Softening Dollar a Mess in the Making
By Peter Eavis
Senior Columnist
05/28/2003 06:58 AM EDT
thestreet.com
Senior U.S. economic officials have taken the weak-dollar policy too far, leaving the greenback vulnerable to a damaging slide that could further complicate the economic mess created in the wake of the '90s boom.
Motivated in the near term by a desire to see President Bush re-elected, Treasury Secretary John Snow has made statements that have helped drive down the dollar. Meanwhile Fed Chairman Alan Greenspan has pursued policies that were bound to put downward pressure on the currency, which hit another low Tuesday before recovering.
To the economically illiterate, a sliding dollar makes a lot of sense. Inflation, the main economic deterrent to depreciation, is currently dormant. In addition, the U.S. can try to use its wilting currency as a stick to beat other nations into following its own economic policies. And who's going to complain? Bush's critics on the left can hardly whine about an apparently pain-free measure that helps America's uncompetitive industries, while many monetarists on the right have long been calling for looser economic policies. The rampantly rising stock market shows that Wall Street also thinks it's a good idea.
But there's one bunch of people left to convince. Those darn foreigners, on whom America relies to finance its gaping current-account deficit. For them, the incentives to hold dollars are weakening by the day.
Over There
It's easier for outsiders to see through U.S. policymakers' nonsense. One reason the dollar is going down against the euro is that rates are lower here than in Europe. Indeed, the speed of the dollar's decline implies that a ferocious carry trade is now taking place, with leveraged investors borrowing dollars at cheap rates and investing in euro instruments.
But why, at 2.5%, is the European Central Bank's benchmark interest rate higher than in the U.S., where it is 1.25%? Isn't Europe's economy just as sluggish? Don't they need to be doing what we're doing? Shouldn't the ECB be on guard against the deflation threat -- just like brave Al?
Those sort of remarks would be funny if they weren't so widely held.
To start with, there is no deflation threat in the U.S. -- not even the whiff of one. The inflation index, though falling, is still solidly positive. Money supply is humming and banks are lending hand over fist to practically any individual who asks. This is not Japan. With incredible guile, Fed governors have raised deflation as an issue, but not as a current problem. Doing it that way has given them a smokescreen behind which they can cut rates without alarming anyone that we are going down the same road as Japan.
The bigger lie is that deflation, or even lower inflation, is a bad thing. Mild deflation is the best thing a normal economy can hope for. It encourages productivity gains because companies have no choice but to become more efficient to maintain or increase market share. Therefore, by expressing a fear of deflation, Greenspan is tacitly admitting that U.S. productivity numbers are either false or unsustainable. The Fed's super-loose monetary policy is a clear sign that it believes economic growth cannot come from productivity improvements within American businesses. Maybe it believes debt levels are too high to give even disinflation a chance.
While European growth may be sluggish and their productivity figures poor, they don't seem overly concerned at their higher level of interest rates. Why is that? Well, their money supply is growing at a robust 8%. And with an inflation rate of 2.1%, the euro area has negative real interest rates. It may also be that they look at the lending binge across the Atlantic with horror.
Spread the Word
As with all economic policies, it pays to inspect what they actually look like in real life. In the case of the Fed's easy money, it has meant a deluge of 0% auto loans clogging up Ford (F:NYSE) and GM's (GM:NYSE) balance sheets, a bubbly real estate sector -- the Mortgage Bankers Association now predicts $3 trillion of mortgages will be written this year, up $500 billion from last year -- and a woefully overvalued stock market that keeps going higher. Central bankers in this country used to be terrified by that sort of thing. They still are in Europe.
Why would Greenspan and Snow be allowing a weak dollar? Because they are gambling that it will help the economy pick up. And when that growth comes, it is hoped that it will absorb the damage done to corporate and personal balance sheets by the Fed's low-interest-rate strategy. But debt levels have a nasty habit of staying high, particularly in good times. And bond markets can turn on a dime. Recent rallies in corporate bonds could be undone if economic growth doesn't bring down leverage sufficiently. U.S. Treasuries will tank when deflation fears are proven baseless. The dollar will keep on sliding because the Fed will insist on flooding the system with money as the solution.
Europe may not be perfect, but it's not stupid. |
