classical economics
for analysis,  forecasting
and policy design

Dollar's Wild Ride
By Wayne Jett
© August 6, 2008

    A children’s book titled Farmer Palmer’s Wild Wagon Ride comes to mind when thinking of the dollar’s path over the past five years. Here’s what it looks like, inverted, as traced by the price of gold:


Essentially, the dollar’s value fell by two-thirds, not all at once or in a smooth line, but in erratic jumps, drops, retracements and falls, none with advance notice or accurate measurement by the Federal Reserve System.
    Capital is stored labor impressed on matter, converted to currency, and held for future release when needed. That being so, is it not clear that the Federal Reserve is conducting U. S. monetary policy in a manner that steals the value of labor exerted by Americans and all others who rely on the dollar? A dollar earned and saved in January, 2003, will now buy less than one-third the amount of gold the same dollar would have bought in 2003. Gold has not changed; the dollar’s value has changed drastically and, in so doing, has broken trust with those who use it worldwide.
    Notice that within the past year alone, the dollar’s value fell from $650/oz to $1,000/oz before backing to near $875/oz. All else aside, this is a net drop of one-third in the most recent 12 months, so today’s dollar includes no assurance its drop in value is finished. To the contrary, all reliance on past integrity of the currency is dissipated.
Federal Reserve Modus Operandi
    As was the case in the years following 1971, the Federal Reserve neither warned of this currency devaluation nor has it admitted the devaluation occurred. We cannot anticipate truthful disclosure of the central bank’s intentions. We must expect it will continue to conceal from the public its intentions and its actions.
    The Federal Reserve excuses its approach to public communications on grounds its role in systemic risk management requires confidentiality. Systemic risk is increased by currency instability and unpredictability more than by anything else a central bank might affect. Had the Federal Reserve provided a stable currency at $350/oz gold during the past five years, as was certainly doable, we can be almost as certain that the housing boom-bust, the diversion of bank credit from small business enterprises to financial firms dealing in mortgage derivatives and other high-risk investment strategies, and other misallocations of liquidity would not have happened.
Current Observations
    In January, 2007, the Federal Reserve shut off positive liquidity its open market operations had provided during 2004-2006 even as its ill-advised funds rate target had deprived small business of bank credit at reasonable rates. At year-end, 2007, open market operations drained $48.4 billion primarily by redemptions of Treasury securities. In January, 2008, an additional $43.5 billion was drained before $32.5 billion was injected during February. Release of more recent data is deferred until it ages five months, retaining insiders’ advantage.
    The funds rate target remains too high, but by only about 1% as contrasted with the 4% error when it was at 5.25%. Thus, small business can get credit at a slightly excessive rate, but still the cost of funds is too high to enable real economic growth. Worse, banks worried by credit woes caused by past lending practices now are reluctant to resume lending to small business, even though SBE did not cause banks’ problems.
    With federal elections three months away, the Federal Reserve will become a live wire again, likely to shock (and hurt, rather than help) the economy. Odds are the worst will be raising the funds rate target, again shutting off bank credit to SBE, raising unemployment and hurting economic growth. What will be done with liquidity is less certain. Since 2006, liquidity has been added only as required to assuage crises. That approach is most likely to continue, which (combined with higher funds rate target) would leave the dollar no stronger than its presently weak value. Preferably, the funds rate target should be kept no higher than its present 2% (even better, float it), so SBE have a better chance to grow and produce jobs. That would give the dollar its best chance to strengthen, which will be difficult at best due to tax and tariff headwinds after the elections. ~