Dollar Strength Will Pose Unforeseen Risks

In markets, when you know what everyone else knows, you know nothing.

And, at present, the consensus is the dollar will continue to weaken, and somehow this will create a problem for us in the indeterminate future. If we reverse this platitude, we should arrive at the opposite conclusion, that a strengthening dollar will benefit the U.S. economy and financial markets.

Unsurprisingly, I beg to differ with this conventional wisdom. The biggest risk to the U.S. financial system will, incredibly, derive from what will seem like a normal and welcome firming of the dollar in response to the Federal Reserve acceding to the inevitable by raising the federal funds rate on May 4.

First, I wish to make it clear -- absolutely clear -- that I am not an advocate of a weaker dollar per se, nor am I falling back on the Reagan-era policy dubbed "benign neglect." I noted as far back as January 2001 that much of the stimulative effect of Federal Reserve rate cuts would derive from a weaker dollar. I began writing in May 2002 that the stock market would not be hurt by a weaker dollar. As a result, I fear being pigeonholed as a permanent advocate of a weak dollar. Perma-bulls and perma-bears are perma-useless.

Nothing could be further from the truth; I have observed on numerous occasions that no country has ever devalued its way to prosperity and that a weaker dollar reduces the global purchasing power of Americans. A deliberate weakening of the dollar -- one not the residual of defensible domestic fiscal and monetary policies -- can wreak havoc on the allocation of resources within the economy.

One result of deliberate undervaluation of any currency is visible in the mercantilist imbalances of the East Asian exporters. The deal can be summed up as follows: We get the cheap goods and they get our bonds. Over the long term, the quality-of-life gap continues to expand between the U.S. and these countries. Have you ever heard a traveler return from Japan and say, "Gee, I'd sure love to live there?"