OldVet on Setting the Value of the Dollar

This is the second of two posts sent to me this morning by readers with very big ideas. This one is by OldVet…


“Currency Values – time for a change?>/span>

“Here, I have some US Dollars. Can I leave the tip?”

As you may know, I’m personally agnostic on the value of the Dollar, except as it affects the real economy of the US . The Bush administrations’ economic jokesters, led by Secretary of the Treasury Mr. Paulson, have a set of comedy routines. The most entertaining routine could be described as the “falling dollar Not-My-Baby.” Bush and Paulson preach the all too familiar mantra “a strong dollar is in our national interest.” I heard one high potentate of finance opine that nobody ever “devalued their way to prosperity.” Oh, really? Ever heard of China ? How about OPEC, who effectively devalue their currencies by pricing Oil in Dollars (until recently.) They addicted the whole world to their exports and got rich in the process. Who are you kidding, Washington ?

The US Dollar used to be a small fraction of the English Pound when Britain ruled the waves. Now it takes only two Dollars to buy a Pound, and during this time America became enormously prosperous. So did Britain , whose currency lost relative value.

Which leads us the value of the Dollar. We’ve run approximately 30 years of continuous trade deficits, meaning more consumption than production taking place. We issue IOU’s by the bushel basket. We claim that “deficits don’t matter” or that “deficits are a sign of economic strength.” Here’s a different theory: Deficits are paid for with borrowing, and that borrowing represents claims on US tax revenues and claims on hard assets in the US such as land or factories. Continuous deficits are signs of an unhealthy addiction to the high life, and growing credit creation leads to a “Minsky Moment” which was the economist Minsky’s observation that credit expansions lead to excess and then collapse.

There is one avid group of traders and thinkers who believe that only the use of a “gold standard” as the basis for the US currency will stabilize trade deficits and credit creation. Their idea is that the Fed and Treasury cannot create more Dollars than are warranted by our stock of gold in Fort Knox to back them up. ( Russia has added massive amounts of Gold to its official government reserves.) That is considered an absolute standard, such as we had till 1972 with the Breton Woods introduction of a floating currency regime in the world, such that governments no longer used Gold as their currency basis. Then there was a modification called, informally, Breton Woods II. Today we have massive one way trade imbalances between the US and much of the rest of the world. That is especially true of the world which “pegs” or fixes in some manner their own currencies to the US dollar. Like the GCC, China , and other countries officially, and via artificially low interest rates also Japan.

A modest proposition: How about rather than an absolute standard like Gold to establish currency value, we use GDP and GDP growth rates? Official monetary expansion would be limited to GDP growth and enough to cover inflation. That would base our currency on our productivity, rather than our consumption or something dug out of the ground. Or we insist that floating market rates determine the value of all currencies against the US dollar, to establish a market price; or no trade takes place until it does, or tariffs make up the difference in estimated value. In other words, a little tough love.

How about a few other ideas to help out Washington?

This one was by OldVet.

My very quick thought… I’m a little confused about how this would work. The gold standard worked because there was an underlying item… an ounce of gold. GDP (or real GDP) is not something that can be bought or sold. And the value of the dollar only makes sense in the context of “relative to other currencies.” If other currencies are free to move against the dollar, is there really a peg?

Your thoughts?