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Thursday, May 22, 2003

US Treasury Secretaries Do Have Dollar Policy: Even When They Blow Their Nose

Gerard baker has a piece in the FT which is turning my hair whiter than it already is. His argument: the whole notion of a dollar policy is a piece of fiction. (And the notion of monetary policy too, I imagine, because all the same arguments could be made about the powerless of Greenspan and co to set interest rates long term, but that doesn't prevent them trying to have a monetary policy).

It is not just that the formal ending of the strong dollar policy had been prefigured by a succession of clumsy attempts at clarification by Mr Snow and Paul O'Neill, his policymaking Doppelgaenger. It is that the whole notion of a dollar policy is a piece of fiction that should have been abandoned years ago. Policymakers can set interest rates, tax rates and public spending levels. They can no more set the price of a nation's currency than they can set the price of an apple or a company's stock.... Before Mr Snow spoke, the dollar had been falling for two years - by more than 25 per cent against the euro, somewhat less against other currencies - because it was bound to.... And it will surely fall further. Mr Snow and his colleagues for once deserve some credit for belatedly simply trying to get out of its way.
Source: Financial Times

Brad buys this in part, but can see problems.

Gerard Baker is largely right, but I see two problems with his analysis:

1/. You can fix the price of your currency--if you have the enthusiastic cooperation of your central bank and the government's budget masters. It's called a fixed exchange rate system. You can do it. You just don't want to: exchange-rate stability is not worth what you have to sacrifice to get it.

2/. This is not an argument a U.S. Treasury Secretary can win--given the mapping that foreign exchange traders believe holds between his statements and U.S. government policy--and it is a costly argument for a U.S. Treasury Secretary to try to make. This is one that you make your underlings wage with the press, on background.
Source: Semi Daily Journal

Now I'm afraid I don't agree with Brad here. There are not only two possible alternatives (fixed or free-floating: see eg my brother . A dollar policy is possible, indeed my argument is that this is what we have. In the world of policy by 'expectations' even the treasury secretary blowing his nose is part of policy. The present policy is being used by the US to try and force Europe and Japan to mend their ways at gunpoint. (But since the analysis of the problem is wrong, forgive me if I beg to doubt the efficacy of the remedy). This is the real result of the Iraq war, no cooperation, no consensus, and we'll see what happens next. But the euro won't hold this value, ie this is NOT a reflection of a market valuation, but the result of expectations being 'steered'.

Movements of this violence in currency markets cannot be good for business. Why make a low return investment in a world of xcess capacity when you can turn 20% this year buying euro-bonds, and maybe another 20% next year buying US treasuries on the ride back up. In theory governments exist to prevent this type of thing, but I know, I am a lone voice here......

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