Valuing the Dollar; Devaluing Our Future

In a thoughtful op-ed piece in the weekend Wall Street Journal, Bob McTeer, former president of the Federal Reserve Bank of Dallas, echoed St. Augustine in wishing for a strong dollar – but not just yet. See Valuing the Dollar.

McTeer makes a strong case that a weaker dollar is part of a solution for the unbalanced US and global economies: “My preference,” he stated, “would be for dollar depreciation to reduce the [U.S.] current account deficit and slow the accumulation of dollar assets abroad. That process has already begun.” He concludes by warning: “A premature strengthening of the dollar would slow needed foreign trade adjustment and neutralize foreign trade as a source of domestic demand as we try to avoid a severe recession.”

This argument is a useful antidote to some of the confused economic logic that often beclouds the vision of Washington decision-makers. Experts are quick to bemoan “unsustainable” imbalances in the world economy, the low US savings rate, and our 35-year propensity to consume more than we produce. Their solution seems to be – get this! – coaxing the American consumer to spend more!

McTeer’s argument is a reminder that the default setting for a market economy such as ours is that persistent imbalances will be corrected through market forces. That’s what the depreciating dollar is doing. It will bring with it higher interest rates, higher exports and – contrary to what McTeer hints at – lower, not higher consumption. McTeer also glosses over the negative consequences of a dollar depreciation for those fools – overwhelmingly American citizens – who continue to hold American assets.

Cheapening the dollar may lead to a fire sale of American assets as foreign holders of dollars cash them in for something of real value at historically low process.

So, if the dollar depreciation runs its course without a major shift in American macroeconomic policy, America’s younger generations can inherit a reduced debt burden – hooray! – accompanied by a lower standard of living, reduced purchasing power, and increased foreign ownership of America’s most valuable assets.

That’s a high price to pay just because America’s political leadership does not take seriously the structural problems of the American economy. For starters, let’s adopt a consumption tax at a rate comparable to those in the rest of the world (say, an 18 percent value added tax). Use the proceeds principally to finance a fundamental restructuring of the rest of the tax system – much lower taxes on corporations and individuals and the elimination of a dozen or more nuisance taxes. Crucial to this is to expense – immediately write off – investments in production capacity.

Unless we change the structure of the American economy so that we can produce more than we consume, the market will achieve that end, however brutal and unfair the process might be. Our longstanding structural problems cry out for effective leadership. If the best that the presidential candidates can do is to argue whether the Bush tax cuts should be made “permanent,” our structural problems just might go on forever and along with it a succession of dollar crises.