The belief that Fed hikes strengthen the dollar is outdated and Keynesian (a bad word in economic circles). Supply siders such as John Tamny have been saying this for a while, and while many understand the Laffer Curve as it pertains to tax revenue, they miss when it comes to Fed policy. Here is one excerpt:
The dollar lost 67 percent versus gold between 1972 and 1975, despite the fact that the Fed hiked rates from 3.5 percent to 13 percent in that period. When the Fed reversed course in 1975, lowering its rate target from 13 to 4.75 percent, gold actually fell 23 percent. When the Fed raised the funds rate all the way to 14 percent in 1980, rather than strengthen, the dollar fell, driving the price of gold from $150 an ounce to an all-time-high of $892.
Just as tax increases don?t always yield commensurate revenue increases due to a downward shift in economic activity, interest-rate hikes frequently fail to enhance dollar demand. In historical terms, rate increases have rarely constituted ?tightening? when it comes to restoring the greenback?s value.
A case in point came at the tail end of Alan Greenspan?s tenure as Fed chairman. Greenspan is frequently blamed for keeping the fed funds rate too low for too long, in such a way that the dollar lost value. But the dollar price of an ounce of gold tells an entirely different story. Gold hovered in the high $300s while Greenspan held the fed funds rate at 1 percent between July of 2003 and June of 2004.Gold only began to rise once the Fed began raising rates that June. After 425 basis points of rate increases, gold has risen nearly 70 percent.
Targeting higher interest rates to combat inflation is very much a Keynesian concept whereby central banks seek to reduce economic activity as well as prices. Contrary to current Fed objectives, the surest way to decrease dollar demand and ultimately cause a net excess of dollar liquidity that would spark new inflationary pressures would be to target the economy for slower growth with higher interest rates.
