Edward at the Fistful of Euros delivers a (good) post on the sliding dollar/soaring euro issue and the wisdom or otherwise of a central bank intervention to prop up the buck, or at least manage decline. He, rightly I think, points up the inconsistency in US Treasury Secretary John Snow's recent remarks - Snow said that the US government maintained a strong dollar policy, but did not say anything about the dollar's increasing strengthlessness - and attributes this to a dissonance between what he perceives as a national interest and what he is willing to say. It may be good for the US economy if the dollar falls some way, but this is not to be said in public.
There are two reasons for this. One, of course, is that other economies - Europe first of all - stand to lose out in a dollar devaluation. The other is that this particular US government is especially attached to the idea of being Tough. This idea frequently gets in the way of rational thought about currencies, and in this case we can see a conflict between a rational decision (to employ the Norman Fowler principle and "leave it floating downwards to find its own level") and the need to say tough things for fear of being branded untough. Either way, it does not seem likely that Mr. Snow will support an international agreement to regulate the dollar (as was done under the Plaza and Louvre accords in the 1980s). If Europe fears a competitive dollar devaluation, then, the question of a unilateral intervention comes up. Now, this might not be as foolish as it sounds. The European System of Central Banks' reserves are gigantic, and anyway you can intervene downwards almost without limit (except the risk of inflation). But there is a serious risk involved, which we might call the Whitney trap. Richard Whitney was the vice-president of the New York Stock Exchange in 1929, who later committed suicide in disgrace over a fraud. The fatal fraud was the result of his action in buying quantities of shares in a distilling firm in an effort to shore up the share price. The point was to support the value of his existing holding in the same firm, which he had pledged as collateral to a large loan. To do this, he borrowed heavily.
Unsurprisingly, as the wider market was collapsing around him and the US (and indeed world) economy was going down the toilet, all that happened was that the other shareholders grasped at this straw to realise at least some cash from their otherwise worthless shares. Whitney kept piling up more and more paper - he got within sight of taking the firm private (by the end he owned 137,672 shares out of 148,750) before being overcome by financial exhaustion. But neither his own stock price, nor the wider market, noticed one jot. Now, this comparison is not perfect. After all, the ECB will never run out of euros. But it is true, though, that other players hold an immense overhang of dollars. If the situation gets worse, they will be under increasing pressure to sell before it gets still worse - and who will buy? The other players, of course, are the Asian central banks who have been intervening like hell for months and hence are awash with depreciating greenbacks. In the Whitney scenario, the ECB's action would simply permit other central banks to get out, while itself piling up sinking dollars. Very possibly, all that would happen would be that the relative positions would be much the same, with the exception that the Asians would hold euros, not dollars, and that an inflationary quantity of euros would have been spilt into the world. Given the ECB's inflation-hawk reputation, we could expect tough and growth-choking interest rate rises. Great.
On the other hand, there is something to be said for a high euro. To a certain extent there is an analogy to the Deutschmark in the 70s and 80s, whose surge effectively cancelled out the soaring oil price. Edward holds that this effect is losing heft, though.
EDITED to remove humiliating brain fart