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Monday August 30, 2004 - 22:16:43 GMT
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Dollar Politics

Dollar Politics

With the US Republican Convention underway in New York City this week and the presidential race very close based on the polls, the question of US dollar policy deserves some focus from the markets. Just where do the two candidates stand on the currency?

The bottom line there is little difference in substance, but some difference in emphasis. The Bush administration still adheres to the strong dollar policy, the legacy of Robert Rubin and the Clinton administration (a strong dollar is in the US interests). Kerry too believes in the Rubin dollar policy (Rubin is one of his top economic advisors). And I think it is reasonable to assume that both Bush and Kerry see the benefit of an orderly decline in the dollar, especially so when the US recovery is not generating adequate jobs growth and voters are sensitive to outsourcing. It would be wrong to assume that Kerry with a Rubin imprint would be any more inclinedn to talk the dollar up in the current economic environment.

Indeed the strong dollar policy is rather meaningless in as much as it purposefully does not define levels (nominal or real) for what constitutes a strong dollar. Backing a strong dollar can mean embracing a sub-100 dollar/yen rate in a weak economic environment with low inflation and equally embracing 140 when the US economy is strong and inflation problematic.

So what purpose then does the strong dollar policy serve if it in fact is so flexibly applied and deliberately undefined? It is an assurance policy. When a country runs a current account deficit in excess of 5% of GDP and it is the size of the US, the dependence on foreign savings (capital inflow) can not be understated. Assuring foreign investors that the policy of the US government is it favors a strong dollar is regarded by both parties as necessary if of little significance on a practical side (3 interventions in 8 years of Clinton including one round of dollar selling and none under Bush is testimony to the mirage of the strong dollar policy).

What are the differences in emphasis between the two candidates on the strong dollar policy? Arguably Kerry would be more inclined to intervene in the FX market if the dollar were overshooting to either the upside or downside. How much more? A shade more perhaps. But even the anti-activist Bush administration (seen also in its unwillingness to sell off some of the strategic oil reserves or even stop adding to them to ease pressure on oil prices). That said Bush officials would never say never to intervention, and one could imagine a round of dollar buying in the event of a disorderly decline in the dollar, say prompted by a terrorist attack on the US.

Where there are more meaningful differences is on trade policy. A Kerry administration would be more confrontational (ironically) with countries who arguably manipulate exchange rates. The Bush administration is quite willing to be patient with Japan on bank reform and China transitioning to a floating exchange rate. I say ironically because of the unilateralist leanings of the Bush foreign policy (Kyoto, Iraq, Nuclear Non-proliferation Treaty, and Korea). On the other hand the Bush administration has used tariffs on steel imports to appeal to steelworkers in key swing states like Pennsylvania and Ohio, which is a blatant example of activist (anti-free market) economic policy. Kerry on the other hand seems more open to using US economic power to secure concessions from trading partners. But Kerry also has a Senate record of backing free trade. Kerry has proposed a tax incentive scheme to persuade US firms to add jobs domestically...also a blatantly anti-free-trade proposal. In other words politics end up guiding trade policy, and neither candidate seems wedded to a philosophy of activism or laissez-faire in international economic policy.

Lastly, a slowing economy could put the dollar into play ahead of November. Equally it could put protectionism into play though both candidates surely recognize the futility of this slippery slope. It is conceivable that a close race and weakening economy could pressure Bush into embracing a weaker dollar to demonstrate to voters a decisiveness on protecting US jobs and firms. I doubt Kerry will attack the Bush administration for failing to talk the dollar down. On the other hand Kerry already has gone on the offensive over the Bush administration's failure to get China to liberalize its exchange rate regime and tolerating Japan intervention/manipulation (less of an issue since Japan stopped intervening in mid-March). Nonetheless, it would take extraordinary circumstances to get the Bush administration to talk down the dollar into the November election given concerns over funding the current account deficit. An orderly dollar decline could become disorderly in a hurry and have unintended consequences like lower US stock market and higher US interest rates/Treasury yields. Bush officials know this and will likely avoid it if at all possible despite the rosy public view of the readiness of foreign investors to buy an ever increasing supply of US assets.

Which leads to another substantive difference in policy between the two sides. Bush officials think the current account deficit can be funded rather readily...indeed they describe not as a problem of US spending too much, but of foreigners investing so much in the US economy, enthralled by its policy mix and economic performance (expected returns). The Kerry crowd think funding the current account deficit can't be taken for granted (Larry Summers recently addressed this in Foreign Policy).

Surely the dollar is not high on the average American's priority list for deciding on who to vote for. My sense is the market will ultimately bring the dollar to the next president and not vice versa. Adjustment in the current account deficit must happen and short of stronger foreign demand or weaker US demand, the currency will have some heavy lifting to do in the next few years to close the trade gap.

David Gilmore


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