Caixin OnlineOpinionMagazine Columnist谢国忠 Andy Xie The Consequences of a Strong Dollar
02.04.2013 14:57

The Consequences of a Strong Dollar

Emerging countries including China should remember the lessons of the Asian Financial Crisis as the U.S.’ currency heads into a bull market
By Andy Xie

Since the end of the Bretton Woods system in 1971, the U.S. dollar has experienced a bull market twice. The first one in the 1980s was due to Paul Volker's high interest rate policy to cure chronic inflation. The second began in the mid-1990s as the IT revolution sucked investment into the United States. The coming dollar bull is due less to the United States' strengths than the weaknesses in other major economies.
Since depegging from US$ 36 per ounce of gold, the dollar has been in bear market 70 percent of the time. The reason is that the Federal Reserve has a dual mandate of maintaining price stability and full employment. Hence, the Fed is more tolerant of inflation than other major central banks. Its dual mandate is helped by the dollar's unique status as a global reserve currency. Its loose monetary policy doesn't trigger capital flight like in an economy with a normal currency.
Regardless of economic strength, a central bank more tolerant of inflation tends to produce a weak currency in the long run. Germany and Japan were vigilant against inflation. Most of the appreciation of the yen and mark against the dollar could be explained by the inflation differences with the United States.
Paper money not anchored to gold is a recent phenomenon. During its 40-year experiment, paper currencies have depreciated greatly against gold. When we say a currency is in bear or bull market, this is relative to other currencies. Paper currencies as a whole have been depreciating in value due to inflation. This is why gold is up 45 times against the dollar since the gold standard was abandoned four decades ago. While gold fluctuates in price and enters bear or bull markets alternately, its value will appreciate against paper currencies in the long run because, without a firm anchor, central banks inevitably expand money supplies to fix short-term problems and worry about inflation later.
The dollar bull market ahead is one of those episodes that will see the dollar outperform other major currencies. In the long run, the dollar will still underperform, and paper currencies in general depreciate in value.
The Weak Euro
The euro crisis has been raging for three years. The focus is on debt sustainability in southern European economies. The solution so far is (1) transfer of money from the north to the south and (2) fiscal retrenchment in the south. It is not working because the measures don't deal with the competitiveness gap between the two. Fiscal retrenchment addresses the competitiveness issue by forcing deflation in the south. But, deflation worsens their debt problems. It is a vicious cycle.
The only solution to the euro crisis is more inflation in northern Europe to balance the competitiveness problem of the south. The rising property price in Germany is the beginning of this process. The underlying force is the European Central Bank's monetary expansion. When it is recognized that the solution to the euro crisis is inflation, not deflation, the euro will decline to address the competitive consequences for the whole euro zone. The chances are that the euro will be a weak currency during this process, possibly for five years.
The Yen's Bear Market
The Japanese yen is in its own bear market independent of the dollar situation. The yen has been a strong currency for the past four decades, quadrupling in value against the dollar. Low inflation, a savings surplus and competitive industries have underpinned the yen's strength. The situation now is quite different.

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