Brad Setser Sends Us to the Economist on the Falling Dollar

Brad Setser praises the Economist on the dollar:

Roubini Global Economics (RGE) Monitor: Good reading on the dollar’s recent move: I have on occasion been critical of the Economist’s coverage, particularly its emphasis on Chinese consumption growth rather than Chinese export growth. But I should also give credit where credit is due. I thought their leader on the dollar was spot on.

Among other things, the leader makes three key points:

Europe has done a lot better recently than most Americans think – think of a US style housing boom that has supported domestic demand combined with a strong export sector. Germany’s rust belt (a.k.a export machine) is doing a lot better than Ohio, even with a strong euro.

The dollar isn’t that weak. At least not yet. There is a tendency to equate the dollar with the dollar/ euro. And no doubt the dollar/ euro matters greatly – for tourists, for the value of US investment abroad and for United States competitiveness in many third party markets. But the dollar has also moved a lot more against the euro than against other currencies. On a broad trade-weighted basis, the dollar remains well above its levels in the late 80s/ early 1990s. See General glut, or compare the major currency index with the other trading partners index. That suggests it needs to fall further.

Countries with lots of dollar reserves may not want to see those dollar reserves fall in value, but most countries with large dollar reserves can only protect the value of their existing reserves by continuing to buy more dollars. That only adds to their exposure to future falls in the dollar (both to falls in the dollar/ euro and to falls in the dollar against their own currencies). Call it the Amaranth strategy.

The Economist hints that some central banks are likely to conclude that they are better off if they don't keep adding to the dollar holdings. I have some sympathy for that argument – Nouriel and I made it strongly two years ago. Central banks have gone on to add $900b (by my estimate) to their dollar reserves over the last two years. Having been premature once, I am a bit gun shy – I don’t (yet) see strong evidence that there has been much of a change in central banks willingness to accumulate reserves. More on that in a bit.

I also wanted to laud Steven Weisman’s coverage in the New York Times, which got, I think, the United States dollar policy more or less right -- though the headline should probably say that a weak dollar rather that volatile dollar doesn't scare to Washington. The US doesn’t just have a strong dollar policy. It has a strong dollar policy and a please-intervene-less-to-keep-the-dollar strong policy. Call it a strong dollar and an-even-stronger RMB policy...

But he is not happy with Robert Samuelson:

That is why I was disappointed to see Robert Samuelson trot out the old “slow growth in the rest of the world” explanation for the expanding US trade deficit. “Faster economic growth in the United States than in many of our major trading partners has stunted our exports and increased our imports.” That explanation just doesn’t cut it right now. Global growth has been very strong since 2004 (look at the IMF’s WEO data). In 2004, you could argue that Europe was lagging. Not so any more. Right now both global and European growth are strong. That is one reason why US export growth has been quite strong since 2004 as well.

So why hasn’t the trade deficit fallen? I suspect we may need to rethink how strong global growth influences the US trade deficit in a world where there isn’t much slack in the oil market. The US imports a lot more of its energy than it has in the past. And with limited spare capacity in the global oil market, strong growth means higher oil prices and a higher oil import bill along with higher exports...