How is one to explain the wild gyrations in the international exchange value of the dollar over the past year or so? During one month it is falling fast, in another it is rising just as fast.
Some older-fashioned bankers must be yearning for the days of fixed exchange rates, for a time when a national currency was attached to the steady price of gold. Alas, no more. So it is not just the dollar and other currencies, but also the spot prices of oil, gold and other commodities that fluctuate wildly in the world markets.
As a comfort, financial columnists will patiently explain why these reversals in currency values occur. Among the reasons: US bond yields are ticking up; some economic indicators point to a resumption of growth; the US balance of payments is forecast to shrink; Federal Reserve chairman Ben Bernanke is talking up the dollar. One could toss in various other market forces, such as the surge in sales of dollar-denominated junk bonds.
So it is all markets, markets, markets. Sell the dollar short on Monday, buy it back on Tuesday. What goes up, must come down, until it goes up again.
Reasons for unease
Still, there are two other aspects to this tale of the dollar’s fate that grip me and make me uneasy in spite of the its recent gains. The first is the conviction among scholars much more learned in global financial matters than myself that the dollar is inexorably headed to a reduction in its share of foreign currency deposits held by national treasuries, because the latter will continually adjust to the shifts in the world’s productive balances, and thus to a currency’s relative purchasing value.
My own tack here on the dollar’s rises and falls isn’t a strictly economic one, but the view of someone professionally trained in the study of history and strategy. It is scarcely surprising to learn that, when crises and wars erupted, bankers and traders seek to put their money in the safest place possible.
Again, if you lived in a country whose governmental policies were economically foolish, and whose national currency suffered as a result, you were only being prudent in locating some of your capital assets in a sounder place: How many of today’s worried Venezuelan or Argentine elites hold bank accounts in the US, Switzerland, the UK or the Cayman Islands?
To a large degree, this benefits the host economy and keeps its currency strong. Occasionally, the national currency becomes so strong that its government imposes negative interest rates to stop the inflow of capital and its possible inflationary consequences.
Still, it is a sign of confidence, a sort of market speculators’ Good Housekeeping Mark of Approval. Water flows ever downhill; smart money flows to where it can prosper and be secure. The history of currency movements thus becomes a not-much-understood history of relative national strengths as well as a history of international crises.
World War I
To give just one example: In the stormy years of repeated international crises before 1914, British treasury officials feared that an outbreak of all-out war in Europe would cause foreign governments and private investors to drain gold from London, then the world’s only free market for gold. In fact, as soon as the July 1914 Balkan crisis seemed destined to lead to a Great Power shootout, foreigners began to pour their gold and other assets into the pound.
All of this, of course, had an ironic double impact.
As seen solely from the perspective of the currency markets, this was a massive vote of confidence in the British financial system. As seen from the perspective of the foreign office, though, this really was a bad omen; it meant that the international order, which the No. 1 power of the time had a massive interest in keeping stable, was tending toward chaos.
Bad news abroad
In short, when a reserve currency strengthens sharply, even in the face of economic fundamentals such as large trade deficits, there is usually, perhaps always, bad news from abroad.
This leads me to a rather gloomy conclusion, which I trust will not be proven correct, but which I think all sensible readers would like to ponder. If the above analysis is correct, then the US has found itself in this first decade of an undoubtedly troubled 21st century in a most peculiar condition as regards its twin roles, as the currency and banker of last resort, and as the key stabilizer of world security and international affairs.
If global politics are relatively calm, the dollar will probably continue its gentle longer-term decline, fluctuating only in accordance with traders’ economic decisions.
But if global politics are bad, then there will be a predictable flight to safety.
It would be an exaggeration to claim that a strengthening dollar must always mean a worsening world situation. But a pattern of stronger dollar, troubled planet does seem to have established itself.
So, given the choice, what would the Obama administration prefer: a rising national currency, with mayhem abroad or the prevalence of peace, with longer-term currency erosion? It’s worth a thought, even during our holiday celebrations.
Paul Kennedy is a professor of history at Yale University. Respond to this column at firstname.lastname@example.org