The risk of dollar devaluation: why team Bush can't devalue its way to a stronger economy.

• Author: Hale, David

The U.S. Treasury scored a minor coup for its exchange rate policy recently. Cuba announced that it will revalue its currency against the dollar by 8 percent. The Treasury did not claim credit for the Cuban decision but it could point to Cuba's decision as a justification for other developing countries to let their currencies appreciate against the dollar.

The Treasury began to encourage dollar depreciation when the Bush Administration became concerned about the loss of three million manufacturing jobs. The Administration wanted to demonstrate that it was promoting manufacturing competitiveness and employment with a soft-dollar policy. Political advisor Karl Rove was very focused on holding the electoral votes of swing industrial states such as Ohio through a mixture of explicit protection--in particular steel tariffs--and dollar depreciation.

The Rove strategy appears to have worked. The president held the electoral votes of Ohio by a slender margin while enhancing his margin in West Virginia and losing Pennsylvania by a very narrow vote. What the Republicans have so far failed to appreciate is how they won elsewhere in the country. The decisive factor which drove the president's reelection was house prices. George Bush has presided over more housing inflation than any president in the twentieth century. During his first four years as president, real house prices rose by 36 percent and produced a $5 trillion capital gain for the American people. The previous record was a 25 percent real house price gain during the second term of Ronald Reagan. The poorest house price record was the term of the first President Bush, when real house prices were flat.

House prices have continued to increase since the election while there are increasing signs of a speculative frenzy in the market. House prices have increased by more than 30 percent in many regional markets during the past year. Realtors report that investors now account for about 23 percent of all home purchases, or a level double what it was five years ago. In Miami, the number is 66 percent. There has been a sharp increase in both variable-rate loans and mortgages without any principal payments for several years. According to the Joint Center for Housing Studies, mortgage payments now consume nearly 20 percent of personal income while one in three households are devoting a third of their income to mortgage payments. The ratio of rents to house prices has risen to a level one-third higher...