The dollar has been drooping. This week, a broad measure of the dollar's value against other currencies fell to a 14-month low. Depending on the commentator, this is either a global vote of no-confidence in the United States; or it is good news, a return to normality as worldwide fears subside. Without exactly leaping between Paul Krugman and his latest sparring partners, there are a number of questions one might ask about the dollar's recent decline. This post kicks off a short series to consider four of them, beginning with: Is the drop in the dollar "natural" currency depreciation or the result of "manipulation?"
The dollar has fallen roughly 15 percent from its recent high this spring. When we see sharp movements in a price, it's natural to look for an active protagonists driving those movements. Every now and then in the past, we've found some. There have been attempts to corner markets in silver, wheat, and even salad oil. Each of these instances involved attempts to drive up a price and some were spectacular failures, but that's not what sets them apart from the case of the dollar. The market for currency absolutely dwarfs these other markets.
The last time statistics were gathered on this (late 2007), the average daily turnover in foreign exchange markets was $3.2 trillion and growing rapidly (up 69 percent since the 2004 survey). To put this in perspective, if we divide U.S. GDP over 240 business days in a year, it was about $0.06 trillion ($60 billion) in 2008. So every business day, the value of currency transactions averaged about 50 times the total value of U.S. output.
The implication is that it's very hard to manipulate the value of the dollar. In fact, this enormity of the market for dollars is one of its great strengths as a reserve currency; no one wants to keep their wealth in a thinly-traded currency that can be easily manipulated. As a general rule, the U.S. government doesn't even try to move the dollar around, and it gets to print the stuff. Every Treasury secretary since Robert Rubin has chanted the mantra "a strong dollar is in the U.S. interest" to avoid making any news that might move the markets in unpredictable ways.
But how can it be "natural" for the dollar to drop as far as it has in the last six months? Ever since the dollar was de-linked from gold almost four decades ago, the value of the dollar is determined continually in those massive global markets. The markets are populated by investors and traders, some with business ideas, some with money to save, some with goods to buy and sell. Some of them want to turn their dollars into euros to buy some French wine, others wish to turn their yen into dollars to buy some oil, a Treasury bond, or an American office complex. Exchange rates balance dollar buyers against sellers.
That means, in part, that we can have many explanations for what happens in these markets. The dollar could go up because American vinophiles turned to Sonoma Valley, or because the U.S. commercial real estate market became more attractive. One popular explanation for the dollar's rise and fall in the recent crisis is offered by Paul Krugman: "the dollar rose at the height of the financial crisis as panicked investors sought safe haven in America, and it's falling again now that the fear is subsiding."
That certainly seems to be part of the explanation. But it gives the impression that all is well, that we have returned to normal and there's little to worry about on the currency front. In fact, there is no indication that we've reached a long-term equilibrium and there is a serious basis for worries about the dollar's fall. That, though, will be the subject of the next post in the series: Has the dollar stabilized or is there risk of a further plunge in its value?
Philip I. Levy is a resident scholar at AEI.