Weak Dollar Can't Be Exploited Much Longer As a Tool To Jump-Start U.S. Economy

President Barack Obama tried this week on his visit to China to persuade the Chinese to allow their currency, the yuan, to rise to reflect the true market. Critics have long contended that the Chinese have kept the value of the yuan against other currencies artificially low to fuel exports. But the president is standing on a shaky platform in critiquing other nations' monetary policies and the Chinese let him know it.

The Chinese had harsh words for the U.S. policy of pushing dollars into the market, causing the currency to decline dramatically in the name of fueling economic growth.

As economist David Littmann said, when "the Americans are pointing fingers at the Chinese, four fingers are pointing back at them." As of Tuesday, the value of the dollar against a basket of other currencies had declined 16 percent since March. The leading Chinese bank regulator blamed the weak dollar and low interest rates for causing a misallocation of capital around the globe.

As if on cue, Ben Bernanke, chairman of the U.S. Federal Reserve, the nation's central bank, said on Monday that Fed policies will "help keep the dollar strong." This caused a rally for the dollar, but Bernanke wasn't more specific about how the Fed would strengthen the dollar.

To be fair to Bernanke, the Fed has pushed dollars into the U.S. and world economies to increase liquidity and forestall a total collapse of the U.S. banking and credit systems.

This has been standard policy since the Fed tried the reverse approach 80 years ago and only exacerbated the Great Depression of the 1930s.

The weak dollar and low interest rates spur U.S. exports and benefit firms with a large portion of their sales overseas. The policy makes dollars readily available to banks and supposedly fuels lending and credit. With the dollar weak, stocks rise.

But there are costs to a weak dollar. Imported commodities such as oil are more expensive, and investments in dollar-denominated assets lose their value. The Chinese, as the largest holder of U.S. debt, are particularly worried about this and have been making noises about switching to investments in other currencies, such as the euro. They are already investing in commodities.

It's too early to panic about all this. Foreign investors, including the Chinese, increased their purchases of long-term U.S. financial instruments in September.

But for the long term, it is better for a nation to have a strong currency than a weak one. Littmann, a senior economist with the Mackinac Center, contends that the Fed should begin to gradually strengthen the dollar by selling notes and bills, which will push up interest rates. Doing this without worsening the recession will take a very precise sense of timing.

Fiscal policy also plays a key role. Large deficits have to be financed with borrowing, which will make it economically difficult to shore up the dollar. Spending control is an essential part of strengthening the dollar.

The Obama administration and Congress have a series of hard decisions to make. But the weak dollar can't be sustained as an economic stimulus tool.

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