Which political party will do a better job at preserving the purchasing power of the U.S. Dollar? A common tenet amongst Treasury Secretaries, irrespective of their political affiliation, has been a claim that the U.S. pursues a strong dollar policy. To find out, let’s look at what type of tax and regulatory policies foster a strong dollar.
Supply and demand determine the value of anything tradable, including a currency. Noteworthy with regard to the value of a currency is a country’s current account deficit, which can be thought of as the amount foreigners need to buy in a year – the required demand -, just to keep the currency from falling. To cover a $470 billion current account deficit, U.S. policy makers generally favor policies that promote growth: after all, foreigners may be more inclined to invest in the U.S. when the economy is expected to grow. However, the notion that growth is always good for a currency may be a myth. Consider Japan: even as Japan is expected to report its first trade deficit in decades for 2011, it continues to have a current account surplus. When the earthquake hit in Japan, putting the brakes on economic growth, the yen rose; in contrast, when an earthquake hit New Zealand, a country with a current account deficit, its currency fell. Interestingly, the Eurozone’s current account is roughly in balance, suggesting that – all else equal - the euro may be able to muddle through in the absence of economic growth.
While the current breed of Republican presidential candidates have distanced themselves from growth through stimulus spending, Democrats and Republicans alike have “put money into the pockets of consumers” or deployed “shovel ready projects”. It’s not an American invention, either: many politicians worldwide like to argue that the “other” party engages in wasteful spending, but if only they were elected, they would direct spending towards “worthy” projects. Presidential candidate Newt Gingrich’s plans to build a permanently manned lunar base may be a classic example of someone decrying deficit spending of the past, yet proposing to deploy resources for more worthy causes.
In our assessment, a strong dollar policy requires policies that support sustainable growth, pursuing policies that limit the supply of dollars relative to their demand. While the Federal Reserve (Fed) controls the printing press with an unlimited checkbook, debt creation in general – be that by the Fed, the Treasury, corporations or consumers – all contribute to a supply of dollars (creating Federal Reserve Notes or quantitative easing all create obligations by the Fed, even if they are mere accounting entries for a central bank; the Fed’s debt is special in that the monetary base created is a platform nurturing a multiple of debt creation in the banking system).
Improving the balance of trade would help the current account balance and, with it, might make the U.S. dollar more robust. Importantly, any country with a serious trade deficit tends to shoot itself in the foot when imposing measures that hinder trade. Historically, the U.S. dollar has often sold off when trade tensions flare up. That’s because the flexible workforce in the U.S. has adjusted to a trade based world. Imposing trade barriers then punishes those that have adjusted, rewarding those that have not. We phrase it in this fashion, suggesting that those that have not adjusted are more likely to be in uncompetitive industries, but stay in business because of government intervention.
U.S. corporations have been in the limelight because they keep cash earned abroad outside of the U.S., not paying “their fair share of U.S. taxes.” Indeed, companies like Microsoft are issuing debt in the U.S. because they don’t want to repatriate their foreign cash. Talk flares up from time to time to grant a temporary tax break to allow companies to repatriate their earnings. Such a strategy may give a temporary boost to the U.S. dollar as money is moved back to the U.S., but in turn, it encourages corporations to repatriate even less thereafter, in anticipation of additional future tax breaks. Opponents tend to argue that the money won’t be used to hire more workers, but typically paid out to shareholders. We don’t have a problem with that aspect: by returning money to shareholders, they can re-deploy it. U.S. policy makers must ensure that investors have incentives to deploy it domestically.
The problem with these temporary policies is that they are temporary. If businesses had a permanent incentive to repatriate earnings from abroad, it would go a far way to encourage investment in the U.S, allowing executives to devise long-term strategies rather than reacting in an ad-hoc fashion to the latest policy move. One reason why the U.S. dollar had become the world’s reserve currency is because of the free flow of capital: being able to move money in and out of a country is a great incentive to invest in the country. President Obama’s recent proposal to tax businesses that take jobs overseas opens a can of worms, as it enters a slippery slope that may lead to capital controls, which could be rather bad news for the U.S. dollar. Even without fearing the worst, the President’s State of the Union address appeared to suggest differentiated tax treatment for different types of activities. Tax policy has every right to channel money to specific sectors of an economy. However, we would like to caution that it is exactly those rules that are put in place with the best of intentions that create the “loopholes” criticized by later generations. Micro-managing an economy may lead to more bureaucracy, but not strengthen the U.S. dollar.
Supply and demand determine the value of anything tradable, including a currency. Noteworthy with regard to the value of a currency is a country’s current account deficit, which can be thought of as the amount foreigners need to buy in a year – the required demand -, just to keep the currency from falling. To cover a $470 billion current account deficit, U.S. policy makers generally favor policies that promote growth: after all, foreigners may be more inclined to invest in the U.S. when the economy is expected to grow. However, the notion that growth is always good for a currency may be a myth. Consider Japan: even as Japan is expected to report its first trade deficit in decades for 2011, it continues to have a current account surplus. When the earthquake hit in Japan, putting the brakes on economic growth, the yen rose; in contrast, when an earthquake hit New Zealand, a country with a current account deficit, its currency fell. Interestingly, the Eurozone’s current account is roughly in balance, suggesting that – all else equal - the euro may be able to muddle through in the absence of economic growth.
While the current breed of Republican presidential candidates have distanced themselves from growth through stimulus spending, Democrats and Republicans alike have “put money into the pockets of consumers” or deployed “shovel ready projects”. It’s not an American invention, either: many politicians worldwide like to argue that the “other” party engages in wasteful spending, but if only they were elected, they would direct spending towards “worthy” projects. Presidential candidate Newt Gingrich’s plans to build a permanently manned lunar base may be a classic example of someone decrying deficit spending of the past, yet proposing to deploy resources for more worthy causes.
In our assessment, a strong dollar policy requires policies that support sustainable growth, pursuing policies that limit the supply of dollars relative to their demand. While the Federal Reserve (Fed) controls the printing press with an unlimited checkbook, debt creation in general – be that by the Fed, the Treasury, corporations or consumers – all contribute to a supply of dollars (creating Federal Reserve Notes or quantitative easing all create obligations by the Fed, even if they are mere accounting entries for a central bank; the Fed’s debt is special in that the monetary base created is a platform nurturing a multiple of debt creation in the banking system).
Improving the balance of trade would help the current account balance and, with it, might make the U.S. dollar more robust. Importantly, any country with a serious trade deficit tends to shoot itself in the foot when imposing measures that hinder trade. Historically, the U.S. dollar has often sold off when trade tensions flare up. That’s because the flexible workforce in the U.S. has adjusted to a trade based world. Imposing trade barriers then punishes those that have adjusted, rewarding those that have not. We phrase it in this fashion, suggesting that those that have not adjusted are more likely to be in uncompetitive industries, but stay in business because of government intervention.
U.S. corporations have been in the limelight because they keep cash earned abroad outside of the U.S., not paying “their fair share of U.S. taxes.” Indeed, companies like Microsoft are issuing debt in the U.S. because they don’t want to repatriate their foreign cash. Talk flares up from time to time to grant a temporary tax break to allow companies to repatriate their earnings. Such a strategy may give a temporary boost to the U.S. dollar as money is moved back to the U.S., but in turn, it encourages corporations to repatriate even less thereafter, in anticipation of additional future tax breaks. Opponents tend to argue that the money won’t be used to hire more workers, but typically paid out to shareholders. We don’t have a problem with that aspect: by returning money to shareholders, they can re-deploy it. U.S. policy makers must ensure that investors have incentives to deploy it domestically.
The problem with these temporary policies is that they are temporary. If businesses had a permanent incentive to repatriate earnings from abroad, it would go a far way to encourage investment in the U.S, allowing executives to devise long-term strategies rather than reacting in an ad-hoc fashion to the latest policy move. One reason why the U.S. dollar had become the world’s reserve currency is because of the free flow of capital: being able to move money in and out of a country is a great incentive to invest in the country. President Obama’s recent proposal to tax businesses that take jobs overseas opens a can of worms, as it enters a slippery slope that may lead to capital controls, which could be rather bad news for the U.S. dollar. Even without fearing the worst, the President’s State of the Union address appeared to suggest differentiated tax treatment for different types of activities. Tax policy has every right to channel money to specific sectors of an economy. However, we would like to caution that it is exactly those rules that are put in place with the best of intentions that create the “loopholes” criticized by later generations. Micro-managing an economy may lead to more bureaucracy, but not strengthen the U.S. dollar.
