Posted on 11/28/2004 4:30:08 AM PST by risk
America’s privilege, the world’s worry
Nov 10th 2004
From The Economist Global Agenda
The dollar plumbed new depths against the euro this week. The greenback’s fall has unnerved European policymakers. But it is their Asian counterparts who have most reason to worry
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CHARLES DE GAULLE, founder of France’s fifth republic, famously resented America’s paramount position in the global economy of the 1960s. The United States, he complained, enjoyed an “exorbitant privilege”. Because its currency, the dollar, served as the world’s reserve asset, America could live beyond its means, unconstrained by the periodic shortages of foreign exchange that haunted other, less privileged nations. Nicolas Sarkozy, France’s spirited finance minister, wants to inherit de Gaulle’s mantle as president of the fifth republic. Though somewhat smaller in stature than the great general, both physically and politically, Mr Sarkozy seems to share his outsized resentment of America’s economic privileges.
Mr Sarkozy has more to envy than de Gaulle ever had. Today’s America lives beyond its means more flagrantly than ever before. Its government will spend about $427 billion more than it raises in taxes this year. The nation as a whole is running a deficit of $571.9 billion on its current account with the rest of the world. These twin deficits, Mr Sarkozy points out, weigh heavily on the dollar. The currency’s fall, interrupted in February, has resumed. On Monday November 8th, it plumbed a new low against the euro of close to $1.30. Only if America restrains its deficits will the markets regain confidence in the dollar, Mr Sarkozy warned. “This is a unanimous message from the Europeans and the International Monetary Fund that we send to the United States.” On Wednesday, the dollar dipped again, this time breaching the $1.30-per-euro mark.
Mr Sarkozy no doubt fears that his American counterparts are quite happy to watch the dollar fall. Their professed commitment to a “strong dollar policy” might disguise a policy of benign neglect. America’s net overseas liabilities amounted to 23% of GDP at the end of last year, close to the record debts it amassed in 1894, according to Ken Rogoff and Maurice Obstfeld of the National Bureau of Economic Research. Crucially, the bulk of these debts are denominated in dollars. Thus America may be sorely tempted to dishonour its dollar debts, not by defaulting on them, but by devaluing them.
The immediate casualties of such a policy would be America’s East Asian creditors. By the end of last year, Asian central banks held $1.89 trillion of foreign reserves, the vast bulk of them in dollars. If these reserves lost value, Asian economies would suffer an almighty capital loss in domestic-currency terms. A recent study by the New York Federal Reserve counted the costs. If the Chinese yuan were to appreciate by 10% against the dollar (and other reserve currencies), China would suffer a capital loss worth almost 3% of GDP, the study found. If the won rose by 10%, South Korea would suffer similarly. The toll would be even greater in Singapore (10% of GDP) and Taiwan (8%).
To avert such an appreciation, Asian central banks would have to amass ever greater holdings of dollars. But this would only expose them to greater capital losses down the road. Alternatively, they might seek to avoid the consequences of a dollar fall, by diversifying into other reserve currencies, such as the euro. But that would only bring the dollar crashing down all the more quickly. In other words, Asian central banks are caught in an awkward dilemma: either they try to break the dollar’s fall, or they try to escape from underneath its collapse.
Despite this dilemma, Asia’s central bankers created less of a fuss on Monday than Europe’s did. Jean-Claude Trichet, president of the European Central Bank (ECB), described the dollar’s fall against the euro as unwelcome and “brutal”, repeating the melodramatic language he adopted in January. But why all the worry? In some ways, the stronger euro will do Mr Trichet’s job for him. It will contain euro-area inflation, which has remained stubbornly above the ECB’s ceiling of 2%. It will offset the higher dollar price of oil—last month’s worry du jour. And if the euros in their pockets gain in value, European households might be more willing to spend them, overcoming the caution that has held the European recovery back for much of this year.
It is true that the dollar has never been weaker against Europe’s single currency since its birth in 1999. But as recently as 1997 it was weaker against a basket of the 12 currencies out of which the euro was fashioned. Back then, no one described the dollar’s movements as brutal. Indeed, at times it seems that European resentment of America’s privileges is a little exorbitant.
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| Copyright © 2004 The Economist Newspaper and The Economist Group. All rights reserved. |
In the late 70s the inflation was felt domestically and was much easier to see.
BUMP
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Thanks, the doom-n-gloomers hate charts because it makes the idea of a dollar 'crisis' harder to swallow. I'm amazed that buy into (literally) this idea that we're heading into some kind of economic disaster caused by the drop in the exchange rate.
The biggest drop in recent memory was '85. No recession and low unemployment for years. We finally had a slight recession in '90, after years of a level exchange. Our next recession was in 2001 after several years of a strengthening dollar.
Next thing you know they'll try saying "aw well the fall of the dollar may not hurt us materially but it really hurts us spiritually! "
The biggest drop in recent memory was '85. No recession and low unemployment for years. We finally had a slight recession in '90, after years of a level exchange. Our next recession was in 2001 after several years of a strengthening dollar.
Well, I like charts but then I don't consider myself to be a doom-n-gloomer. I did note that you're displaying the "real" value for the trade-weighted exchange index for major currencies. The "nominal" values shown in the following graph have a little more of a downward bias.
The "real" values correct the U.S. dollar AND the major currencies for their local inflation rates. From what I've read, neither the real or nominal values are inherently superior. In any case, I've posted the exchange rates for all of the major currencies at http://home.att.net/~rdavis2/xchngmc.html.
What I think that many people find disturbing about the drop in the exchange rate is the steep downward movement, not its current level. If the exchange rate now goes up or stabilizes as in did in 1988, most people will likely breathe a sigh of relief. It's current level is not a disaster. It could be a different story, however, if the downward movement continues. Only time will tell.
What I find more disturbing is the trade deficit which has been increasing rapidly for five years. You can see a graph and chart of it at http://home.att.net/~rdavis2/tradeall.html. The worry of many is that this and the budget deficit are what is putting the downward pressure on the value of the dollar. I very much hope that the downward trend of the dollar does reverse or stabilize as it has in the past. However, I don't think that such a reversal is guaranteed, especially given the negative trends in the twin deficits.
If you want to ignore the 1987 stock market crash.
Thanks for the reply, Remember. I think the disturbing part is the trade deficit isn't coming as much from economic growth as in years past. And yes the twin deficits are having an impact. However we have to consider that the administration has had an unofficial weak dollar policy for some time now. They've never said anything in support of the dollar, which is actually an important factor in currency circles. Plus the policy allows GWB to do nothing serious to address either deficit like cutting spending or using his first veto.
IOW, the article (the world’s worry [US Dollar]) is full of it.
In fact, if what we really care about is selling things (like goods, services, or stocks in our companies) this cheap dollar is terrific. We should hope it goes lower if what we care about is stocks and the trade deficit. What I care about is unemployment and sex (not in that order) but all this talk about unemployment, trade, stocks, and sex is getting off topic. The dollar is fine.
The real reason we have a weak dollar policy is so Greenspan can keep interest rates low. The trade balance is just a smokescreen.
Interesting take. I was just about to make a snide remark about reaching for my tin foil and then I thought about how the FED's only job is to set short term interest rates for banks. Greenspan made them low for a few years (that and the tax cuts made all the difference) and low rates attracted less money from overseas hence a weaker dollar.
OTOH, he's raising them back up these days because the economy is all better now. That would mean a stronger dollar (in a few years).
I'm thinking out loud here-- your thoughts?
My take is he raised interest rates to help support the dollar (and help lower oil prices). Interestingly, Saudi Arabia gave a press release a day or two after he raised rates each time, saying they'd discovered new production capacity. They hate a weak dollar and this was their reward to him for raising rates. Another thing that happened was long term interest rates came down. A sign that Greenspan was doing the right thing.
Now the dollar is falling again and long term rates are going up. A sign that Greenspan needs to raise rates again. However, on Nov. 19th he seemed to give a signal that he'll support the weak dollar policy. We'll see what happens at this month's meeting. Remember, Greenspan's rates have more to do with the rate of money creation than they have to do with interest rates.
Yup. All of the above. One may criticize the internal debt of Euro nations but I don't think they've racked up anything like our cumulative external (foreign) trade debt thanks to running foreign trade deficits each year since Lord knows when
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