THOUGHT LEADERS CAPITAL FLOWS The Weal< Dollar Caused the Great Recession Erespons explanatio si tionshi ver s began y crisi pebetwee a .sThi nnha implici osfswh ii nnsit th th ysth teofficia officia eGrea rela e cri--ltl Recession and the Dodd-Frank law of summer 2010, which carpeted the financial industry with regulations. Dodd-Frank has allowed its advocates in Washington to presume that a lack of regulation caused the panic of 2008. Treasury Secretary Timothy Geithner wrote recently, as he cited the law, "The failure to modernize the financial oversight system sooner is the most important reason why this crisis was more severe than any since the Great Depression, and why it was so hard to put out the fires of the crisis." Yet it is questionable to identify in a response to something an explanation of its cause. Clearing away all the background noise of how the crisis was responded to from 2008 to 2010—setting aside TARP, Dodd-Frank, quantitative easing, stimulus spending, budget deficits—let us ask: What caused the crisis? The most obvious problem with the economy during its mud boom fi-om 2003 to 2007 was sectoral. There was way too much investment in things like housing, energy and commodities. Here are the statistics. The CaseShiller housing index blew past its usual secular peak of a 15% increase and went up by 90%. Oil did more, retracing the upward march to $34 a barrel it had made in 2000, this dme not stopping until it crashed through $100. And gold, which had been parked at about $300 an ounce for two decades, kept lifting its head up after BY BRIAN DOMITROVtC 2003 such that it was brushing $1,000 by crisis time. Otherwise nothing too unusual was going on in the economy in the "Bush boom" years. Unemployment and inñation were low, GDP growth was mud but respectable, budget deficits were within reason. Given this lay of the land, you want to ask one question. Why the mad dash on the part of capital for housing, energy and commodities? Traditionally, activity of this sort will mean one thing: People aren't trusting the dollar. Housing (which is to say land), energy and commodities are all classic hedges against superfluous dollar production. Since these investment categories are limited in supply by geology, they cannot match any unnecessary dollar production with corresponding increases in their own supply; the only thing they can do correspondingly is to increase in price. So there is highly suggestive evidence of a run on the doUar on account of fears of its devaluation, in spades from 2003 to 2008. Were any of these fears justified? HOUSING. ENERGY AND COMMODITIES ARE ALL CLASSIC HEDGES AGAINST SUPERFLUOUS DOLLAR PRODUCTION Again, the numbers. After falling by a typical 10% against major currencies from 2002 to 2003, the dollar bounded all the way down by 35% against these currencies by 2008. As for easy money, the Federal Reserve kept the federal funds rate mightuy low through the 2001-02 sluggishness, at a bit over 1%. Then it lowered that rate into the recovery of 2003, so that it was as much as three percentage points below what conventional models, such as the Taylor Rule, said it should be. This status quo was maintained until 2007. A relationship becomes clear. Cause: comprehensive devaluing of the dollar on the part of its masters in the government. Effect: major investment shifting into hard assets corresponding to fear for the dollar's soundness. In this light, the exposure in 2008 of the financial sector to currency-hedge instrtiments, especially to those in land, is clearly but a symptom of the root cause. As the fiight from the dollar proceededfi-om2003 to 2008, the financial sector was prevailed upon to provide products and insurance commensurate with the major development This it did. To mistake credit-default swaps, subprime mortgages, easy loan approvals and all the rest with the fundaments of the crisis is to fail to ask why markets for these things suddenly materialized out of nowhere from 2003 to 2008. Since they in fact came in the face of major dollar devaluation, the real story cannot be thefinancialsector's accommodation of the new dollar weakness, but rather the fact and origins ofthat weakness itself. As our great economy stOl only pokes along in this election year, it is time to get serious and admit that the major economic arms of the federal government, the Federal Reserve and the Treasury, mismanaged the currency, and concede that because of it the nation had to endure not only the mildness of the 2003-07 boom but the brutal Great Recession as well. ® 32 I FORBES MAY7.2OL2 BRIAN DOMITROVIC IS A PROFESSOR OF ECONOMIC HISTORY AT SAM HOUSTON STATE U. AND THE AUTHOR OF ECONOCLASTS: THE REBELS WHO SPARKED THE SUPPLY SIDE REVOLUTION AND RESTORED AMERICAN PROSPERITY.Copyright of Forbes is the property of Forbes Inc. and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use.