Does the United States need a new dollar policy?

Former Treasury Secretary Lawrence Summers seems to think so.  

The vast majority of the US current account deficit is now being funded by central banks accumulating reserves as they seek to avoid appreciation of their home currencies. While the US dollar is usually viewed as a floating rate currency, substantial and critical parts of the world economy operate with currencies pegged to dollar parities or at least managed with them in mind.

This suggests the need for rethinking traditional approaches to dollar policy at a time when the global economy is more vulnerable than it has been since 1998.

The Clinton administration approach of asserting the desirability of a strong dollar based on strong fundamentals while allowing its value to be set on foreign exchange markets was highly successful in its time and has largely been followed by the Bush Treasury. But it is insufficient in the current world, where the dollar’s trade-weighted exchange rate is to an important extent managed abroad. Some means of engagement must be found with those who have yoked their currencies and so their financial policies to that of the US.

I -- rather obviously -- agree strongly with Dr. Summers' argument that the dollar doesn't really float right now, at least not against most of the rapidly growing emerging world.  I also share his sense that a new US administration like will also need to find a new approach to the dollar.  

Many have noted the very obvious gap between the United States rhetoric about a strong dollar and the dollar's current weakness against the euro.  But the policies internal contradiction -- as  a "dollar whose value is set in the foreign exchange market" won't necessarily be "a strong dollar" -- may be even more important.  

Right now, the global economy is adjusting to a US slowdown primarily through a rise in China's surplus and an increase in Chinese financing of the US, not through a fall in the US deficit.   US exports are growing at a nice clip, but they are not growing as fast as China's exports.  The fall in the US current account deficit in the past few quarters -- a fall likely to be offset by the rise in oil prices -- has been small relative to the rise in China's surplus. The world economy would be better off if a fall in the US deficit, not a rise in China's already large surplus, led to a fall in the combined Sinoamerican current account deficit.  

Summers hints that China may hesitate to allow the RMB to move too much now out of fear that the next US administration will want it to do even more.  Better to hold off and do a deal later.   

He may well be right. But if the dollar's current decline against the world's freely floating currencies continues (Right now, it takes about 1.44 dollars to buy a euro), it may not be in China's own interest to wait that long.  

And for that matter, it also may not be in the Gulf's interest to wait.   The Gulf's peg to the dollar would be rather strange in a world where OPEC no longer necessarily wants to price oil in dollars.

Then again, both China and the Gulf may still prefer importing US monetary policy -- and risking an asset bubble  -- to any change.   Read Stephen King.    The "dollar" block may not need a monetary easing imported from the US, but the effects of an imported easing at a time of strength are easier to bear than the effects of imported tightening at a time of weakness.