WSJ Editorial: The world is fleeing the dollar, they lack confidence in U.S. leadership

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Run on Washington

July 17, 2008; Page A14

Washington's biggest names – from President Bush to Ben Bernanke to Nancy Pelosi – have all trotted out publicly this week to declare their profound concern about the American economy. Alas, our leaders are promising to do everything except what might really do some good: Abandon what they've been doing for the past year.

When the financial market turmoil hit last August, the U.S. economy was growing, albeit slowly, with moderate inflation. Washington has since embarked on a stampede of easy money from the Federal Reserve, nonstimulating tax rebates from Congress, and a crisis-driven, haphazard approach to credit market triage.

The result a year later: The overall economy is still expanding, albeit slowly, but with inflation roaring and the dollar hitting historic lows. Soaring oil and commodity prices – the byproduct of a weak dollar – have tanked the airlines, the car companies and trucking firms, cattlemen and hog farmers, among many others. Meanwhile, the financial mess rolls ahead, having spread from Wall Street to the midsized banks, and engulfing even the government-chartered companies that Washington only weeks ago declared were our saviors, Fannie Mae and Freddie Mac.

It's not exaggerating to say that the world is fleeing the dollar in what amounts to a global run on Washington itself – from Capitol Hill to the White House to the Federal Reserve. The world's investors are saying they lack confidence in U.S. leadership.

* * *

That's certainly true of the Fed, where Mr. Bernanke looks increasingly like a professor shocked to find that the world has rejected his academic theories. Yesterday's dreadful inflation numbers are as stark a repudiation of Fed policy as you could imagine: up 1.1% in June alone, 5% for the last 12 months, the highest in 17 years. Energy and food prices led the way, as every American consumer already understands. But the report showed that inflationary expectations are also creeping through more of the economy, including services and transportation.

Mr. Bernanke stated the obvious when he told Congress Wednesday that inflation "is too high." And markets rallied even on the hint of a tougher line, with oil and gold both falling as the dollar rose. Yet Mr. Bernanke, Vice Chairman Donald Kohn and Governor Frederic Mishkin – the Fed's three intellectual amigos – continue to pursue a reckless policy of negative real interest rates with no change on the horizon. For months, they have overestimated the risks of recession while underestimating the dangers of inflation. They have been too attentive to the pleas of Wall Street and Capitol Hill, and not enough to the American middle class.

Meanwhile, Congress wants to double down on its failures, with Speaker Pelosi proposing a second round of "stimulus" spending. Someone should ask what happened to the first. Just as critics predicted, the rebate checks gave consumer spending a short-term fillip without changing longer-term incentives. The checks did, however, add $168 billion or so to the federal deficit. And now the Speaker wants to add $50 billion more – all as a prelude to next year when she'll claim we need to raise taxes to reduce . . . the deficit.

While Barack Obama campaigns on "change," the irony is that for the past year Washington has been pursuing his economic policy mix. The tax rebates and spending were his idea of "stimulus," too, while he's said nary a discouraging word about the Fed or the dollar. The left's leading economic gurus – Larry Summers, Robert Rubin – have also urged the Fed on. With the huge tax increases he's proposed for next year, Mr. Obama's policies are another source of the global run on Washington.

As for the Bush Administration, the best one can say is that it looks tapped out. By agreeing without a fight to January's tax rebates, Mr. Bush gave up his last chance to shape this year's economic debate. He might not have won in Congress, but he would at least have had an argument. Instead, he told the American people that the rebates would spur growth, and now that they haven't he's undermined the popular appeal of tax cuts more broadly.

The President could still play a role in crisis financial management, such as reforming Fannie and Freddie. But he seems to have abandoned that field to Mr. Bernanke and his Treasury Secretary. Hank Paulson has been an expert at media relations, and the Members love him on Capitol Hill. He and the Fed have done some creative work on emergency financing through the Fed's discount window. But Mr. Paulson has also invited the dollar's fall as a way to boost exports, despite the resulting oil spike and collateral damage to Detroit and American consumers.

The Treasury chief is also still behind the curve in cleaning up the financial system. The Fannie Mae debacle caught him by surprise, and he still hasn't triggered the Federal Deposit Insurance Corporation Improvement Act to prepare for the inevitable bank failures. With more IndyMacs on the way, this is the kind of advance financial plumbing that would help restore confidence.

* * *

For all of this blundering, the miracle is that the U.S. economy has so far avoided a recession. Housing prices will find a bottom eventually – all the faster if Congress doesn't pass its current housing bailout. Parts of the economy are showing remarkable strength, as Intel's earnings showed this week.

The main problem is political, and intellectual. Washington has spent the last year running from the stable dollar and pro-growth tax policies that have marked most of the past 25 years. In its waning days, the Bush Administration has lost its will and bent to Congress's agenda while staying silent as the Fed has encouraged a damaging inflation.

There's an opportunity here for John McCain, if he has the wit to seize it. He could describe how Washington has lost its Reaganite moorings on the dollar, taxes, spending, and the corporate socialism of Fannie Mae. He still may not win the election. But educating voters about this collective Washington failure, and then separating himself from it by pointing in a new direction, may be his only chance.

http://online.wsj.com/article/SB121625138777760125.html

[AnaAndDaniel 0]

so, what do we invest in? pesos? rupees? yens? euros? or maybe buy dollars since they are cheap!

you know things are gonna be better whoever replaces the current prez.

Daniel

[w¡n9Nµ7 §£@¥€r 123]

Whoever the next President is will have to deal with the current crisis and the fallout from all the failed attempts to deal with it. McCain is a self-admitted economic illiterate and Obama (let's be honest) is too much of an economic populist to make the hard decisions necessary.

[AnaAndDaniel 0]

Whoever the next President is will have to deal with the current crisis and the fallout from all the failed attempts to deal with it. McCain is a self-admitted economic illiterate and Obama (let's be honest) is too much of an economic populist to make the hard decisions necessary.

yeah, maybe so, but the rest of the worls will love us again and restart investing in USA Inc again.

Daniel

[Ban Hammer 13,352]

so, what do we invest in? pesos? rupees? yens? euros? or maybe buy dollars since they are cheap!

Daniel

sounds like a good plan. send me a $1.10 to invest in dollars now!

[DairyFarmer 1]

Whoever the next President is will have to deal with the current crisis and the fallout from all the failed attempts to deal with it.

Doesn't that happen every time? Where ever you are from the next political climate has to deal with the screw ups of the past. Whilst taking credit for success' which they had nought to do with but trickled into their political "reign".

Edited July 17, 2008 by DairyFarmer

[w¡n9Nµ7 §£@¥€r 123]

Whoever the next President is will have to deal with the current crisis and the fallout from all the failed attempts to deal with it.

Doesn't that happen every time? Where ever you are from the next political climate has to deal with the screw ups of the past. Whilst taking credit for success' which they had nought to do with but trickled into their political "reign".

Yes, it does.

The economy doesn't turn magically toggle every four years.

[w¡n9Nµ7 §£@¥€r 123]

Sovereign funds cut exposure to weak US dollar

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One big sovereign fund in the Gulf has cut its dollar-denominated holdings from more than 80 per cent a year ago to less than 60 per cent, while China's State Administration of Foreign Exchange (SAFE) has been looking to strike deals with private equity firms in Europe as a part of a strategy to reduce its dollar holdings.

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Continuing market turbulence has ... shaken their faith in US policy and policymakers.

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Behind the scenes, fund officials are questioning the credibility of the Federal Reserve and US Treasury in defending the dollar and maintaining financial stability.