"Strong Dollar" Policy Loses its Grip

'Strong dollar' policy loses its grip By Patrice Hill THE WASHINGTON TIMES John W. Snow, President Bush's pick to head the Treasury Department, faces an immediate challenge of how to handle a rapidly tumbling dollar. For reasons ranging from fear about war with Iraq to low interest rates, a weakening economy and huge trade and budget deficits, the greenback since November has fallen quickly to three-year lows against the euro and is down by 17.5 percent against six other major currencies in the last year. That raises the cost of imported goods from cars to French wine and makes it more expensive for Americans to travel overseas. The biggest concern for the Treasury is that a falling dollar also makes it more difficult for the country to finance its burgeoning debts, which require $1.4 billion in daily inflows from overseas. The White House says it has not changed its "strong dollar" policy, but the currency's decline accelerated noticeably last month after the departure of former Treasury Secretary Paul H. O'Neill, who after a rough start two years ago became a strong defender of the dollar. Mr. Snow, who as chief executive of CSX Corp. comes to Washington from industry rather than Wall Street, like Mr. O'Neill starts out handicapped in assuming the Treasury secretary's unique role as chief spokesman for the dollar. As CEO of the transportation company, he advocated a weaker dollar to help U.S. manufacturers deal with overseas competition. Mr. O'Neill, a former chief executive of Alcoa Inc., never won any accolades from Wall Street, but he gained credibility as a dollar defender by steadfastly spurning pleas for a weaker currency from U.S. exporters in industries battered by the recession. Mr. Snow is expected to adhere to the administration's earlier "strong dollar" policy, though he has refrained from commenting on the dollar or other economic matters ahead of his confirmation hearing tomorrow before the Senate Finance Committee. All signs are that traders in the vast dollar market ? who are known to push a currency to the extreme once it has reversed course ? will put Mr. Snow to the test quickly. More than $1 trillion exchanges hands in trading each day. "The U.S. dollar is in a full-fledged bear market, and the downtrend is still in the third inning out of nine," Merrill Lynch told clients last week. The Wall Street firm attributes the dollar's troubles mostly to the trade deficit, which in the last year bloated to $453 billion, or nearly 5 percent of the gross domestic product. "The huge U.S. current account deficit is perhaps an old and tired story," Merrill Lynch said, "but breaking above 5 percent relative to GDP is a big deal ? the threshold that in the past got emerging markets into trouble." To reduce the trade deficit to a more normal 2 percent of GDP, Merrill Lynch estimates that the dollar would have to decline another 20 percent. Ironically, it notes that the deficit has widened partly because the United States has been growing faster and absorbing more imports than major trading partners such as Japan and Europe. Federal Reserve Chairman Alan Greenspan and former Fed Chairman Paul Volcker have been warning for years that the relentless growth of the trade deficit is unsustainable and someday will exact a price, causing the fall of the dollar. Mr. Volcker has told the National Press Club that his biggest worry about the U.S. economy is that a precipitous drop in the dollar will touch off a full-fledged financial crisis, although he added that such a dire scenario can be avoided if the decline is gradual. The United States was able to sustain large trade deficits when its economy and financial markets were booming during the 1990s, acting like natural magnets that lured foreign investors to put their dollars back into the United States. But after three years of big stock losses and economic weakness, investors have been casting about for more profitable alternatives. Money has been flowing into everything from gold and bonds to Swiss francs, real estate and even the Norwegian krona and Canadian dollar ? currencies that have gained status as safe havens if the United States goes to war with Iraq. That is a reversal for the dollar, which for years has been the world's principal safe-haven currency. Nick Parsons, head of currency strategy at Commerzbank, said the "daily ebb and flow" of jousting between the White House and Iraq has played a bigger role than economic factors recently in driving down the dollar. "If we could construct an index of bellicosity, it would show a near-perfect correlation with the dollar," he said. European leaders, who struggled to support the euro as it sank steadily against the dollar after its introduction in 1999, have been pleased about the reversal of fortunes. The euro is up by 26 percent against the dollar in the past year. German Chancellor Gerhard Schroeder and French Prime Minister Jean-Pierre Raffarin issued a statement last week gloating over the euro's gains. "It's not the euro that's strong, it's the dollar that's less attractive," said French Finance Minister Francis Mer, who is hosting a meeting of the Group of Seven finance ministers in Paris next month. Investors who saw the United States as the best-performing economy during the 1990s now, after two years of recession and faltering recovery, "question if the U.S. method is still the best to create growth," he said. Economists point out that the moderate decline of the dollar in the past year has had some beneficial effects. An important one was giving the European Central Bank leeway to stop defending the euro and cut interest rates to stimulate growth in the euro zone. A softer dollar also helps hard-hit U.S. manufacturers, farmers and other exporters sell more goods overseas. The growth in exports, in turn, fuels growth in the economy and eventually helps to reduce the trade deficit. A weaker dollar also improves the earnings of U.S. corporations that have offices overseas. In the short term, however, a lower dollar raises the cost of imports and causes the trade deficit to bulge further, while raising prices and threatening to reignite inflation. "The deficit is clearly draining tons of cash from the economy" and is a major culprit in the dollar's decline, said Joel Naroff of Naroff Economic Advisors. "As long as uncertainty over the U.S. economy and geopolitical risks continue, it will be difficult for the dollar to rally with this kind of deficit." But Mr. Naroff predicted that the economy will reaccelerate once worries about the war are put to rest, and "the dollar will follow suit." He said the promise of returns on investments in the United States remains higher than it is in Europe or other regions. Nariman Behravesh, economist with Global Insight, agreed that stronger growth in the United States in the end will support the dollar. "The odds of a dollar crash are low," he said. Even if its decline accelerates into a free-fall, "the Fed and other central banks would likely intervene to prevent disruptive events."

gold has no more inherent value than large wads of green paper.

Gold has no "inherent" value at all. It is not edible, makes lousy tools, etc. It has only the value that actors in the market ascribe to it. Historically right up to now, gold has been used as the ultimate store of value. It makes no sense to a nonproducer who feels himself insulated from the market but the effect is that gold is indeed unvarying in value. That is because gold does not erode and can only be chemically combined with other substances at great cost and a negligible amount of gold exists in compounds. Gold cannot be counterfeited. Any alloy that has the same mass and volume as gold is more valuable than the gold it is meant to counterfeit. Gold is used only in limited amounts industrially.

Gold is not producible in great amounts because of the cost of mining it. All of these characteristics do not make gold useful to eat or wear but it has gained for the metal the trust of humanity for 5000+ years. That will not change just because people sit down and conclude that gold is not a rational basis for money.

Some people think government is a much better basis for the money because they think that governments can make everyone rich by making unlimited amounts of money and just passing it around. Gold cannot be destroyed nor can it be produced in amounts called for by anybody's arbitrary plan.

In an extreme scenario, if US has no restrictions on imports, no tariffs, and the rest of the world has high tariffs, The rest of the world's investment capital will flow to the US because that is where the highest rate of return will apply.

The only reason rates of return in that scenario would be high is because of astronomical interest rates propping up an otherwise plummeting dollar. Do you think astronomical interest rates are good for the economy?

non sequitur. High interest rates are mostly a function of inflation. There is a basic rate of about 3%. That seems to be about the minimum that will induce people to rent out their capital. To that is added the rate of inflation.

Inflation occurs when the government adds liquiddity faster than the banks can lend it out at a given rate. Foreign capital would come to US because it is a safe investment and a lucrative one. It is not merely a matter of interest. There are much higher capital gains in a dynamic expanding economy. That makes for a better rate of return than does the lack of capital gains in a highly "protected" economy. Total return is much better in the free economy than in the protected one.

Please prove that this would happen, especially given your implication that the US interest rate would also be low relative to that of other countries.

your implication that the US interest rate would also be low relative to that of other countries

The rates in those other countries are not even particularly relevant. Where there is stagnation there is very low total rate of return. There may be high rates of interest but only if there is also inflation. Real rates will not be so high and there will be a lower demand for capital because the economy is stagnant, businesses are limited in their ability to expand. Tariffs limit the market for industries on both sides of that tariff. When there are no barriers either way then that which a people can produce the most efficiently will be produced by that prople. If their substance is wasted in producing for themselves that which another nation can produce more efficiently then the whole economy is less efficient and there are fewer jobs and lower production.

The US has the highest and most rapidly rising productivity in the world. So long as the US has the least hindered economy that will continue to be the case. Tariffs reduce competition and slow the economy.If an industry can continue to be profitible because competition is suppressed by tariffs or bans, then that industry has no incentive to invest in more efficient modes of production in order to reduce prices. Consider AT&T before deregulation and the rapid pace of improvement in telephone service and the drastic reduction in phone bills since.

Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.