Ultimately, what we are witnessing is a second Nixon shock played out in slow motion. And the Fed’s dual mandate ensures that John Connally’s remark from 1971 holds true today: “the dollar is our currency, but your problem.”
That’s from a post by Macro Man, a trader who appears to know what he’s talking about. It’s almost a week old, but I just noticed it (via Brad Setser via Menzie Chinn).
The “dual mandate” is Congress’s 1977 instruction to the Fed to promote both price stability and maximum employment. Most other central banks–in particular the European Central Bank–are legally directed to worry only about prices. Of course, the people who run them obviously think about other stuff like unemployment, but there may be something to the argument that the Fed is always going to be slightly laxer than its brethren and that this is one reason for the weakness of the dollar.
The big reason, though, is something simpler: The economies of China and the Gulf states are in such different straits than that of the U.S. right now that it’s crazy for them to keep allowing the Fed to run their monetary policy (which is what pegging their currency to the dollar more or less does). The Nixon shock to which Macro Man refers was the 1971 decision to sever the dollar’s link to gold, and in the process break up the Bretton Woods system of managed exchange rates. In the past couple decades we’ve seen the evolution of what some call Bretton Woods II, in which emerging economies link their currencies to the dollar. That’s what is unraveling now. Writes Macro Man:
What it all means is that we may be rapidly approaching that Minsky moment when dollar-peggers have to change policy. At that point, we could actually see currencies like the euro and sterling decline against the buck, with dollar weakness manifesting itself most against erstwhile peggers. For the time being, reserve diversification flows should keep the euro broadly supported for the next month and a half, but Macro Man is now entering profit-taking mode on his euro long.
As for John Connally’s line about the dollar being “our currency, but your problem,” I think it still holds. It won’t forever, though.