Importance of the dollar

The CFA Society of the Cayman Islands recently hosted John Tamny at an event at Casanova Restaurant. Tamny is senior economist with H.C. Wainright Economics in Washington, DC, and is also the editor of RealClearMarkets.com.  He frequently writes about the securities markets along with tax, trade and policy issues that impact those markets for a variety of publications including the Wall Street Journal, National Review and the Washington Times. Gareth Pulman from the CFA reports. Second in a two-part series.
 
Lost dollars
Turning to the current crisis, Tamny addressed the root causes of the housing bubble and subsequent bust. He explained that in his view, putting money into housing was effectively putting money into the ground. His belief was that such activity starved the economy of capital and that the flow of money into unproductive hard assets was the root cause of the recession. He added that while conventional wisdom was that the housing bubble was caused by Fed Chairman Alan Greenspan cutting the Fed Funds interest rate to 1 per cent, there was no evidence to support this. In fact, the few empirical studies that had been done in this area suggested the opposite was true and that the housing market tended to perform best when interest rates were rising, not falling.
 
The crux of Tamny’s argument was that when money loses value, it tends to flow into the assets that are the least vulnerable to this loss of value, including real estate. He noted that the Fed had taken the blame for the housing bubble, but at the same time the Fed was not in a position to control the direction of the US dollar. Instead, this was the preserve of the US Treasury. His view was that the Bush administration had adopted a deliberate policy of dollar devaluation, with the first two Bush Treasury Secretaries (O’Neill and Snow) purposefully mocking the concept of dollar strength. Meanwhile, he felt that the more recent appointee, Henry Paulson, was brought in with a mandate to encourage the Chinese authorities to strengthen the Yuan against the dollar.
 
These actions sent a clear signal to the market that the US Treasury would not support the dollar, with the housing market being the clear beneficiary. While Tamny agreed that the housing boom was a global phenomenon, he noted that the US dollar was not the only currency that had suffered depreciation over period of the housing market bubble. While the US dollar declined against gold by 270 per cent from mid-2001 to 2008, sterling slipped by 151 per cent, the Canadian dollar fell by 122 per cent, the euro dropped by 101 per cent and the Australian dollar by 94 per cent. His view was that when the US dollar devalues, it is always a global event. He said that in this instance, it triggered a global rush into real estate.
 
Tamny suggested that the net result was that what should have been a short recession turned into a global crisis. Because money was being put into the ground rather than going into entrepreneurship, real wages fell over the period at the same time as mortgage payments were rising. This was, in his view, compounded by the bailout/stimulus culture that has prevailed since the global crisis broke. Tamny said the bailout of Bear Stearns was the trigger for the crisis.
 
He said there was no evidence to suggest that a failure to rescue Bear Stearns would have triggered a domino effect. Instead he said the bailouts were a death sentence for weak and healthy banks alike. The banks that were bailed out are unlikely to be viable for investment in the near-future, while the healthy banks face an unlevel playing field, competing with banks financed with funds that are not their own.
 
Looking to the future, Tamny sees the outlook as bearish. In his view, we have sacrificed long-term commercial health for the short-term security of government support. He said government intervention will act as a drag on the economy for the foreseeable future. So far as currencies are concerned, in his view the US has ceded global responsibility for providing a global currency through its actions before and during the crisis. He suggested that the US Treasury should step up to define the value of a dollar (ideally tied to the price of gold). He concluded by saying that periods of floating currencies such as we have now have historically been the exception to the rule.

dollarSM

CFA Society of the Cayman Islands board members with the keynote speaker: From left, Georgie Loxton, Geoff Ruddick, Simon Cawdery, Monique Frederick, Russ Burt, John Tamny and Rich Ellison.

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