10.01.2008 0

Dollar Diplomacy

  • On: 10/22/2008 12:09:47
  • In: Monetary Policy
  • ALG Editor’s Note: As ALG News has repeatedly reported to you, a weak dollar has awful economic consequences to the American people, but as the following featured column by Steve Forbes notes, it also has bad foreign policy implications as well:

    Dollar Diplomacy

    Steve Forbes 08.21.08, 6:00 PM ET
    Forbes Magazine dated September 15, 2008

    President Bush can start to reverse the U.S.’ and the west’s Carteresque response to Russia’s subjugation of Georgia by strengthening the U.S. dollar. In 2004 the weak dollar triggered a global commodities boom–just as it did in the 1970s. Major commodity-producing countries such as Russia have since received revenue windfalls of hundreds of billions of dollars. The higher the price of oil, the more assertive Moscow has become in its foreign policy.

    In 1981 Ronald Reagan fearlessly attacked a rise in inflation far worse than the current one. He succeeded. The dollar was strengthened, and interest rates came tumbling down. Then sky-high oil prices tumbled, from almost $40 a barrel to $10 by the mid-1980s. That precipitous fall in oil was a critical–and utterly unappreciated–factor in the Soviet Union’s collapse. Mikhail Gorbachev ascended to power with the vigorous support of hard-liners. Starved for hard currency, he turned to such liberalizations as glasnost and perestroika out of desperation, not principle.

    Strengthening the dollar with Reaganesque determination would send oil to the $40–to–$50-per-barrel range. At the same time the U.S. and its allies could start putting restrictions on Russian/oligarch-held bank accounts in Europe and here.

    Mark to Nonsense

    Another culprit in the continuing currency crisis, in addition to the weak dollar, is a seemingly arcane accounting principle called mark to market (MTM). The concept was formalized last November by the Financial Accounting Standards Board and mandates that most financial assets held by financial institutions be repriced constantly to reflect the value of those particular assets in the marketplace.

    The concept makes perfect sense for liquid securities, such as Treasurys and most publicly traded equities. The problem arises in new kinds of securities for which there is no established liquid market. Active trading in most of the packages of subprime mortgages and other exotic instruments is almost nonexistent, yet the accounting profession dictates that an institution must value a security at whatever price it would fetch if it were suddenly dumped on the market. If there is no market, then the bank or insurance company must slash the value of the security, possibly all the way to zero. Even if subprime mortgages are current–that is, payments of principal and interest are being made–the holding institution must whack the book value of those securities. Many of the big writedowns from banks and insurance companies aren’t derived from actual losses but from sheer guesses or evaluations based on arbitrary computer models.

    When rigidly applied to nonmarketable securities, MTM–or what critics call “mark to make-believe”–exacerbates credit cycles. It feeds a down cycle and gooses an up cycle. When times were good, such as the 2004–06 period, the markups encouraged more dicey lending–the fees were good, the book profits were great (MTM here meant markups) and bankers reaped outsize bonuses.

    Accountants and regulators should apply some common sense to hard-to-value assets. For an asset intended to be held to maturity, there ought not be any writeups or writedowns except under extraordinary circumstances, such as if a class of assets were clearly deteriorating. Neither losses nor gains should be booked until they’re actually realized. There certainly shouldn’t be the wholesale writeoffs we are now experiencing.

    Of course, current problems with the MTM concept shouldn’t stand in the way of rules for more transparency, for barring banks and insurers from putting exotic financial assets off their balance sheets. Regulators and financiers should create standards for these kinds of securities so that we have helpful, market-friendly standardization. But in the meantime the SEC, which oversees the accounting profession, should mandate temporary time-outs on these mark-to-market insanities.

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