea to combine Canada, Mexico and the US into a Union to rival the rise of the European Union. The Amero would be the combined currency of the three countries. When I first heard it I thought it was definitely just a crackpot conspiracy theory, but then I saw this clip from Lou Dobbs (not that Lou Dobbs is the official arbiter of what is conspiracy and what is mainstream):



I think this interviewer was completely blindsided by the Amero discussion:


Here is a picture of the Amero. Looks harmless enough, eh? (I'm just getting used to being a part of Canada)
Hat Tip: Brad Setser