Pentonomics – Monopoly Money and Manufacturing

May 18, 2011 at 10:09 PM

For an investor to prosper, it is imperative to understand the mindset of those relatively few individuals in government who control the direction of the economy and the markets. One such person is C. Fred Bergsten. This gentleman has many titles; He is a Senior Fellow for the Council of Foreign Affairs, Director of the Peterson Institute for International Economics and, most importantly, a member of the President’s Advisory Committee on Trade Policy.

Mr. Bergsten declared on a CNBC interview last week that the decline of the U.S. dollar “is an unambiguously good thing for the United States.” The so called evidence presented for making that assertion was is his claim that the dollar lost 25% of its value during 2002-2007, which cut the trade deficit in half from 2006-2009. Watching C. Fred espouse the benefits of a falling dollar was a perfect lesson on how to data mine the facts in order to present a spurious conclusion for the sole purpose of supporting a political agenda.

He went on to state quite emphatically that; “every 1% decline of the dollar strengthens our trade balance $20-$25 billion per year, once the lags of two or three years play through”. He continued, “That means if the dollar goes down even a modest 10%, we get a quarter of a trillion dollars of greater economic growth. That translates into something like a quarter of a million to a half a million jobs. So, it’s unambiguously good for the U.S. economy and that’s what we need at this point in time to get a sustained and strong recovery.”

You can watch the whole train wreck here.

Of course, the CEO of Caterpillar Doug Oberhelman, who was part of the interview, was quick to agree. Since Caterpillar is a large multi-national corporation, it earns a good deal of its revenue from foreign sources. Therefore, it makes his company’s foreign earnings look much better once they are repatriated back into U.S. dollars.

But Mr. Bergsten’s facts are just as wrong as his conclusions. First off, the U.S. dollar lost about 35% of its value on the Dollar Index (DXY) from the start of 2002 thru the end of 2007; not the 25% he claims. During that six year time frame, the U.S. deficit in services and goods soared from $420.52 billion to $702.09 billion, according to the Census Bureau.

He then cleverly claims that the deficit was cut in half from 2006-2009. That much is true. However, he selectively chose 2006 as his starting point because it was the high water mark of $759.24 billion worth of red ink.  But he doesn’t offer any explanation as to why the trade deficit soared 80% during that five year period from 2002 thru 2006. Instead, he falsely credits the falling dollar, instead of The Great Recession, for lowering the trade deficit. In fact, his deception is so nefarious that he conveniently forgets to mention the tremendous U.S. dollar rally, which took the currency from the low 70’s in 2007, to 89 in 2009, during that time frame.

The real reason why the U.S. trade deficit fell was because of the greenback’s rebound. It was not due to a decline in its purchasing power. The rising dollar caused the price of imports to fall—especially oil, which fell from $147 a barrel in the summer of 2008 to the low 30’s in early 2009. So we bought less oil because of the recession–and at much lower price.

Another one of Mr. Bergsten’s contentions is that a falling dollar helps create manufacturing jobs. Remember, he claims that a 10% drop in the value of the dollar would create a quarter to a half million jobs. Since the dollar dropped 35% on the DXY between 2002-2007, we should have seen at least a million manufacturing jobs created during that time frame. After all, C. Fred acknowledges that 80% of all trade is manufacturing. So where are the jobs? From the start of 2002 thru the end of 2007, the U.S. actually lost 1.7 million manufacturing jobs! And during his so called “pay-off period” of a falling dollar between 2006-2009, the economy lost 2.7 million manufacturing jobs!

What Mr. Bergsten and the current administration fail to understand is that our inflationary policies have not kept the dollar price of our domestically produced goods static. The value of goods and services produced in the U.S. has increased in conjunction with the decreased purchasing power of the currency. The result is that those foreign importers who have allowed their currency to appreciate vis a vis the dollar have become immune from our inflation and can purchase roughly the same amount of goods using the same amount of their currency.

But if the rate of dollar destruction continues, the U.S. will discourage most investment while sending prices for both domestic and foreign purchases out of reach for the average American consumer. The resulting inflation will eventually destroy the domestic manufacturing base because the purchasing power of the middle class will be greatly diminished–rising prices cause the elimination of discretionary purchases, causing massive job losses and plummeting output.

Turning the U.S. dollar into Monopoly money doesn’t engender a manufacturing renaissance. But a dramatic decrease in the purchasing power of a currency ruins the economy as it creates inflation and destroys all incentives to save. Ironically, during the same interview Bergsten acknowledged the need for Americans to save more, yet by punishing savers with a weaker dollar, his policy prescription would produce the opposite effect. Therefore, C. Fed Bergsten and the administration need to understand that a falling dollar doesn’t balance trade, but rather is a job and economy killer.