Fast Track to a Dollar Crisis

Trade Alert ^ | 7/8/02 | Alan Tonelson

[madeinchina]

The House of Representatives' decision last week to move the fast track trade bill closer to final passage has moved the nation closer to a major dollar crisis -- and to years of economic stagnation.

The dollar has been so strong for so long that many Americans take the advantages for granted. And chronically scarce investment opportunities throughout Europe, Asia, and Latin America have understandably generated confidence that the world's investors are stuck lending to the United States however bad America's national balance sheet (its current account) gets.

In fact, leading economic voices across the spectrum, from the National Association of Manufacturers to the globalization-happy Institute for International Economics to the AFL-CIO are now complaining loudly that the dollar is still way too strong, and thus hurting U.S. exports. They believe that a devaluation can be engineered in an orderly way, so as not to bring on the major inflation or steep recession that a truly weak dollar could produce.

But the weak dollar faction is overlooking some powerful economic trends that make a soft landing for the greenback far-fetched. First, the U.S. budget is heading for a period of significant deficits. Some of the reasons are avoidable -- mainly, politicians' determination to use the war on terrorism to spend billions on pork barrel projects. Some of the reasons are legitimately controversial -- e.g., President Bush's refusal to raise taxes, and the Democrats' refusal to call for such hikes explicitly. After all, now that the economy is weak, how can tax increases help but weaken it further? But a big reason for the impending deficits is unavoidable -- the war. And another big reason is inevitable -- the impact of slower growth on federal revenues and transfer payments.

All of this net new spending floods the world economy with dollars, and as is the case when the supply of anything soars too high, the value of each unit tends to fall. Therefore, dollars become less desirable to hold.

Second, signs of inflation are returning. Not in the manufacturing sector, where breakneck globalization has deprived most companies of meaningful pricing power. Instead, prices are rising in the largely non-traded service sector -- which happens to be about three times the size of manufacturing.

According to Mickey Levy, chief economist for the Bank of America, prices for housing (by far the biggest component of the Consumer Price Index and the sector that has largely kept the economy afloat despite the capital spending collapse) are rising by four percent annually. The cost of health care is increasing at a 4.5 percent annual rate. And anyone with a teenage child knows where the cost of college keeps heading. Levy also notes that service sector inflation has been speeding up, not slowing down. Meanwhile, though oil prices have dipped recently, they remain considerably higher than their average level during the 1990s, and big Middle East-related uncertainties persist about supplies.

Where government budget deficits put downward pressure on the dollar indirectly, inflation does the job directly. Both processes, moreover, tend to feed on themselves: As each individual dollar becomes worth less and less because of oversupply, investors unload more of them, boosting the supply yet higher, lowering the value further, and so on. This is why, as Jimmy Carter found out during the 1970s, it's a lot easier to talk the dollar down than to talk it back up again.

A third reason for growing investor disenchantment with the dollar likely entails fears that the U.S. current account deficit -- along with its biggest component, the trade deficit -- is spiraling out of control. And this is where fast track comes in. America's recent one-way trade deals have been a major contributor to this trade deficit.

For example, in 2000, when the United States signed its first bilateral trade agreement with Vietnam, America's deficit with that impoverished country was just under $500 million. This year, the deficit is on track to hit $800 million, even though lower American growth should be reducing the U.S. demand for net imports. Vietnam, however, is a country not only too poor to be a big market for American-made products. It is a country whose growth heavily depends on exporting to the United States.

Jordan won a free trade agreement in 2000, when the United States ran a $232.8 million surplus with the Hashemite Kingdom. This year, a $6.6 million deficit is likely. Over the last decade, extending NAFTA to Mexico and expanding trade with China have resulted in vastly greater absolute and relative deterioration in the U.S. trade balance.

Indeed, as Peter Coy, economics editor of Business Week, has just written, U.S. exports remain so much lower than U.S. imports that exports must grow 40 percent faster than imports just to keep the trade deficit stable. But investors can throw stability out the window if the White House wins fast track. For the president views NAFTA as a model for the new trade deals he would pursue.

Coy reports that economists at Goldman Sachs & Co. project that the trade deficit will hit a new record in 2003 even if the dollar falls by another 5-10 percent. He concludes from this that the dollar isn't weak enough. But why would he or any of the other soft-landers assume that dollar dumping would halt even its root causes keep worsening?

Only an irresponsible alarmist would claim that a perfect monetary storm is gathering. But with the administration, the Congressional leadership, the unions, the multinational companies, and many economists still in deep dollar denial, and the White House pushing hard for a destructive trade policy, it should be obvious that the weather is getting worse.

[dennisw]

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[Free the USA]

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