When it comes to U.S. dollar policy, judge Treasury Secretary Janet Yellen not by her words but by her deeds.
While with words she is intimating that she would like to have a weak dollar to help U.S. exporters gain an international competitive edge, with her deeds she is almost guaranteeing that the U.S. will have a strong dollar during her tenure. She is doing so by fully embracing President Biden’s excessively expansionary budget policy.
The clearest indication that Yellen would like a weaker dollar can be found in her recent Senate confirmation hearings. When asked for her views on the dollar, Yellen departed from a long tradition of former Treasury secretaries by refraining to stick to the oft-repeated mantra that, “a strong dollar is in the United States’ interest.” Instead, she replied that under a Biden administration the dollar’s value would be determined by foreign exchange markets and that the United States would oppose attempts by other countries to weaken their currencies.
As a former highly distinguished economics professor, Yellen must know that in today’s world of open capital accounts and floating exchange rates, the dollar’s value is largely determined by the capital flows across our border. Those flows in turn are determined by the relative attractiveness of our interest rates. If our interest rates rise relative to those of our competitors, money will flow into the United States in search of higher returns and the dollar will strengthen. Conversely, if our interest rates were to decline, money would flow out of the country and the dollar would depreciate.
Knowing that interest rates are a primary driver of exchange rates, it is difficult to understand how Yellen is not seeing the contradiction between the $1.9 trillion Biden budget stimulus package that she is supporting and the weak dollar that she seemingly would like to have. This is particularly the case considering the very scale of that package. Coming on top of the $900 billion bipartisan budget stimulus in December, over the next 12 months the Biden stimulus will ensure that the U.S. economy will be getting budget stimulus of some 14 percent of the size of the U.S. economy. Such stimulus would be more than three times the size of the 2009 Obama fiscal stimulus.
Former Treasury Secretary Larry Summers is correctly warning that a budget package on the scale of that now being proposed by the Biden administration runs the very real risk of leading to an overheated U.S. economy. That would almost surely cause the Federal Reserve to raise interest rates in an effort to keep inflation contained. In turn, a rise in our interest rates would likely lead to a strong U.S. dollar. This would especially seem to be the case at a time when our main competitors have low interest rates and are not engaging in anything like the budget stimulus policies we are pursuing.
Yellen must also know that in times of world financial market trouble, money flows into the United States in search of the safe haven for their investments that our very deep capital market provides. Yet she does not seem to be appreciating that by forcing U.S. interest rates higher, her overly expansive budget policy could usher in a period of global financial market instability. It could do so by triggering the bursting of today’s everywhere-global-equity-and-credit-market bubble, which is premised on the mistaken assumption that low U.S. interest rates will last forever.
During his administration, former President Trump failed to deliver on his campaign promise of eliminating the U.S. external current account deficit. He failed on this score by engaging in a large unfunded tax cut that caused the U.S. budget deficit to rise and the country’s saving level to fall. Yellen now looks like she is on her way to making a similar mistake. By pursuing a budget policy that will force U.S. interest rates higher, she is very unlikely to deliver us the weaker U.S. dollar that she seems to desire.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.