In an essay, The ‘Strong Dollar’ Policy of the US, Buiter argues that a steadily declining nominal and real effective exchange rate for the dollar over the past nine years suggests, in reality, the pursuit of a successful weak dollar policy.
Buiter argues that the main motivation behind official jaw-boning about dollar strength, despite the empirical evidence that it has weakened, is the desire of senior US policymakers to prevent a sharp decline in the dollar’s value, something that “would almost surely be associated with a sharp rise in long-term US Treasury yields and of the many economically and politically important public and private interest rates that co-move with them” – in particular, the rate on 30-year fixed-rate mortgages.
“A lower dollar reduces the local currency return on dollar investments for foreign investors and should call forth an increase in the yield required for foreign investors to hold on to, let alone add, to their holdings of Treasury securities,” he argues.
An expansionist monetary policy, led by a second round of quantitative easing, has successfully kept Treasury yields close to all-time lows, Buiter points out, despite persistent dollar weakness, a large budget deficit and rising debt.
Buiter, a member of the Bank of England’s Monetary Policy Committee from 1997 until 2000, notes that a weaker dollar has also had a beneficial role in solidifying the US’s slowly developing export-led recovery, by improving relative dollar competitiveness.
He notes too that the US’s ratio of trade, the sum of imports and exports, to GDP is around 30%, making it a more open economy than has historically been the case.
The most obvious downside to such contrarian rhetoric, Buiter argues, has been damage to the reputational capital of the US monetary and fiscal authorities, and a reduction in their ability to use statements of intent or announcements of future policy actions to influence markets.
He notes for instance that the US’s moral high ground in negotiations with China over slow renminbi appreciation is significantly weakened if the Fed is “seen to engage in a form of market-mediated downward adjustment of the dollar exchange rate” in spite of contrary rhetoric.
Buiter concludes by noting that immediate prospects for an end to strong-dollar rhetoric are unlikely, given that rapidly rising debt levels mean US officials are likely to continue using “open-mouth” policy operations to effectively talk down Treasury yields.
In addition, a further boost for the recovery in net export growth owing to a weak dollar will be welcomed by the Fed, “if not explicitly acknowledged”, he argues.
| Selected Countries — Official Policy Rates, 2007-2011 |
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| Source: Citi |