"I think the dollar is now under question and I think the system will need to be reformed, so that the United States will be subject to the same discipline as is imposed on other countries," said Soros, whose famous bet against the British pound earned his Quantum Fund $1 billion in 1992.
"Being the main issuer of international currency, we have been exempt and we have abused that because we have effectively consumed 6.5 percent more than we have produced. That is now coming to an end."
Soros said there was a risk of a "tipping point" for the dollar which would see it slump, triggering higher interest rates and choking growth.
"This leads you to what used to be stagflation -- stop, go. And I think that is what's probably in store, rather than... hyperinflation. . . .
. . . . U.S. consumer spending has to fall to 60 percent of gross domestic product, compared two-thirds now, he continued."
Here is a man who knows how to talk his book -- he wants a strong dollar and reduced consumption. If a strong dollar reduced consumption the Chinese and other Asian exporters wouldn't have been propping up the dollar against their currencies despite a growing trade surplus. They wanted their export driven economies to continue to boom. To think they were lending us the capital out of largesse is wrong. If U.S. consumption did drop to 60% of GDP, as he suggests it should, and investment spending failed to pick up the slack that would be one heck of a downward adjustment to overall activity in the U.S. and globally.
For the dollar to have stayed strong in light of a growing trade deficit meant either the Fed had to raise interest rates or our trading partners, those with whom the U.S. has a big trade deficit, were willing to hoard dollars. Dollar hoarding won the day and the U.S. lost because the Fed, blinded by low inflation, kept interest rates too low. That meant credit was priced too cheap and that distorts activity just the same as high inflation expectations. That is what we got and that is why we are in the mess we are in. It was the Fed's misread of the economy, not financial sector abuses, that allowed those inflows of foreign capital hunting for yield to keep growing.
Mr. Soros knows that one of many steps to get the U.S. out of this mess is for the dollar to depreciate. We should really think of it as no longer allowing our trading partners to keep their currencies too cheap. Letting the dollar depreciate will also steepen the curve and give some real profit out of having zero carry. A dollar adjustment is not the cure all but it is a step in the right direction and even the Fed recognizes (see earlier post) that letting the dollar fall is far from the end of the world for this economy.
In truth, I am no longer sure what our policy is given all the zigs and zags since the summer of 2007. FASB has been bullied to change its rules so banks can again mark assets to their models but at the same time PPIP lets PIMCO and others bid for these assets with government leverage and a government guarantee against loss. If you are the bank, why sell them now that they are marked at 90 instead 40 -- I would imagine they would be buying instead. Or, more to the point, swapping their own legacy assets for others thereby picking up the free leverage and the guarantee against loss. I am not sure that this is what the Fed and the Treasury had in mind.
It is tough getting somewhere if you don't know where you are going. First one road looks good, then another, and before you know it you are in the same place where you started but out of gas. Policy is either going to manage the deleveraging of the U.S. economy through a lower dollar and higher real rates or it is going to try to restore the leverage by replacing private credit with public credit. Geithner said on "Meet the Press" a few weeks ago that a more sober economy will emerge while also saying that lower mortgage rates now give homeowners the opportunity to refinance and spend -- and they should do just that.
If in the end all we get is a public/private debt swap with a strong dollar policy aided and abetted by the nations where the U.S. has its biggest trade deficit then we are only delaying the inevitable adjustment.