The Great Shrinking American Dollar
By PETER BOONE AND SIMON JOHNSON
Peter Boone is chairman of the charity Effective Intervention, a research associate at the London School of Economics’ Center for Economic Performance, and a principal in Salute Capital Management Ltd. Simon Johnson, a senior fellow at the Peterson Institute for International Economic, is the former chief economist at the International Monetary Fund.
The American dollar is in the midst of a large fall in its value, or depreciation, as measured against other major currencies. The decline has been steady since 2002 and our currency is down about 35 percent from that peak. After strengthening slightly more than 10 percent during the global financial crisis of the past 18 months, the dollar is again falling back toward its pre-crisis lows, representing its weakest international value since 1967.
But there is a definite possibility that the dollar could soon decline further or faster.
At the level of general economic strategy, the American government has responded to a financial sector crisis with an expansionary fiscal policy, and the Federal Reserve is implementing loose monetary policy. Andrew Haldane, responsible for financial stability at the Bank of England, puts it this way:
For the authorities, [excessive risk-taking by the financial sector] poses a dilemma. Ex-ante, they may well say “never again.” But the ex-post costs of crisis mean such a statement lacks credibility. Knowing this, the rational response by market participants is to double their bets. This adds to the cost of future crises. And the larger these costs, the lower the credibility of “never again” announcements. This is a doom loop.
In addition to a financial crisis, we also have a large current-account deficit, meaning that we buy more from the world than we sell. The deficit was $100 billion in the latest available (second quarter) data, which is around 3 percentof gross domestic product, and we finance that with capital inflows from abroad. (The current-account deficit is down from around 6 percent, but two-thirds of the decline is due to the lower price of oil).