Talking Down the Dollar
A correspondent asks why I am so annoyed with Treasury Secretary John Snow's attempts to talk down the dollar:
...a weaker dollar [is] a good idea... you soft-pedal the fact that we need a big real exchange rate adjustment eventually, so why not get started now?
The answer is that there are good ways and bad ways to talk down the dollar, and Snow chose a bad way. A good way convinces foreign investors that future monetary policy is likely to be accomodative and interest rates low as a way of inducing them to try to sell their dollar-denominated portfolio assets for less. This way promises to boost exports eventually (because the value of the dollar falls) and to boost investment (because it adds further credibility to the Federal Reserve's promises to keep interest rates low for quite a while). It so boosts aggregate demand, reducing unemployment. And it reduces the magnitude of the dollar's overvaluation, thus diminishing the chance that we will have to face a severe dollar-driven financial crisis a few years down the road.
A bad way to talk down the dollar convinces foreign investors that their investments in dollar-denominated securities are riskier than they thought they would be because the Treasury Department does not care. In this case, the value of the dollar falls (promising to boost exports eventually) but interest rates rise (as bond traders sense that there will be less in the way of foreign money flowing into the bond market in a couple of years). The rise in interest rates depresses investment spending, and the net effect is probably a minus for aggregate demand. Moreover, the increase in the perceived riskiness of dollar-denominated assets both reduces the value of the dollar today and reduces foreign investors' long-term willingness to hold dollar assets. To a first approximation, the magnitude of overvaluation does not change as the fall in the current value of the dollar is matched by a fall in the long-run "fundamental" value.
Guess which way John Snow chose?
And, of course, there are other reasons for being annoyed with John Snow: his unwillingness to take on the White House political apparatus, his craven total surrender of all of his deficit-hawk convictions, et cetera, et cetera.
Posted by DeLong at 08:07 AM | Permanent Link |
