A Monetary Turning Point?

Behind the turmoil afflicting global currency and financial markets in recent months and the dollar's travails in Europe and Asia, economist John H. Makin of the American Enterprise Institute discerns an intriguing pattern. "I think we are witnessing a major shift in U.S. economic policy vis-a-vis Europe and Asia," he says, "the emergence of a monetary Monroe Doctrine--a hemispheric dollar standard."

This policy shift, claims Makin, is implicit in the stance of the Federal Reserve. Resisting pressures to prop up the plunging dollar against the yen and the mark, the Fed has instead emphasized the trade-weighted dollar's stability over the past year. And surprisingly, the stock and bond markets have responded by mounting rallies in spite of the dollar's weakness against major currencies.

The irony is that the dollar's overall stability comes from its strength against the shaky Canadian dollar, the fallen Mexican peso, and other weak Latin currencies. In part, the recent U.S. equity- and bond-market rallies have been fueled by the huge volume of dollars rushing out of Latin America in search of a safe haven. Declining U.S. interest rates relative to rates in Europe and Japan, in turn, have fostered the flow of short-term cash out of dollars into yen and marks.

The other part of the picture is the resilience of the U.S. economy, which is entering its fifth year of expansion without excesses and obvious price pressures. By adopting a hemispheric standard for the dollar and deferring an interest-rate hike, says Makin, the U.S. is sending a clear message to Europe and Japan: It will neither imperil its major trading partners to the North and South nor jeopardize its own expansion to keep German and Japanese currencies from appreciating.

In short, the U.S. has confronted Germany and Japan with what amounts to a competitive dollar devaluation. And this strategy is already boosting the prospects of U.S. exporters to Europe and Japan while undermining the competitiveness of European and Japanese exports to America and other nations with currencies tied to the dollar.

Pushed too far, warns Makin, this "devaluation" could feed on itself, touching off a wholesale run on the dollar, with calamitous consequences for the world economy. But pushed just far enough, it could propel Germany and Japan to further loosen their highly restrictive monetary policies and convert their current hesitant recoveries into the full-fledged global expansion observers have long anticipated.

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