Credits in the U.S. balance of payments give rise to a demand for dollars. Debits reflect the supply of dollars. Together, they determined the exchange rate for the dollar. So far, so good. Everybody knows that.

Then why is it that virtually all the commentary on the dollar on financial TV and in blogs fails to mention the balance of payments when discussing the dollar? The dollar is considered super-important these days while the balance of payments isn’t considered important enough to mention. That’s like saying the price is important, but supply and demand don’t matter.

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(Not All Details are Bad)

The front page of today’s Wall Street Journal features a useful breakdown of the third quarter real GDP statistics. On the negative side, it shows that the strength in consumption spending benefited from various temporary government programs: primarily cash for clunkers and the first time home buyers’ credit. Those will eventually go away.

Showing imports as well as exports is almost a breakthrough since commentators typically focus only on exports as a positive to GDP growth. The chart showed exports as contributing 1.5 percentage points of the total increase of 3.5 percentage points. Fair enough. But it also showed imports subtracting 2.0 percentage points, making net exports (exports minus imports) a net drag of 0.5 percentage points.

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I’ve been reading Amity Shlaes’ wonderful book, The Forgotten Man, A New History of the Great Depression, with an eye out for parallels and lessons for our current crisis. You will find some of those and much, much more.

Amity showed great restraint in writing her book. A scholar with her expertise could have driven the ideological lessons home and saved those of us on a practical mission some time. Instead, she patiently let the characters and the circumstances speak for themselves letting the nuance show through for us to savor.

While I wasn’t totally clueless about the depression, not having lived through it, you see, I must admit that my knowledge of many of the details was limited.

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Much hand-wringing is taking place over the reduction or possible loss of the dollar’s reserve currency status. That’s a bit ironic since the whole concept of a reserve currency is no longer valid in a system of floating exchange rates.

Under the dollar-exchange system established at Bretton Woods, New Hampshire after World War II, countries committed to keep their own currencies in a narrow band around a par value expressed in U.S. dollars. No reserves were needed to offset upward pressure on the domestic currency since the monetary authority could sell their own currencies for dollars in theoretically unlimited amounts. But to offset downward pressure on the domestic currency, a reserve currency was needed to purchase and support the domestic currency. A country’s ability to defend its currency from downward pressure was thus limited by the amount of the currency held in reserve. Since the parity was expressed in dollars, it was convenient to use dollars as the reserve currency.

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Following on from my previous post, the dollar can be boosted in very indirect ways. Given the zero-sum relationship between the nets of domestic investment and domestic saving, government spending and taxes, and exports and imports, an imbalance in the first two categories will require a balancing change in the third category, which is the current account balance. While many factors influence that balance, the exchange value of the dollar is one of the principal ones.

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We continue to discuss the topics above as separate issues, without acknowledging their interdependence. They are mutually determined as in the solving of simultaneous equations. For example, our budget deficit indirectly, and our current account deficit more directly, affect the dollar exchange rate and the size of our trade deficit (and capital inflow). With China’s trade surplus being the main counterpart to our deficit, its inflow of dollars to China depends more on the size of that imbalance than their desire for dollars over other currencies.

Our national saving—made up of personal, business and government saving—is being supplemented by the foreign capital inflow that finances our current account deficit and helps support domestic investment. The floating dollar adjusts to help maintain the necessary relationships.

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Promote Growth:

Visit: www.FairTax.org

My title is taken from the following quote from Monday’s (10-12-09) Dallas Morning News:

“The financial services sector has enjoyed a fine summer rally, but I just can’t get too excited about a bunch of financial stocks leading the market higher.

I mean, we are talking about banks, for heaven’s sake. These are the same charlatans and ne’er-do-wells who got us into this mess in the first place.” (Emphasis added)

Where to start?

First, let me simply say that, in my 36-year career with the Fed, I met many, many bankers. I don’t recall any that would fall into the category of charlatans and ne’er-do-wells. Not any.

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Nonfarm payroll employment declined by another 263,000 jobs in September. According the the Labor Department release, over the recent period . . .

“From May through September, job losses averaged 307,000 per month, compared with losses averaging 645,000 per month from November 2008 to April. Since the start of the recession in December 2007, payroll employment has fallen by 7.2 million.”

As usual, most of the TV commentators gave the impression to their viewers that there was no job creation in September and that there were 263,000 job losses. A typical question was “When are we going to see job creation again?”

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You can see my CNBC profile and view additional interviews here.

Financial TV is full of talk about Governor Warsh’s opinion piece in Friday’s Wall Street Journal. One theory is that it was a shot across Chairman Bernanke’s bow. I doubt it, but even if it was in some limited sense, my experience on the FOMC for almost 14 years suggests to me that the following probably happened. Governor Warsh wrote the piece, then showed it to Chairman Bernanke and asked if he was okay with submitting it to the WSJ. Whatever the Chairman really thought down deep, he probably said “That’s okay with me. Go ahead.” This, of course, is only a guess, but an educated guess.

The timing was odd, however, and awkward, for the Governor since it was so soon after an FOMC meeting in which he didn’t dissent. It looks like he’s trying to have it both ways. Of course, it’s always possible that he and the Chairman together are trying to have it both ways.

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“You can’t spend your way out of recession” is a sound bite heard almost every day on financial TV. Recently a guest commentator combined that sound bite with this one: “You can’t borrow your way out of debt.” Perhaps the second one was intended to divert our attention from the first one. Clever. Perhaps too clever by half.

Of course you can spend your way out of recession, almost by definition. A recession can be defined as a shrinkage of spending and income. More spending is needed to generate more income. Therefore, more spending will do the job.

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I try to keep up, but occasionally it dawns on me that I’ve been missing something. The latest example is the importance being placed on G-20 meetings. I wake up to find that there is to be a debate in Pittsburg on such matters as how much the respective governments should restrict banker pay packages. Apparently, we plan to crack down, but not as much as most others. There will be a debate.

What’s going on here? It’s not just that the debate will be over different degrees of government intervention into areas of business not normally under government jurisdiction. More scary is the idea that we might be morally bound, or even influenced, in such matters by the other 19. I didn’t get to vote for those guys. How did they get a vote on my banker’s pay?

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(Old Bones for the Week-end)

When I was president of the Dallas Fed (1991-2004), I frequently spoke to the graduates of our rank-and-file training programs. I just ran across the following summary outline someone made of my remarks on such an occasion in February 2002. Maybe you can use my suggestions on your kiddos. Commenters may want to add their own favorites to the list.

1. Plan your life on paper. Where would you like to be in your career in 5 years?  10 years?

2. Do a time line.

3. Write out your goals, objectives and ambitions. Be very specific and detailed.

4. Translate your goals into activities and schedule those activities on your calendar. Write your to-do lists with your goals in mind.

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Why can’t we learn even the most obvious lessons from the Great Depression? Many policy mistakes were made then, but perhaps the biggest and most destructive was the Smoot-Hawley tariff that contributed to a world-wide trade war and the reinforcement of the depression’s downward spiral. We’ve already dissed our Mexican neighbors by abrogating the trucking provisions of NAFTA. Do we really want to have a tire war with China to pander to domestic unions? The Chrysler bond holders would probably have an opinion on that.

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Written on the bathroom wall at a Libertarian convention in France in July 2001:  “Defy Authority!”

 Next day below that:  “Who are you to tell me what to do?” 

The Tobin Tax came up on financial TV the other day. It brought back memories.

I gave the keynote address at a conference in Dax, France  in 2001, celebrating the 200th anniversary of the birth of Frederic Bastiat, most easily described as the French Adam Smith. The conference was by Le Cercle Frederic Bastiat and was sponsored by the International Society for Individual Liberty and Libertarian International. I titled my remarks, Why Bastiat is My Hero.

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(A More Realistic Look)

This is the year that the whole world apparently discovered the importance of the Fed's Balance Sheet. Unfortunately, their discovery was made when it suddenly doubled in the context of a severe financial panic. This is awful! Right? We've got to get it back down to size! Right?

The suddenness of these revelations prevented useful perspective on why the balance sheet is important and why the composition of the balance sheet is just as important as the size. Money and banking text books for decades have discussed the Fed's balance sheet in the context of bank reserves and the Fed has for decades provided a statistical release on "Factors Affecting Reserves."

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(And They Called Supply-Side Voodoo)

The only really sensible investment advice I know of came from Will Rogers, who is alleged to have said:

"You buy your stock.
When it goes up, sell it.
If it don't go up, don't buy it."

Advice I just don't get includes the following:

People are very optimistic; so stocks will decline.

People are pessimistic; it's a good buying opportunity.

Stocks go down in September and October.

You can't beat the market; it's all priced in.

You've got to do your homework.

Go with the momentum.

The Dow is 5½ points below Fair Value.

Sell in May and go away.

Cash is king; stay liquid.

If you're out of the market a few days, you can miss the run-up.

The trend is your friend.

It's a random walk.

(The Glass is Half Full; not Half Empty)

The good news that employment declined less in August than in previous months is more important than the bad news of the rise in the unemployment rate. As I've noted here previously, the unemployment rate (from the household survey) had not kept up with employment losses and a convergence was over due. It should not be considered new bad news. The unemployment rate will rise further, even if employment losses continue to decline. One reason is that discouraged workers will come into the labor force as their perceived prospects improve. Keep your eye on employment rather than unemployment as a measure of how the economy is doing.

When I was in graduate school in the olden days (1960s), Professor Waller hired me as his grader in his money and banking and monetary policy classes. At first, he limited my chores to multiple-choice and true-false questions, but he gradually trusted me with essay questions-following his strict guidelines of course.

"Are budget deficits inflationary?" was one of his favorite questions on final exams, and he had a precise idea of the components of an "A" answer. Using T-Accounts (Remember the Chicago Fed's Modern Money Mechanics booklet?), the students were supposed to show the alternate ways of financing government spending, including deficits. The answer to the question, you see, depended almost entirely on the method of financing. Another way of saying that is that the impact of fiscal policy depended almost entirely on the accompanying monetary policy.

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