Posted on 07/09/2002 8:28:40 AM PDT by madeinchina
The National Association of Manufacturers has been campaigning against an 'over-valued dollar' for the last year. As recently as June 20, when the Department of Commerce reported that the April trade deficit had been a record $35.9 billion, NAM Chief Economist David Huether argued, "April's record trade deficit is the result of two fundamental factors: the U.S. recovery is outpacing growth abroad, and the high value of the dollar, which has undercut American firms' competitiveness."
Now that the dollar is dropping on world markets, most economists are expressing alarm rather than joining NAM in cheering the trend. The reason for concern is contained within Huether's argument, though as usual, NAM seems confused about how the world works.
It was the very attractiveness of the American economy that brought in the foreign capital which kept the dollar strong. It is when confidence in the United States is shaken, as by the wave of corruption scandals jolting major corporations and accounting firms, that the dollar suffers.
Strong economies have strong currencies; whereas devaluation is a sign of trouble. In the 1970s, when the U.S. experienced 'stagflation' and generated 'misery indexes' of high inflation and high unemployment, the dollar fell by a quarter against the world's major currencies. When the economy pulled out of these problems in the 1980s, the dollar recovered. The dollar hit its peak in 1986 as America rebuilt its image as a confident world leader under President Reagan.
The dollar then fell steadily after 1987 -- losing 20% of its value against major currencies on a real, trade weighted basis by 1997. It then started an upward move as the rest of the world slid into recession following the Asian financial crisis. By the end of 2001, it was roughly 10% above its 1973 level, but still about 10% below its 1986 peak.
What has made economists worry about the current downturn is that the dollar is floating on intangible factors of confidence rather than on material factors of economic strength. Though the U.S. recession seems to be over, the economy has not resumed robust growth. Real gross domestic product (GDP) may have grown at less than a 2% annual rate in the second quarter of this year. The Business Outlook section of the July 8 issue of Business Week warns, "The twin deficits have returned. A ballooning federal budget shortfall and a widening trade gap are towering, Godzilla-like, over the nascent recovery. These two deficits, if unchecked, could cause trouble for the financial markets, the U.S. dollar, monetary policy, and U.S. growth."
The budget deficit was curtailed in 1997, but due to the combined impacts of the economic slowdown (tax revenues down about 11%) and the war on terrorism (spending up about 10%) projected surpluses have vanished. The Congressional Budget Office projects a shortfall above $100 billion for 2002, and private forecasters put the total at more than $150 billion in both 2002 and 2003, a sharp reversal from the $127 billion surplus of 2001.
Budget deficits can be bad for the economy if they crowd private investment out of the capital markets, but they can also stimulate the economy if the government spends the money in ways that boost output. Budget deficits do not automatically translate into downward pressure on the dollar, unless it is perceived as slowing the economy or increasing financial risks.
It is the trade deficit that directly puts downward pressure on the dollar, as it affects the demand and supply of dollars in the international money market. In 2000, the U.S. current account was in deficit by $444.7 billion, to which the trade deficit contributed $375.7 billion. The trade deficit in goods was $452.2 billion, but was partially offset by a surplus of $76.5 billion in services.
The other major components of the current account are capital movements and the return on capital invested overseas. It is because the U.S. must cover such a large trade deficit with foreign capital that economists worry about sudden, destabilizing events that could shift the financial flows away from the America market and send the dollar plummeting.
As the London-based Financial Times noted last week, in 2000 the inflow of foreign investment to the United States was $228 billion. In the second half of 2001, the inflow had reversed; with the U.S. suffering an outflow of $16 billion. In the past year, foreign purchases of stocks and bonds are down 24% and foreign direct investment is off 63%.
The weaker dollar could be part of a vicious cycle of disinvestments in the United States. If foreigners believe that the dollar is going to be worth less, they will hold fewer dollar-denominated assets, such as U.S. stocks or bonds. But, as they scale back investment, they weaken the American economy, depress the greenback further and turn their fears into self-fulfilling prophecies.
The world has provided plenty of recent examples -- Mexico, South Korea, Russia, Argentina -- of the kind of economic costs a country must endure after a financial-currency collapse. But for the United States, such a fall would also have a profound impact on its national security and world leadership.
A strong and stable dollar is a strategic national asset. A strong dollar improves the terms of trade, making it easier to import vital raw materials and other necessary imports. That the world price of oil is denominated in dollars helps shield the United States from the full impact other countries feel from the oil cartel's manipulations.
A strong dollar also supports American influence by making it easier for American business firms to acquire foreign assets and less expensive for U.S. military forces to operate overseas. It also makes U.S. foreign aid more valuable. Until the middle of the Vietnam War, the U.S. ran trade surpluses that subsidized America's global power projection.
The fact that the dollar is the world's reserve currency, held as a 'store of value,' allows Washington to draw on additional resources in a crisis, and to get away with financial gambits that would sink lesser countries. Unfortunately, by using 'emergency' financial measures during normal times, there is nothing left to draw on in a crisis.
Few things better demonstrate the foolishness of our present trade policy -- and those like NAM who support it -- than the argument that it is better to gut the value of the dollar than deviate from the sterile dogma of 'free trade' that allows large deficits to accumulate. Instead, the Bush Administration should be taking direct measures to reduce the trade deficit -- which means limiting imports, both to defend the dollar's integrity and America's economic strength. A trade policy that protected American-based production would greatly reduce the risk of investment in the United States, which in turn would both support, and be supported by, a strong dollar.
There are, however, foreign interests who like to see America taken down a notch or two. In 1971, when the Nixon Administration was forced to devalue the dollar and drop its link to gold, it was the French government which applied the pressure. The resulting turmoil destroyed the post-World War II Bretton Woods system.
Today, the European Union, whose trade policies are heavily influenced by France, are anxious to see the dollar falter so it can be replaced by the new Euro as the international standard. No wonder the EU is so aggressive in trying to cripple America's trade laws and block any attempt to stem the U.S. trade deficit. The EU sees a chance to end the post-Cold War American hegemony that has so vexed European sensibilities.
The Bush Administration must not let this happen.
I guess some of these writers don't realize it's really easy to check the daily exchange rates...
Michael
I have felt that the fear of trade deficits is overblown. Although we have some mechanisms which deal with currency exchanges, the details of which I am not familiar, we are no longer concerned with depleting our gold and silver reserves as a result of trade deficits. If necessary we can increase the money supply to accomidate a crisis. The purists say this will lead to inflation and a lack of confidence in the dollar but I say any such reaction will be only temporary, not much different from what happens after a stock split.
Just as the French attacked our economy in the seventies they are attempting it again as a force in the EU. In fact, they were the empitus behind the formation of the EU. Just vain old hasbeens who don't know when to give it up. The EU replacing the U.S. as the world leader? The Euro replacing the dollar as the primary international currency? Give me a break!!
Betcha a couple chocolate krullers at Krispy Creme.
Michael
"The report goes on to forecast that the dollar will decline by an additional 8% against world currencies over the next 12 months. Even then, the study continues, the dollar still will have further to fall."
That's utter hogwash. Someone has taken a few currency positions and wants some gullible fish to bite. I'm not one of them.
Michael
The trade weighted dollar started its rise under Robert Rubin in 1995 not 1997.
But a lot of what he says is correct. We buy too much from overseas. Unfortunately, we have also shipped our manufacturing plants off-shore and now with capacity at low utilizations and many corporations being cutoff from new financings, manufacturers will have a hard time replacing those facilities in the US.
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