The Strong Dollar
Jude Wanniski
August 20, 2001


Memo To: Treasury Secretary Paul O’Neill
From: Jude Wanniski
Re: What Makes it “Strong”

I’m glad you appeared on the Evans/Novak/Hunt/Shields program this past weekend, even though you made no news to speak of. At least I got to see why you think a “strong dollar” is good for the economy. You clearly equate “strength” with productivity, and because you correctly believe the nation’s productivity is a goal to be cherished, you think you must tell the world you are absolutely in favor of a strong dollar. It is natural that you make that connection, because in the most recent past, a dollar that has increased in value relative to other currencies has been accompanied by a strong economy, increased government revenues, budget surpluses, low unemployment, low inflation rates, and lower interest rates. There is no correlation over time, though, and it is easy to see why.

When you think of people wanting dollars, you think of them as wanting to invest in the U.S., which is how you put it to Novak. Dollars, though, are not investment opportunities, though, as they pay no interest and pay no dividends. If you are a foreigner and want to buy shares of IBM, you will have to acquire dollars in order to do so. But whoever sells you the IBM shares will then have the dollars that you acquired by either selling us goods or services you have produced abroad, or by finding someone with dollars who would like to buy those goods, and needs to convert them into your currency to complete the transaction. You see, Paul, productivity has definite connections to other assets that are priced in dollars, but not to dollars themselves. You can persuade yourself of this by noting that other countries that tie their currencies to the dollar, which Argentina has done in its constitution, can have extremely weak economies with negative productivity growth – even though the peso is equal to the dollar. You may have let Alan Greenspan smoke this strong-dollar/productivity argument past you at one of your weekly lunches, as he pooh-poohs the argument that he is to blame for the problems of our economy by failing to supply the dollar liquidity which the market has needed and wanted. It is hard to admit mistakes when you have been celebrated in song and story as the Master of the Universe.

The dollar was weak in those years when inflation was the problem afflicting our economy and the world’s, as the world tends to key its currencies against the dollar. This was because of the law of supply and demand. If the system wants X dollars and the Fed supplies X+Y, then the supply exceeds the demand, and each dollar becomes worth less in terms of real goods and services, which is what we know of as monetary inflation. If the system wants X dollars and the Fed supplies X-Y, then the demand exceeds the supply, and each dollar becomes worth more in terms of real goods and services, which is monetary deflation. It was enlightening to have Novak ask you if you consider us in a deflation, based on low commodity prices, and for you to say you did not think so. If you clear away the productivity matter, which may confuse you, I think you may come around to seeing there is no other explanation. We are in the midst of a deflationary process that will get worse if you do not come to grips with it.