What Is Killing the U.S. Dollar?

us dollar devaluationAs of late, what is killing the U.S. dollar is the second round of quantitative easing, dubbed “QE2.” Ben Bernanke is no stranger to criticism, from economists to lawmakers alike, but the latest bout of criticism is not U.S.-centric only. Even international policymakers have started berating Bernanke for being the world reserve currency’s worst keeper.

What has everyone in such an uproar? The Federal Reserve is likely to dump more money into the financial systems. As the world waits for that to happen, the U.S. dollar keeps on declining against other world currencies. Not even the weekend G-20 finance ministers’ meeting did much on the front of helping the greenback. It seems the U.S. dollar is the only currency in the history of currencies to be treated as both the world’s reserve currency and the global currency markets’ pariah.

Next week, the Federal Reserve Open Market Committee will meet, at which time it is expected that more QE will be approved, probably in the form of the Fed buying billions of dollars worth of government securities. What do Bernanke’s counterparts around the world think about this? If we ask Germany’s finance minister, Rainer Brüderle, his answer is, “An excessive, permanent increase in money is, in my view, an indirect manipulation.”

It seems the term “currency war” has gone viral. It has been adopted like the ugly puppy no one wants, but no one can turn out, from traders to politicians to currency analysts. The designated bogeyman of the day is China, which is keeping its yuan currency on a tight leash and causing all kinds of volatility in the global markets and on the international trade stage. You know it is bad news for the U.S. dollar when the only currency declining against it is Colombia’s peso, and not because of the greenback’s strength, but because Colombia wants to rein in its own peso’s wild upward momentum.

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In Bernanke’s defense, it is not as if he can determine policy based solely on the greenback’s value or in response to the volatility in the global currency markets. To do that, Bernanke would have to defy Congress itself.

The Fed operates in a democracy and, in this context, the central bank has some leeway against political pressures, as long as it delivers on its mandate. This mandate involves two primary objectives: maintaining stable price levels; and reaching as high an employment rate as practicable. I don’t have to tell you that the Fed is failing miserably on both counts. Deflation remains a threat and the labor market in the U.S. is in a shambles. So, either Bernanke figures out how to stabilize prices and fix the labor market or he’ll have some tough explaining to do before Congress. And the only way Bernanke figures he will be able to deliver on his obligations is to unleash the QE2, albeit at the expense of the U.S. dollar.

The world’s reaction to this is expressly negative. Joseph Stiglitz, a Nobel Prize winner in economics and a professor at Columbia University, said, “The U.S. will always focus disproportionately on its own interests. In this case, what is a concern to me is that the U.S. is getting very little benefit out of this measure, but is imposing a really large cost on the rest of the world.” I would agree with Stiglitz, and add that this is what usually happens when you are caught between a rock and a hard place.