VTI - What To Do About The Dollar And Inflation

2023-04-25 14:48:44 ET

Summary

• A nation's currency is the single most important price in the economy - Paul Volcker.
• The price of the U.S. dollar is falling these days.
• Since the value of the U.S. dollar was floated in 1971, there have been three other periods when the value of the dollar fell for an extended period of time.
• These periods were always followed by a period in which U.S. inflation was brought under control and the value of the dollar began to rise again.
• Leaders always arose in the past to fight inflation and make the dollar strong, so the question we face is whether or not we have those leaders in place right now.

Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, wrote the following comment about a nation's currency:

"A nation's currency is the single most important price in the economy: it will influence the entire range of individual prices, imports and exports, and even the level of economic activity. So it is hard for any government to ignore large swings in its exchange rate."

This quote is from the book by Paul Volcker and Toyoo Gyohten titled "Changing Fortunes: The World's Money and the Threat to American Leadership," published by Times Books in 1992. The quote is found on page 232.

So, let's look at what has happened to the value of the U.S. dollar over the past fifty years or so. We can see just what has happened to it and see if we can draw any conclusions about the current place of the U.S. dollar in the midst of everything that is now going on.

Two points to constrain the discussion.

First, we will begin our analysis in August 1971, the time when President Richard M. Nixon took the gold backing away from the U.S. dollar and floated the value of the currency.

Second, I am going to use the work of Niall Ferguson, published in Bloomberg Opinion . I have quoted from this article in a post written for Seeking Alpha.

Floating The U.S. Dollar

On August 15, 1971, President Richard M. Nixon presented his "New Economic Plan," a plan that included the freezing of wages and prices and the release of the U.S. dollar from its gold backing.

From that date, up to the present time, the value of the U.S. dollar has been determined in the open market.

Mr. Ferguson begins his analysis using July 1971 as a start date. I use his definitions as a backdrop for my analysis of what happened to the most important price in the United States...the price of the U.S. dollar.

Mr. Ferguson writes:

"Since then, the currencies of the world have fluctuated against one another and against gold, sometimes quite violently, sometimes barely noticeably."

Mr. Ferguson separates the data, up to the present times, into four sub-periods. These subperiods are determined by whether or not the value of the dollar rose during the period or declined during the period.

The measure used is the trade-weighted real effective exchange rate of the U.S. dollar.

• From July 1971 to October 1978, the value of the dollar plunged by 32 percent.
• From November 1978 to March 1985, the dollar rose by 49 percent.
• From April 1985 to August 1992, the dollar plunged by 36 percent.
• From October 1992 to February 2002, the dollar rose by 33 percent.
• From March 2003 to July 2011, the dollar plunged by 26 percent.
• From August 2012 to October 2022, the dollar rose by 53 percent.
• From November 2022, the dollar has been falling.

Mr. Ferguson exclaims: the dollar has sure been bouncy.

"And," he states that "it is precisely this lack of rigidity that explains the persistence of the post-1971 monetary system. Unlike the gold standard, the dollar system has an elastic anchor--a fiat dollar, the supply of which is primarily determined by domestic economic considerations."

In other words, the existence of a floating currency allows the value of the U.S. dollar to be determined by market conditions. This is so a government can focus on things other than the value of its currency, and markets can absorb the volatility that might be created by the changing focus of the government.

But, note. In Mr. Ferguson's scheme, we have a period where the dollar rises for a number of years, and then we have a period of time when the value of the dollar falls.

It is easy to tie each period of time to whether or not the U.S. economy is experiencing price inflation.

In the first, third, fifth, fifth, and seventh, the value of the dollar is falling.

Also, as we shall see that during these periods, inflation is a major concern of the government.

In the second, fourth, and sixth periods, inflation has been brought under control.

And, this brings us back to the comments of Mr. Volcker.

"A nation's currency is the single most important price in the economy...."

His conclusion:

"It is hard for any government to ignore large swings in its exchange rate."

Inflation

What seems to keep the exchange rate falling?

Inflation.

What seems to cause the exchange rate to rise?

A government fighting inflation.

So what do we see in the data presented above?

Well, look at periods two, four, and six cited above.

Number two, from November 1978 to March 1985: what name comes to mind when we talk about this period? Paul Volcker again, who, as the Chairman of the Federal Reserve's Board of Governors, caused the Federal Funds rate to rise above 20 percent and did what was necessary to bring inflation under control.

Number four, from September 1992 to February 2002: who are the leaders from this period? Well, I raise two names here. First, President Bill Clinton; and second, U.S. Treasury Secretary Robert Rubin. Mr. Clinton was adamant about bringing the U.S. budget into a surplus, which he was able to accomplish with the help of Mr. Rubin. It was truly a surprise success story.

And, number six? I think that the credit here goes to Ben Bernanke, the Chairman of the Fed's Board of Governors. What did Mr. Bernanke do? He built the Fed's policy of quantitative easing that keep prices under control during the longest period of economic expansion in U.S. history. Consumer prices rose by a compound rate of only 2.2 percent for a very, very long time.

Right now, I won't go into the reasons for the declining U.S. dollar during the other periods. That is for another time.

Fighting Inflation

Now we go back to current times.

What does the above narrative tell us?

Well, it tells us that the value of the dollar is a very, very important price in U.S. history.

We also see that a falling dollar is also closely connected to the amount of inflation that turns up in the economy.

Inflation must be fought.

A strong value of the U.S. dollar needs to be maintained.

The fight to achieve this is not easy and success is not achieved overnight.

Compared with previous periods, one does not see the strength of leadership in the government, either in the White House or in the Federal Reserve, that is needed to sustain a really hard fight against inflationary pressures.

In fact, it appears as if the run for the presidency in 2024 is getting underway. The incumbent president certainly wants to have an economic policy in place that will help to get him re-elected.

Richard Nixon wanted to get re-elected in 1972, and Arthur Burns, who was the chairman of the Federal Reserve then, was the man Mr. Nixon expected to help him.

Also, Mr. Nixon believed his wage-price deal, coming in August 1971, would help Mr. Burns provide him with the help needed.

Unfortunately, Mr. Volcker did not come along until somewhat later.

Mr. Biden wants to get re-elected. Do you think that Mr. Powell will be Mr. Nixon's Arthur Burns... or not?

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